Topic: EconomicsCurrency

Last updated: March 4, 2019

The Great Depression was the worst economic downturn in the historyof the industrialized world, lasting from 1929 to 1939. Before The Depression,there was short depression that lasted from 1920 to 1921, which is called asthe Forgotten Depression. During this period, the U.S.

stock market fell bynearly 50 percent, and corporate profits declined over 90 percent. People didnot notice that there will be a depression during this period. The even enjoyedthe 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 investorshelped to cause an unprecedented increase in asset prices.

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Speculativefrenzies affected both the real estate markets and on the New York StockExchange. However, things started to fallen a part. The bubble economycould not last any longer. The New York Stock Exchange bubble burstabruptly on October 24, 1929, which now known as Black Thursday. Thestock market would eventually fall almost 90 percent from its 1929 peak. TheGreat Depression began in the United States as an ordinary recession in thebeginning of 1929.

The downturn became markedly worse, however, in late1929 and continued until early 1933. Wall Street had a huge panic, and thedeclined 33 percent. By 1933, when the Great Depression reached its lowestpoint, some 15 million Americans were unemployed and nearly half thecountry’s banks had failed. This sudden economic crash spread its negativeimpact to Europe triggering other financial crises. Great Britain struggled withlow growth and recession during most of the second half of the 1920s.

Britaindid not have severe depression as much as US had. However, until early1930, and its peak-to-trough decline in industrial production was roughlyone-third that of the United States. France also experienced a relatively shortdownturn in the early 1930s. French industrial production and prices both fellsubstantially between 1933 and 1936. While some less-developed countriesexperienced severe depressions, others, such as Argentina and Brazil,experienced comparatively mild downturns. Japan also experienced a milddepression, which began relatively late and ended relatively early. The GreatDepression was the greatest and longest economic recession in modernworld history. It began with the U.

S. stock market crash of 1929 and did notcompletely end until 1946 after World War II. Economists and historians oftencite the Great Depression as the most catastrophic economic event of the20th century.2. Background InformationThroughout the 1920s, the U.S. economy expanded rapidly, and thenation’s total wealth more than doubled between 1920 and 1929, which isknown as “the Roaring Twenties.” The relatively new Federal Reservemismanaged the supply of money and credit before and after the crash in1929.

At that time the Fed as pretty new government department since it wascreated in 1913. Beginning of the first eight year, the fed remained inactive.After the economy recovered from the 1920 to 1921, the ForgottenDepression depression, the Fed allowed significant monetary expansion. TheFed began raising the fed funds rate in the spring of 1928. It kept increasing itthrough a recession that started in August 1929. Total money supply grew by$28 billion, a 61.8 percent jumped between 1921 and 1928. Bank depositsrose by 51.

1 percent, savings and loan shares increased by 224.3 percentand net life insurance policy reserves increased 113.8 percent. All of thisoccurred 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. Atthat time, the gold standard supported the value of the dollars held by the U.

S.government. Speculators began trading in their dollars for gold September1931. That created a run on the dollar.

Surplus money supply growth causedhuge bubbles in the stock market and real estate. After the market crashedand the bubbles burst, the Fed cut the money supply by about a third to theoriginal money supply. This caused severe liquidity problems for many smallbanks. The Fed raised interest rates again to preserve the dollar’s value.

Thisrestricted the availability of money for businesses. More bankruptciesfollowed. People believed that bank panics would normally resolved withinweeks. But the Fed failed to prop up the system with a cash injection between1929 and 1932.3.

Body ParagraphMuch of the debate centers on whether monetary conditions were”easy” or “tight” during the Depression, whether money and credit wereplentiful and inexpensive, or scarce and expensive. During the 1930s, manyFed officials argued that money was abundant and cheap, because marketinterest rates were low and few banks borrowed from the discount window.Modern researchers who agree generally believe neither that monetary forceswere responsible for the Depression nor that different policies could havealleviated it. Others contend that monetary conditions were tight, noting thatthe supply of money and price level fell substantially. They argue that a moreaggressive response would have limited the Depression. Among those whoconclude that contractionary monetary policy worsened the Depression, therehas been considerable debate about why Federal Reserve officials failed torespond appropriately. Most explanations fall into two categories.

One holdsthat Fed officials, failed to understand that more aggressive action wasneeded. The first sight argues that Strong had not developed a countercyclicalpolicy and that the Fed would have failed to recognize the need for vigorousaction during the Depression. In their view, Fed errors were not due toorganizational flaws or changes, but simply to continued use of flawedpolicies. A second category of explanations holds that the Fed’scontractionary policy was deliberate.

contend that Fed officials understoodthat monetary conditions were tight. This sight asserts that the Fed believed acontraction was necessary and inevitable. When it did act, they argue, it wasto promote the interests of commercial banks, rather than economic recovery.emphasize even more the Fed’s interest in aiding its member banks. Theyargue that monetary policy was designed to cause the failure of nonmemberbanks, which would enhance the long-run profits of member banks andenlarge the System’s regulatory domain. Today there is considerable debateabout the causes of business cycles and whether government policies canalleviate them. A few economists, like Irving Fisher (1932), applied theQuantity Theory of Money, which holds that changes in the money supplycause changes in the price level and can affect the level of economic activityfor short periods. These economists argued that the Fed should preventdeflation by increasing the money supply.

The other extreme, proponents of”liquidationist” theories of the cycle argued that excessively easy monetarypolicy in the 1920s had contributed to the Depression, and that “artificial”easing in response to it was a mistake. Liquidationism thought thatoverproduction and excessive borrowing cause resource misallocation, andthat depressions are the inescapable and necessary means of correction.One implication of the liquidationist theory is that increasing the money supplyduring a recession is likely to be counterproductive. During a minor recessionin 1927, for example, the Fed had made substantial open market purchasesand reduced its discount rate.

In their view, because economic activity waslow, the reserves created by the Fed’s actions fueled stock marketspeculation, which led inevitably to the crash and subsequent depression.During the Depression, proponents of the liquidationist view argued againstincreasing the money supply since doing so might reignite speculation withoutpromoting an increase in real output. Indeed, many argued that the FederalReserve had interfered with recovery and prolonged the Depression bypursuing a policy of monetary ease. Keynesian explanations of theDepression differed sharply from those of the liquidationism.

Keynesianstended to dismiss monetary forces as a cause of the Depression or a usefulremedy. Instead they argued that declines in business investment orhousehold consumption had reduced aggregate demand, which had causedthe decline in economic activity.10 Both views, however, agreed thatmonetary ease prevailed during the Depression. Classical economics is thebody of macroeconomic thought associated primarily with 19th-century Britisheconomist David Ricardo. Ricardo focused on the long run and on the forcesthat determine and produce growth in an economy’s potential output. Heemphasized the ability of flexible wages and prices to keep the economy at ornear its natural level of employment. According to the classical school,achieving what we now call the natural level of employment and potentialoutput is not a problem; the economy can do that on its own. Classicaleconomists recognized, however, that the process would take time.

Ricardoadmitted that there could be temporary periods in which employment wouldfall below the natural level. But his emphasis was on the long run, and in thelong 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 inmuch 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 outputand to the natural level of employment. Keynesianism provided an answer tothe question of how to generate growth via surplus despite rising wages. Theclassical economists, and the businessmen who had assimilated their ideas,thought in terms of a Zero-Sum Game.

The experience of the GreatDepression certainly seemed consistent with Keynes’s argument. A reductionin aggregate demand took the economy from above its potential output tobelow its potential output, the resulting recessionary gap lasted for more thana decade. While the Great Depression affected many countries, we shallfocus on the U.S. experience.

The plunge in aggregate demand began with acollapse in investment. The investment boom of the 1920s had left firms withan expanded stock of capital. As the capital stock approached its desiredlevel, firms did not need as much new capital, and they cut back investment.The stock market crash also reduced consumer confidence throughout theeconomy. The reduction in wealth and the reduction in confidence reducedconsumption spending and shifted the aggregate demand curve to the left.

Fiscal policy also acted to reduce aggregate demand. As consumption andincome fell, governments at all levels found their tax revenues falling. Theyresponded by raising tax rates in an effort to balance their budgets. As if allthis were not enough, the Fed, in effect, conducted a sharply contractionarymonetary policy in the early years of the Depression. The Fed took no actionto prevent a wave of bank failures that swept the country at the outset of theDepression. Between 1929 and 1933, one-third of all banks in the UnitedStates failed.

As a result, the money supply plunged 31% during the period.The Fed could have prevented many of the failures by engaging inopen-market operations to inject new reserves into the system and by lendingreserves to troubled banks through the discount window


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