This was an economic downturn began in 1929 and continued until about 1939. The depression was the most severe ever experienced by the developed Western world. Though the Depression started in the United States, it gave rise to drastic declines in output, acute deflation and severe unemployment in almost every country of the world.
Introduction
In the U.S, the Great Depression started in 1929. The downturn became evidently worse in late 1929 until early 1933. Actual prices and output fell precipitously. Between the trough as well as the peak of the downturn, real GDP in the United States fell 30 percent and industrial production declined 47 percent. The wholesale price index declined 33 % (“deflation”). Though there is some discussion about the consistency of the statistics, it agrees that the unemployment rate exceeded 20 % at its highest point. The harshness of these declines becomes clear as they are compared with America’s next worst downturn of the 20th century, of 1981–82, where real GDP declined just 2 % and the unemployment rate peaked at fewer than10 %. Furthermore, during the recession between 1981– 82, prices continued to increase, though the rate of price increase slowed significantly.
The price deflation apparent in the United States was present in other nations. Nearly every developed country experienced declines in wholesale prices of 30 % or more between 1929 and 1933. The recovery began in the spring of 1933 in the United States. Output grew swiftly in the mid-1930s: real GDP went up at an average rate of 9 % per year between 1933 and 1937. Output had dropped so severely in the early years of the 1930s; nevertheless, it remained considerably below its long-run tendency level all through this period. In 1937–38, the U. S suffered another downturn, however, after mid-1938; the economy America grew even more quickly than in the mid-1930s. U.S. output lastly returned to its long-run tendency level in 1942.
Causes of the Great Depression
The vital cause of the Great Depression in the U.S was a decline in spending (aggregate demand) that led to a decline in production as merchandisers and manufacturers noticed an unintentional rise in inventories. The sources of the reduction in spending, in the United States varied throughout the Depression; however, they cumulated into a monumental drop in aggregate demand. The American decline was spread to the rest of the world through the gold standard. Nevertheless, a variety of other factors also influenced the downturn in many countries (Betz 71).
Stock Market Crash
The initial decline in output in the U.S in the summer of 1929 is extensively believed to have stemmed from constricted U.S. monetary policy aimed at regulating stock market speculation. The 1920s had been a thriving decade, but not an exceptional period of boom; prices of wholesale goods had remained almost constant throughout the decade and there had been slight recessions in both 1924 and 1927. The one evident area of excess was the stock market. Stock prices had increased above fourfold to the peak reached in 1929. Between 1928 and 1929, the Federal Reserve had raised up interest rates in expectations of slowing the rapid increase in stock prices. These higher interest rates depressed interest sensitive expenditure in areas such as automobile purchases and construction that in turn reduced production. Some researchers believe that the boom in construction of houses, in the mid-1920s resulted to an excess supply of housing and a large drop in construction in between 1928 and 1929.
American total demand was reduced by the stock market crash considerably. Consumer purchases of business investment and durable goods fell sharply after the crash. A better explanation is that the fiscal crisis caused substantial uncertainty about future income that in turn led firms and consumers to put off purchases of durable goods. Though the loss of wealth caused by a drop in stock prices was comparatively small, the crash also depressed expenditure by making individuals feel poorer. Because of the drastic drop in firm and consumer spending, real output in the United States, which had been falling slowly up to this level, fell swiftly in late 1929 and during 1930.
Banking Panics and Financial Contraction
The next blow to aggregate market happened in the fall of 1930, when the four waves of banking panics gripped the U.S. A banking panic arises when depositors lose confidence in the banks solvency and concurrently demand their deposits be paid to them in cash. Banks that typically hold only a fraction of deposits as cash reserves should liquidate loans to raise the needed cash. This procedure of a hasty liquidation can lead to a previously solvent bank to fail. The United States experienced extensive banking panics in the fall of 1930, the fall of 1931 and the fall of 1932. The wave of panics continued through the winter of 1933 and ended with the national “bank holiday” affirmed on March 6, 1933 by President Franklin Roosevelt. The holiday closed all banks, allowing them to reopen after being deemed solvent by inspectors of the government. On the United States banking system, the panics took a severe toll.
Economic historians believe that considerable increases in farm debt in the 1920s, and with U.S. strategies that encouraged undiversified, small banks, created an environment where such panics could spread and ignite. The farmers borrowed to improve land for production increase. The drop in farm commodity prices following the war made it hard for farmers to carry on with their loan payments. The Federal Reserve did nothing or less to attempt to stem the banking panics. Strong had been a dynamic leader who understood the ability of the central bank to bound panics. The death of Benjamin left a power space at the Federal Reserve that allowed less sensible opinions from leaders to block effective interference. The panics resulted to a dramatic increase in the currency amount individuals wished to hold comparative to their bank deposits. The increase in the currency to deposit ratio was a major reason the money supply in the U.S declined 31% between 1929 and 1933 (Cogley and Sargent 463).
Researchers believe that such declines in supply of the money caused by Federal Reserve decisions had a severe contractionary effect on output. The drop in the money supply depressed expenditure, in a number of ways. Perhaps most significantly, because of actual price drops and the rapid reduction in the money supply, business people and consumers came to expect deflation (they expected prices and wages to be lower in the future). Consequently, even though nominal interest rates were very low, individuals did not want to borrow, as they feared that future profits and wages would be insufficient to cover the loan payments (White 759). This indecision, in turn, resulted to severe declines in both consumer expenditure and business investment expenditure. The panics confidently exacerbated the decline in expenditure by generating cynicism and loss of confidence. Additionally, the failure of so many banks disrupted the lending, thus reducing the funds available to finance investment.
The Gold Standard
Some economists believe that the Federal Reserve caused or allowed the huge declines in the American money supply to preserve the gold standard. Under the gold standard, each nation set its money value in terms of gold and took financial actions to protect the fixed price. It is likely that had the Federal Reserve increase significantly in response to the banking panics, outsiders could have lost confidence in the United States’ gold standard commitment. They could have resulted to large gold outflows and the U.S could have been forced to devalue. Correspondingly, had the Federal Reserve not limited in the fall of 1931, it is likely that there would have been the dollar speculative attack and the United States would have been required to abandon the gold standard alongside with Great Britain.
Whereas there is debate on the role the gold standard played in restricting U.S. monetary policy, no question that was a major factor in the transmission of the American drop to the rest of the world. Under the gold standard, imbalances in asset or trade flows resulted to international gold flows. Once the economy of United States began to contract harshly, the trend for gold to flow out of other countries and toward the U.S increased. This took place as deflation in the United States made American goods mostly desirable to foreigners, whereas low income condensed American demand for foreign products (Ohanian 2321). To counteract the causing trend toward American foreign gold outflows and trade surplus, central banks all over the world elevated interest rates. Upholding the international gold standard, essentially, needed a massive monetary contraction all over the world to match the one happening in the United States. The outcome was a decline in prices and output in countries all over the world that also almost matched the downturn in the United States.
International Lending and Trade
Some researchers stress the significance of other international linkages. Foreign loaning to Latin America and Germany had increased greatly in the mid-1920s. Lending abroad then fell between 1928 and 1929 in United States because of the booming stock market and high interest rates in the United States. This decline in foreign lending may have resulted to further credit declines and contractions in output, in borrower countries. Reduced international lending effects may explain why the economies of Argentina, Germany, and Brazil turned down before the Great Depression started in the United States.
Sources of Recovery
Given the major roles of the gold standard and monetary contraction in causing the Great Depression, it is not surprising that the financial expansion and currency devaluations became the leading sources of recovery all over the world. Devaluation did not increase output directly. Rather, it permitted countries to increase their money supplies without concern about exchange rates and gold movements. Nations that took greater benefit of this freedom saw greater recovery. The monetary expansion that began in the U.S in early 1933 was mainly dramatic. The American money supply improved by almost 42 % between 1933 and 1937 (Seidman 35). This monetary expansion stemmed mainly from a considerable gold inflow to the United States, caused to the rise of political tensions in Europe that eventually resulted to World War II. Global financial expansion stimulated expenditure by making credit more widely available and lowering interest rates. It also created expectations of inflation, instead of depression, which made potential borrowers more confident that their profits and wages would be adequate to settle their loan payments if they decide on borrowing.
One indication that financial increase stimulated recovery in the U.S by encouraging borrowing was that business and consumer spending on interest sensitive items such as trucks, cars and machinery rose well before consumer expenditure on services. Fiscal policy played a moderately small role in stimulating recovery, in the United States. Certainly, Revenue Act of 1932 increased American tax rates importantly in an attempt to stabilize the federal budget that dealt another contractionary setback to the economy by further discouraging expenditure. Because, the new spending programs introduced by the New Deal had slight direct expansionary effect on the economy. United States military spending connected to World War II was not large to affect total output and spending until 1941 (Mitchener 171).
Consequences of Great Depression
The great depression had various political consequences, among which was the rejection of classic economic liberal approaches that Roosevelt replaced in the United States with Keynesian strategies. It was a major factor in the execution of social democracy and planned European countries economies (Ohanian 2329).
The Great Depression major impact economically was human suffering. In a short period, standards of living and world output dropped precipitously. Whereas situations began to recover by the mid-1930s, total recovery was not achieved until the end of the decade. The policy and Depression response also changed the economy worldwide in crucial ways. The Great Depression speeded if not caused, the end of the global gold standard. Though the system of fixed currency exchange rates was reestablished after Second World War under the Bretton Woods system, the world economies never incorporated that system with the conviction they had brought to the gold standard (Friedman 17). Fixed exchange rates were unrestrained in accord of floating rates by 1973. Both the welfare state and labor unions expanded considerably during the 1930s. This tendency was stimulated by both the passage of the 1935 National Labor Relations Act and the severe unemployment of the 1930s, which encouraged collective bargaining. The United States established unemployment compensation, survivors’ and old age insurance through the Social Security Act (1935) that was approved in response to the hardships of the 1930s. It is unclear whether these fluctuations would have ultimately happened in the United States without the Depression.
Many European countries had experienced important growths in union membership and state pensions established before the 1930s. These two tendencies, nevertheless, accelerated in Europe during the Depression. The United States, for instance, established the Exchange and Securities Commission in 1934 to regulate stock market trading practices and new stock issues. The Banking Act of 1933 prohibited banks from underwriting or dealing in securities and established deposit insurance in the United States. Deposit insurance that did not become common universal until after World War II, efficiently eliminated banking panics as a worsening factor in recessions, in the United States after 1933. The Depression played a main role in the development of macroeconomic policies planned to temper economic upturns and downturns.
The vital role of reduced financial contraction and spending in the Depression led British economist John Maynard Keynes to come up with the ideas in his General Theory of Money, Interest and Employment (1936). Keynes’s theory recommended that increases in government spending, monetary expansion and tax cuts be used to counteract depressions. This perception, combined with an increasing consensus that government should attempt to stabilize employment, has resulted to more activist policy since the 1930s (Almunia et al. 259). Central banks and legislatures throughout the world now regularly try to moderate or prevent recessions. Whether such a change would have happened without the Depression is again a mainly unanswerable question. It is clear that this change has made it doubtful that a decline in expenditure will ever be permitted to spread and multiply throughout the world as it did in the Great Depression of the 1930s.
Conclusion
The 1930s Great Depression was an economic disaster unlike any that had been perceived in the United States before. A rival economic opinion came into existence, related with the name of John Maynard Keynes. This new view showed that the predictions of the Classical economic opinion may not hold in a time of severe depression and that government action through fiscal policy might be essential to bring about good economic times. America's involvement in Second World War in 1941 led to the end of Great Depression. The end of the Great Depression was related with a large increase in government expenditure (on World War II) only appeared to confirm the conclusions of Keynes. In the post-World War II era, the role of the state, influenced by the concepts of Keynes, has been forever changed. Nowadays, Presidents are credited when the economy does well and blamed when there are economic hitches, even if the hitches have nothing to do with any actions taken by the President. Government is expected to bring prosperity to its citizen.
Works cited
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