American Public University
GREAT DEPRESSION
The great depression in 1920s in the United States has taught an important lesson to the agents in the American Economy. The lesson we learned was that the efficiency of the resource distribution in the economy plays very essential role to provide an economic development and sustainability. The American economy failed to provide the sustainability in the financial sector and the real sectors. The relation between the financial sectors and the real sector is truly important for a healthy economy. This relation in 1920s has disappeared, and the crisis in the financial sector placed the real sectors into a terrible position. Especially the agricultural production industry has failed, and many farmers lost their lands.
1920s were the years of the World War I and the American government decided to invest in the industries that support the American army power. The American government spent huge amounts on the manufacturing industry by using the government savings (taxes). Considering that the taxation system is the strongest resource distribution channel in every economy, the American government used the resources for the army development and the private investors could not find enough resources to develop new investments in the country. In economics, this influence is called crowding-out effect. When the government uses the most of the resources for the government spending, then the private investors cannot have enough funds to make new investments. Also, considering that the government spending’s efficiency is lower compared to the private investments, the redistribution of the resources through the taxation and the government spending causes a decrease in the efficiency of the economic resources in the American economy. The crowding-out might cause other problems in the economy as happened in 1920s in the American economy.
The relatively higher demand of the American government for the available resources in the economy has caused an increase in the interest rates. The interest rate is the most important indicator for the cost of using capital in the economy. As a developing economy in 1920s, the investors and the producers in the United States were using the large amount of credits to expand and continue their businesses. The increase in the interest rate made their lives miserable.
Essentially, the farmers were terribly dependent on the credits to continue their production. Considering that the productivity of the farming heavily depends on the weather conditions, the agricultural production has a fluctuating production structure. When the weather conditions are not suitable for the agricultural production, the producers receive very low level of income in this year. In 1920s, a few years were terrible years for the farmers because of the bad weather conditions, and they could not receive the income they were expecting. The farmers used large amounts of credits for these years, and they were expecting to receive relatively higher income in the following years; unfortunately, in the agricultural business, the income is not guaranteed. Continuation of the bad weather conditions in 1920s placed the farmers into an undesired financial situation. They could not repay the credits and the loans they borrowed from the financial institutions.
This situation caused a financial crisis in the banking system and many banks, and some other financial institutions bankrupted. The bankruptcies of the financial institutions in the American economy caused a chain effect on the entire industries. The government debt was so high, and available funds were limited. Bailing out the companies was almost impossible. In this time, the Federal Reserve did not respond to the financial crisis on time, and the financial crisis got deeper and deeper in 1920s.
The limited available resources in the American economy and a bad economy management continued for a while, and the real sector producers faced an economic crash. John Maynard Keynes was an economist who could comprehend what happened in the American economy, and he suggested a new theoretical approach to the economic system. The free market economy was facing a severe crisis because the invisible hand could not provide the sustainability in the American economy. The most important theoretical innovation developed by the Keynesian approach was the expectation theory. The agents in the economy were using their past experiences to make future predictions. If the agents are pessimistic about the future depending on their past bad experiences, they decrease their expectations from the future.
In the American economy, the pessimistic environment in the agents' world causes worse economic conditions in the following years. The aggregate demand was decreasing because the speculators in the economy thought that the Great Depression was hard to overcome.
The Keynesian approach suggested increasing the aggregate demand. If the aggregate demand could be increased, then the agents in the economy would believe that they might sell their products in the following years. The decreasing aggregate demand was because of a psychological situation, and if the agents in the economy believe in that the American economy would develop in the following years, they could be willing to produce again. Following this idea, Keynes suggested increasing the government spending to stimulate the aggregate demand and the American economy. The American government developed the Marshall program that was offering to increase the government spending through increasing the current expenditures. The current expenditures would increase the income of the people, and they would spend the money they receive because they needed. This suggestion worked, and the American government could stimulate the American economy again.
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