Topic: EconomicsCurrency

Last updated: March 4, 2019

The Great Depression was the worst economic downturn in the history
of the industrialized world, lasting from 1929 to 1939. Before The Depression,
there was short depression that lasted from 1920 to 1921, which is called as
the Forgotten Depression. During this period, the U.S. stock market fell by
nearly 50 percent, and corporate profits declined over 90 percent. People did
not notice that there will be a depression during this period. The even enjoyed
the sudden growth during the rest of the decade by naming it as the “roaring
’20s.” Easy money supply and high levels of margin trading by investors
helped to cause an unprecedented increase in asset prices. Speculative
frenzies affected both the real estate markets and on the New York Stock
Exchange. However, things started to fallen a part. The bubble economy
could not last any longer. The New York Stock Exchange bubble burst
abruptly on October 24, 1929, which now known as Black Thursday. The
stock market would eventually fall almost 90 percent from its 1929 peak. The
Great Depression began in the United States as an ordinary recession in the
beginning of 1929. The downturn became markedly worse, however, in late
1929 and continued until early 1933. Wall Street had a huge panic, and the
declined 33 percent. By 1933, when the Great Depression reached its lowest
point, some 15 million Americans were unemployed and nearly half the
country’s banks had failed. This sudden economic crash spread its negative
impact to Europe triggering other financial crises. Great Britain struggled with
low growth and recession during most of the second half of the 1920s. Britain
did not have severe depression as much as US had. However, until early
1930, and its peak-to-trough decline in industrial production was roughly
one-third that of the United States. France also experienced a relatively short
downturn in the early 1930s. French industrial production and prices both fell
substantially between 1933 and 1936. While some less-developed countries
experienced severe depressions, others, such as Argentina and Brazil,
experienced comparatively mild downturns. Japan also experienced a mild
depression, which began relatively late and ended relatively early. The Great
Depression was the greatest and longest economic recession in modern
world history. It began with the U.S. stock market crash of 1929 and did not
completely end until 1946 after World War II. Economists and historians often
cite the Great Depression as the most catastrophic economic event of the
20th century.
2. Background Information
Throughout the 1920s, the U.S. economy expanded rapidly, and the
nation’s total wealth more than doubled between 1920 and 1929, which is
known as “the Roaring Twenties.” The relatively new Federal Reserve
mismanaged the supply of money and credit before and after the crash in
1929. At that time the Fed as pretty new government department since it was
created in 1913. Beginning of the first eight year, the fed remained inactive.
After the economy recovered from the 1920 to 1921, the Forgotten
Depression depression, the Fed allowed significant monetary expansion. The
Fed began raising the fed funds rate in the spring of 1928. It kept increasing it
through a recession that started in August 1929. Total money supply grew by
$28 billion, a 61.8 percent jumped between 1921 and 1928. Bank deposits
rose by 51.1 percent, savings and loan shares increased by 224.3 percent
and net life insurance policy reserves increased 113.8 percent. All of this
occurred after the Federal Reserve cut required reserves to 3 percent in 1917.
Gains in gold reserves via the Treasury and Fed were only $1.16 billion.
When the stock market crashed, investors turned to the currency markets. At
that time, the gold standard supported the value of the dollars held by the U.S.
government. Speculators began trading in their dollars for gold September
1931. That created a run on the dollar. Surplus money supply growth caused
huge bubbles in the stock market and real estate. After the market crashed
and the bubbles burst, the Fed cut the money supply by about a third to the
original money supply. This caused severe liquidity problems for many small
banks. The Fed raised interest rates again to preserve the dollar’s value. This
restricted the availability of money for businesses. More bankruptcies
followed. People believed that bank panics would normally resolved within
weeks. But the Fed failed to prop up the system with a cash injection between
1929 and 1932.
3. Body Paragraph
Much of the debate centers on whether monetary conditions were
“easy” or “tight” during the Depression, whether money and credit were
plentiful and inexpensive, or scarce and expensive. During the 1930s, many
Fed officials argued that money was abundant and cheap, because market
interest rates were low and few banks borrowed from the discount window.
Modern researchers who agree generally believe neither that monetary forces
were responsible for the Depression nor that different policies could have
alleviated it. Others contend that monetary conditions were tight, noting that
the supply of money and price level fell substantially. They argue that a more
aggressive response would have limited the Depression. Among those who
conclude that contractionary monetary policy worsened the Depression, there
has been considerable debate about why Federal Reserve officials failed to
respond appropriately. Most explanations fall into two categories. One holds
that Fed officials, failed to understand that more aggressive action was
needed. The first sight argues that Strong had not developed a countercyclical
policy and that the Fed would have failed to recognize the need for vigorous
action during the Depression. In their view, Fed errors were not due to
organizational flaws or changes, but simply to continued use of flawed
policies. A second category of explanations holds that the Fed’s
contractionary policy was deliberate. contend that Fed officials understood
that monetary conditions were tight. This sight asserts that the Fed believed a
contraction was necessary and inevitable. When it did act, they argue, it was
to promote the interests of commercial banks, rather than economic recovery.
emphasize even more the Fed’s interest in aiding its member banks. They
argue that monetary policy was designed to cause the failure of nonmember
banks, which would enhance the long-run profits of member banks and
enlarge the System’s regulatory domain. Today there is considerable debate
about the causes of business cycles and whether government policies can
alleviate them. A few economists, like Irving Fisher (1932), applied the
Quantity Theory of Money, which holds that changes in the money supply
cause changes in the price level and can affect the level of economic activity
for short periods. These economists argued that the Fed should prevent
deflation by increasing the money supply. The other extreme, proponents of
“liquidationist” theories of the cycle argued that excessively easy monetary
policy in the 1920s had contributed to the Depression, and that “artificial”
easing in response to it was a mistake. Liquidationism thought that
overproduction and excessive borrowing cause resource misallocation, and
that depressions are the inescapable and necessary means of correction.
One implication of the liquidationist theory is that increasing the money supply
during a recession is likely to be counterproductive. During a minor recession
in 1927, for example, the Fed had made substantial open market purchases
and reduced its discount rate. In their view, because economic activity was
low, the reserves created by the Fed’s actions fueled stock market
speculation, which led inevitably to the crash and subsequent depression.
During the Depression, proponents of the liquidationist view argued against
increasing the money supply since doing so might reignite speculation without
promoting an increase in real output. Indeed, many argued that the Federal
Reserve had interfered with recovery and prolonged the Depression by
pursuing a policy of monetary ease. Keynesian explanations of the
Depression differed sharply from those of the liquidationism. Keynesians
tended to dismiss monetary forces as a cause of the Depression or a useful
remedy. Instead they argued that declines in business investment or
household consumption had reduced aggregate demand, which had caused
the decline in economic activity.10 Both views, however, agreed that
monetary ease prevailed during the Depression. Classical economics is the
body of macroeconomic thought associated primarily with 19th-century British
economist David Ricardo. Ricardo focused on the long run and on the forces
that determine and produce growth in an economy’s potential output. He
emphasized the ability of flexible wages and prices to keep the economy at or
near its natural level of employment. According to the classical school,
achieving what we now call the natural level of employment and potential
output is not a problem; the economy can do that on its own. Classical
economists recognized, however, that the process would take time. Ricardo
admitted that there could be temporary periods in which employment would
fall below the natural level. But his emphasis was on the long run, and in the
long run all would be set right by the smooth functioning of the price system.
Economists of the classical school saw the massive slump that occurred in
much of the world in the late 1920s and early 1930s as a short-run aberration.
The economy would right itself in the long run, returning to its potential output
and to the natural level of employment. Keynesianism provided an answer to
the question of how to generate growth via surplus despite rising wages. The
classical economists, and the businessmen who had assimilated their ideas,
thought in terms of a Zero-Sum Game. The experience of the Great
Depression certainly seemed consistent with Keynes’s argument. A reduction
in aggregate demand took the economy from above its potential output to
below its potential output, the resulting recessionary gap lasted for more than
a decade. While the Great Depression affected many countries, we shall
focus on the U.S. experience. The plunge in aggregate demand began with a
collapse in investment. The investment boom of the 1920s had left firms with
an expanded stock of capital. As the capital stock approached its desired
level, firms did not need as much new capital, and they cut back investment.
The stock market crash also reduced consumer confidence throughout the
economy. The reduction in wealth and the reduction in confidence reduced
consumption spending and shifted the aggregate demand curve to the left.
Fiscal policy also acted to reduce aggregate demand. As consumption and
income fell, governments at all levels found their tax revenues falling. They
responded by raising tax rates in an effort to balance their budgets. As if all
this were not enough, the Fed, in effect, conducted a sharply contractionary
monetary policy in the early years of the Depression. The Fed took no action
to prevent a wave of bank failures that swept the country at the outset of the
Depression. Between 1929 and 1933, one-third of all banks in the United
States failed. As a result, the money supply plunged 31% during the period.
The Fed could have prevented many of the failures by engaging in
open-market operations to inject new reserves into the system and by lending
reserves to troubled banks through the discount window


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