An Overview of the Great Depression

What makes a Depression Great?

• Recession: When your neighbor loses his or her job.

• Depression: When you lose your job.

Why study the Great Depression?

• Worst economic disaster of the 20th century.

• Cause or causes are still debated.

• A defining event, especially for the government’s involvement in the economy.

• Useful for learning important macroeconomic concepts.

• Real output (GDP) fell 29% from 1929 to 1933.

• Unemployment increased to 25% of labor force.

• Consumer prices fell 25%; wholesale prices 32%.

• Some 7000 banks failed.

How Great was the Great Depression?

Why Did It Happen? Some Suggested Causes

•What event is often the first to come to mind when people think of the Great Depression?

-The stock market crash – end of the party

Stock Market Boom and Bust

Sept. 1929

July 1932

S&P Composite Index

The Stock Market Crash

The timing of the crash (Oct. 1929) is suggestive.

Possible channels:

• Destruction of wealth

• Increased uncertainty

• Role of banks

Conclusion: Probably had some effect, but not big enough by itself.

Why Did It Happen? Some Suggested Causes

• The stock market crash – end of the party

• Collapse of world trade – globalization in reverse

Why Did It Happen? Some Suggested Causes

• The stock market crash – end of the party

• Collapse of world trade – globalization in reverse

• Monetary collapse

Why Did It Happen? Some Suggested Causes

• Was the crash big enough to cause the Great Depression?

• No.• What specific trade policies do some

economists suggest caused the Great Depression?

• the Smoot-Hawley tariff and protectionist trade policies

Why Did It Happen? Some Suggested Causes

• Were protectionist trade policies alone enough to cause the Great Depression?

• No.

What were some of the excesses of the 1920s that some economic historians?suggest caused the Great Depression?

• capitalism– such as excessive production of commodities,

excessive building, excessive financial speculation and an excessively skewed distribution of income and wealth

What were some of the excesses of the 1920s that some economic historians?suggest caused the Great Depression?

• What is the one explanation that has stood the test of time? – the collapse of the U.S. banking system and

resulting contraction in the nation’s money stock

What were some of the excesses of the 1920s that some economic historians?suggest caused the Great Depression?

• What happens if the money supply (stock) shrinks? – deflation

Bank Failures

• 7000 banks failed -- many during “panics”

• Number of banks fell from 25,000 in 1929 to 15,000 by 1934

Possible Channels:

• Loss of deposits → decline in expenditures

• Customer relationships broken → harder to borrow

• Money supply contraction

Commercial Bank Failures, 1920-2004

Banking Panics

• Bank depositors lost confidence bank runs

• Banks lost gold, currency and other reserve assets

• Loss of reserves caused banks to reduce loans and deposits (causing money stock to fall)

• Contracting money stock reduced spending

• Reduced spending led to lay-offs (increased unemployment), falling prices (deflation) and lower output.

• The Depression was not a failure of capitalism or markets, but rather a failure of the Federal Reserve.

• Monetary policy should maintain price stability – avoid deflation and inflation.

• The Fed should respond to financial crises that increase the demand for money or threaten to disrupt the payments system.

Could It Happen Again?