A major economic depression that engulfed the world during early thirties of the twentieth century is commonly referred to as ‘The Great Depression’. Wikipedia defines depression as a sustained decline in the economic activities of one or more economies. The general characteristics of a depression are substantial increase in unemployment rates; credit crunch, mostly due to impact of depression on the banking system; and increased volatility in currency’s relative value. It also has a deep and devastating impact on the financial system of a country. Depression is an extreme form of long term downturn. Sometimes, it is also described as recession of a longer duration.
According to Wikipedia, the great depression started in 1929 and its effects lasted till late 1930s or early 1940s. The effects of this crisis were felt across economies. The great depression phenomenon is considered as one of the biggest downturn of the century. There is a lot to learn from this economic crisis. This paper describes the great depression in more detail. The paper is broadly divided into four sections. The first section describes the economic impact of the great economic depression. The second part of the paper explains the causes of this economic crisis. The third section discusses the process of recovery from economic depression. The fourth section concludes the paper and mentions the key learning from this major economic debacle.
Economic Impact of Great Depression
As the name suggests, the great depression had a severe and negative impact on the world economy. The devastating effects of this depression were felt in terms of increase in the unemployment rate, decline in real GDP, fall in prices and weakening of financial markets. The following piece discusses each of these impacts in detail.
Decline in Real GDP
The real GDP of the United States fell by up to 47% during the great depression (Romer 1). There was a decrease in the industrial production because of reduced demand and falling prices. Some sectors like construction and mining were virtually still during this period. Real GDP in agriculture also suffered decline because of heavy fall in prices of agricultural produce. This also impacted the commodity trading market across the world.
Increase in Unemployment Rates
The great depression witnessed an alarming increase in the unemployment rate. It is widely agreed that unemployment rates were the highest during the great depression and exceeded 20 per cent in the United States (Romer 1). According to Wikipedia, unemployment rate in the United States increased by over 600% during 1929-1932. Other major economies of the world also experienced sharp increase in unemployment rates. This increase can be chiefly accounted to the reduction in industrial output and application of cost cutting measures, which led to layoffs in factories.
Fall in Prices
The fall in prices during this economic crisis was, primarily, because of reduced demand. The reduced demand was due to joblessness and decline in the standard of living. The Wholesale Price Index in the United States declined 33 per cent during this period (Romer 1).
Weakening of Banking System
Falling prices and deflation led to panic in the banking system and the banks became very cautious in lending. This adversely affected the flow of credit in the system. It also led to a phenomenon wherein the real value of old debts increased and put insolvency pressure on the borrower. This altogether weakened the banking system and further worsened the economic debacle.
Causes of the Great Depression
There are different points of view on the main causes of the great depression. However, some of the key reasons mentioned for this great debacle in the twentieth century were tightening of monetary policies and reduction in demand. Unfavourable labour market policies and high leverage due to over-indebtedness were other factors that, some economists believe, triggered this great economic crisis. The following piece discusses the impact of monetary policies and reduction in demand in detail.
Ineffective Monetary Policies
A few economists believe that an ordinary slowdown in economy transformed into a great depression because of lack of sound monetary policies. According to Bernanke, the great depression was actually caused by tight monetary policies introduced by the Federal Reserve (Amadeo). He also discusses the various mistakes committed by the Fed in instituting the monetary policies.
Firstly, the raising of Fed Fund rate led to recession and stock market crash. People started investing in currency market due to collapse of stock market. Dollar began being over sold in the currency market depreciating its value. Secondly, to prevent depreciation of dollar, interest rates were increased by Fed. This reduced money supply in the market and reduced credit flow. Thirdly, Fed did not take adequate measures to increase supply of money. Last but not the least, banks collapsed because of reduced money supply in the market. In all, the money supply dropped by around 30% during the great depression (Amadeo).
Reduction in demand
Some economists believe that the great depression was triggered by reduction in demand. Reduced demand was a result of lack of confidence in the system and reduced consumption. Investments also saw a decline during this period. This lack of confidence led to fall in prices and people found it more profitable to keep the money with them. It resulted in crashing of stock market and decline in money circulation in the market. Hence, reduced demand was the driver for the great depression according to this demand-driven theory.
Recovery from the Great Depression
Monetary policy played an important role in speedy recovery from the great depression. During this period, money used to be backed with gold. Money supply grew by almost 17% due to inflow of gold in the United States (Romer 6). One issue was that the monetary expansion couldn’t lower nominal interest rates as they were almost zero (Romer 6). Hence, attempt was made to bring back the confidence of people through monetary expansion policies. This helped in driving demand, increasing consumerism, stabilising prices and increasing consumer spending. Monetary policies also worked well during near zero nominal interest rate. The hint of stabilisation encouraged the investors to invest in the market, thereby increasing circulation of money. People were more willing to part with money as holding the money was not giving them any material benefit. With price stability, older debts were not becoming more and more expensive.
Various other attempts were made to recover from the great depression during early 1930s. To contain unemployment, 42 new agencies were created and unemployment insurance was provided (Amadeo). World War II also helped in creating military related jobs for the unemployed. A number of recovery programmes were launched in the United States to manage depression. Some of these programmes were formulation of Social Security Act, Securities and Exchange Commission, and the National Labour Relations Act (Britannica.Com). The Social Security Act was aimed at providing insurance support for the old and survivors. The Securities and Exchange Commission was established with an aim to regulate stock markets. The National Labour Relations Act promoted joint labour negotiations.
Some fiscal policy measures that helped stimulate recovery were the new Revenue Act and New Deal programme. In order to reduce fiscal deficit, the Revenue Act helped in increasing tax collection. The New Deal programme helped in establishing minimum wages, incentivise farmers and increase prices.
Conclusion
The great depression started in 1929 and lasted till late 1930s or early 1940s. The impact of this debacle was felt in the entire world, though with varying intensities. The impact of the great depression was felt in terms of decline in real GDP, increase in unemployment, fall in prices and weakening of the banking system. The main reasons for this economic crisis have been stated as ineffective monetary policies and reduction in demand. A lot of measures have been taken for speedy recovery from depression. Along with introduction of new programs like social security act and national labor relations act, some fiscal and monetary policy measures have also been taken.
A few lessons that can be learnt from the great depression are stated here. Firstly, financial recovery and real recovery go hand-in-hand (Romer 9). Secondly, monetary policies should be instituted with a lot of sensitivity given its huge impact on economy. Monetary policies improve or worsen the economic situation depending up on the way it is instituted. Thirdly, recovery policies should be made for sustainable and long term development of the economy. Last but not the least, depression is temporary in nature. However worse it may be, it does die ultimately.
Works Cited
Amadeo, Kimberly. “The Great Depression of 1929”. About.com. Web. 19 Apr. 2012.
Britannica. “Great Depression”. Britannica.Com. Web. 19 Apr. 2012.
Romer, Christina D. “Great Depression”. Elsa.Berkeley.Edu, 20 Dec 2003. Web. 19 Apr. 2012.
Romer, Christina D. “Lessons from the Great Depression for Economic Recovery in 2009”, Brookings.Edu, 9 Mar. 2009. Web. 19 Apr. 2012.
Wikipedia, The Free Encyclopedia. Wikimedia Fundation, Inc. Web. 19 Apr. 2012.
