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An Overview of the Great Depression. David C. Wheelock September 20, 2007. 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.

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an overview of the great depression
An Overview of the Great Depression

David C. Wheelock

September 20, 2007

what makes a depression great
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
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.
some concepts
Some Concepts
  • Gross Domestic Product (GDP): Comprehensive measure of the nation’s output of final goods and services.
  • Real GDP: GDP measured at a fixed price level (i.e., inflation adjusted).
  • Nominal GDP: GDP measured at current prices.
  • Recession: Sustained decline in real GDP (approximately two quarters). Officially declared by NBER committee.
  • Depression: Very severe recession.
more concepts
More Concepts
  • Inflation: A sustained increase in the general price level (often calculated in terms of the Consumer Price Index (CPI)).
  • Deflation: A sustained decrease in the general price level.
  • Money Stock: The stock of assets that serve as media of exchange (e.g., coin, currency, checking accounts).
  • Real Interest Rate: Measure of the cost of borrowing adjusted for inflation/deflation.
slide6

How Great was the Great Depression?

  • 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.
slide7

Why Did It Happen? Some Suggested Causes

  • The stock market crash – end of the party
stock market boom and bust
Stock Market Boom and Bust

S&P Composite Index

slide9

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.

slide10

Why Did It Happen? Some Suggested Causes

  • The stock market crash – end of the party
  • Collapse of world trade – globalization in reverse
the collapse of world trade
The Collapse of World Trade

$ value imports of 75 countries

slide12

Why Did It Happen? Some Suggested Causes

  • The stock market crash – end of the party
  • Collapse of world trade – globalization in reverse
  • Monetary collapse
slide13

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
slide15

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.
slide16

The Fed’s Monetary Policy

  • Fed officials did not watch (or even measure) the money supply. But, why didn’t they respond to bank panics?
    • Most failed banks were small, nonmember banks.
    • Interest rates were falling and few banks borrowed at the discount window.
but were interest rates really falling
But Were Interest Rates Really Falling?
  • Deflation caused the real interest rate (i.e., the real cost of borrowing) to rise sharply:

i(nominal) – inflation rate = i(real)

e.g., 2% - (-10%) = 2% + 10% = 12%

 Firms stopped investing in new buildings, equipment, etc.

 Bankruptcies increased as borrowers lacked the incomes to repay their debts.

 Banks failed because borrowers defaulted on their loans.

recovery
Recovery
  • Rapid money supply growth (end of banking panic, gold inflows)

 rising price level

 falling real interest rate

 and increased spending.

the real interest rate and business investment
The Real Interest Rate and Business Investment

Business Investment, Billions of Dollars; Annual Data

Treasury bill yield minus inflation rate

recovery24
Recovery
  • Rapid money supply growth (end of banking panics, gold inflows)  rising price level, falling real interest rate and increased spending.
  • FDR and the New Deal?
    • Restored confidence in banking system (FDIC)
    • Early years marked by regulation/reform, little new spending (alphabet programs, e.g., NRA, WPA, PWA, CCC, etc.)
    • Later years saw increased spending
recovery25
Recovery
  • Rapid money supply growth (end of banking panics, gold inflows)  rising price level, falling real interest rate and increased spending.
  • FDR and the New Deal?
    • Restored confidence in banking system (FDIC)
    • Early years marked by regulation/reform, little new spending (alphabet programs, e.g., NRA, WPA, PWA, CCC, etc.)
    • Later years saw increased spending
  • World War II (when unemployment finally fell below 10%)
could it happen again
Could It Happen Again?
  • 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.