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 governments involvement in the economy. Useful for learning important macroeconomic concepts.

Unemployment during the Great Depression

By 1933, the height of the depression, unemployment had risen from 3% to 25% of the nations workforce. Wages for those who still had jobs fell 42%. GDP was cut in half, from $103 to $55 billion. This was partly because of deflation, where prices fell 10% per year. By 1933, world trade plummeted 65% as measured in dollars and 25% in total number of units. The Depression caused many farmers to lose their farms. At the same time, years of erosion and a drought created the Dust Bowl in the Midwest, where no crops could grow. Thousands of these farmers and other unemployed workers traveled to California to find work. Many ended up living as homeless hobos or in shantytowns called Hoovervilles, named after then-President Herbert Hoover

Europe After War

Europe left bankrupt after WWI Countries outside Europe such as America and Japan had better conditions in finances

Some Concepts
Gross Domestic Product (GDP): Comprehensive measure of the nations 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
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.

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.

Why Did It Happen? Some Suggested Causes

The stock market crash end of the party

Stock Market Boom and Bust

S&P Composite Index

35

Sept. 1929

30

25

20

15

10

July 1932
0 Jan-1921May-1922 Oct-1923Feb-1925Jun-1926 Oct-1927Feb-1929Jun-1930 Oct-1931Feb-1933Jun-1934Oct-1935Feb-1937Jun-1938 Oct-1939 Feb-1921Jun-1922 Nov-1923Mar-1925 Jul-1926 Nov-1927Mar-1929 Jul-1930 Nov-1931Mar-1933 Jul-1934 Nov-1935Mar-1937 Jul-1938 Nov-1939 Mar-1921 Jul-1922 Dec-1923Apr-1925Aug-1926 Jan-1928May-1929 Oct-1930Feb-1932Jun-1933Oct-1934Feb-1936Jun-1937 Oct-1938 Apr-1921Aug-1922 Jan-1924May-1925 Oct-1926Feb-1928Jun-1929 Nov-1930Mar-1932 Jul-1933 Nov-1934Mar-1936 Jul-1937 Nov-1938 May-1921 Oct-1922Feb-1924Jun-1925 Nov-1926Mar-1928 Jul-1929 Dec-1930Apr-1932Aug-1933 Jan-1935May-1936 Oct-1937Feb-1939 Jun-1921 Nov-1922Mar-1924 Jul-1925 Dec-1926Apr-1928Aug-1929 Jan-1931May-1932 Oct-1933Feb-1935Jun-1936 Nov-1937Mar-1939 Jul-1921 Dec-1922Apr-1924Aug-1925 Jan-1927May-1928 Oct-1929Feb-1931Jun-1932 Nov-1933Mar-1935 Jul-1936 Dec-1937Apr-1939 Aug-1921 Jan-1923May-1924 Oct-1925Feb-1927Jun-1928 Nov-1929Mar-1931 Jul-1932 Dec-1933Apr-1935Aug-1936 Jan-1938May-1939 Sep-1921 Feb-1923Jun-1924 Nov-1925Mar-1927 Jul-1928 Dec-1929Apr-1931Aug-1932 Jan-1934May-1935 Oct-1936Feb-1938Jun-1939 Oct-1921 Mar-1923 Jul-1924 Dec-1925Apr-1927Aug-1928 Jan-1930May-1931 Oct-1932Feb-1934Jun-1935 Nov-1936Mar-1938 Jul-1939 Nov-1921 Apr-1923Aug-1924 Jan-1926May-1927 Oct-1928Feb-1930Jun-1931 Nov-1932Mar-1934 Jul-1935 Dec-1936Apr-1938Aug-1939 Dec-1921May-1923 Oct-1924Feb-1926Jun-1927 Nov-1928Mar-1930 Jul-1931 Dec-1932Apr-1934Aug-1935 Jan-1937May-1938 Dec-1939 Jan-1922 Jun-1923 Nov-1924Mar-1926 Jul-1927 Dec-1928Apr-1930Aug-1931 Jan-1933May-1934 Dec-1935Apr-1937Aug-1938 Feb-1922 Jul-1923 Dec-1924Apr-1926Aug-1927 Jan-1929May-1930 Dec-1931Apr-1933Aug-1934 Jan-1936May-1937 Dec-1938 Mar-1922 Aug-1923 Jan-1925May-1926 Dec-1927Apr-1929Aug-1930 Jan-1932May-1933 Dec-1934Apr-1936Aug-1937 Jan-1939 Apr-1922 Sep-1923 Sep-1922 Sep-1924 Sep-1925 Sep-1926 Sep-1927 Sep-1928 Sep-1929 Sep-1930 Sep-1931 Sep-1932 Sep-1933 Sep-1934 Sep-1935 Sep-1936 Sep-1937 Sep-1938 Sep-1939

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

The Collapse of World Trade

$ value imports of 75 countries

Why Did It Happen? Some Suggested Causes

The stock market crash end of the party

Collapse of world trade globalization in reverse Monetary collapse

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

4500 4000 3500 3000 2500 2000 1500 1000 500 0 1920 1925 19301935 19451950 19601965 19751980 1940 1955 1970 19851990 2000 1995

Banking Panics The Feds Monetary Policy

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 Feds Monetary Policy

Fed officials did not watch (or even measure) the money supply. But, why didnt they respond to bank panics? Most failed banks were small, nonmember banks. Interest rates were falling and few banks borrowed at the discount window.

Nominal Interest Rate, 1922-33

Percent

4 3

0 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933

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.

Nominal and Real Interest Rates, 1922-33

Percent

14 12 10 8 6 4 2
Nominal Real

0 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933

Recovery

Rapid money supply growth (end of banking panic, gold inflows) rising price level falling real interest rate and increased spending.

Money and the Price Level

Consumer Price Index Monthly, 1913-2003. Source: www.BLS.gov Data adjusted to time series flow July 2, 2003. D:\Dave Wheelock Projects\stock market booms\cpi.xls Stock Index from file "schwert_may03" - S&P stock price index Stock Index 9.134702 2.2120806 8.8286424 2.1780013 8.6520695 2.1577985 8.640298 2.1564371 8.4048675 2.128811 7.9810927 2.0770753 8.0870364 2.0902623 8.3106954 2.1175433 8.393096 2.1274095 8.1341225 2.0960679 7.9222351 2.0696734 7.9222351 2.0696734 8.2165232 2.1061471 8.3460099 2.1217836 8.1929801 2.1032777 7.9810927 2.0770753 8.0281788 2.0829577 7.9575497 2.0741211 7.5220033 2.0178325 . #VALUE! . #VALUE! . #VALUE! . #VALUE! 7.2041722 1.9746603

Jan-1913 Feb-1913 Mar-1913 Apr-1913 May-1913 Jun-1913 Jul-1913 Aug-1913 Sep-1913 Oct-1913 Nov-1913 Dec-1913 Jan-1914 Feb-1914 Mar-1914 Apr-1914 May-1914 Jun-1914 Jul-1914 Aug-1914 Sep-1914 Oct-1914 Nov-1914 Dec-1914

9.8 9.8 9.8 9.8 9.7 9.8 9.9 9.9 10 10 10.1 10 10 9.9 9.9 9.8 9.9 9.9 10 10.2 10.2 10.1 10.2 10.1

2.2823824 2.2823824 2.2823824 2.2823824 2.2721259 2.2823824 2.2925348 2.2925348 2.3025851 2.3025851 2.3125354 2.3025851 2.3025851 2.2925348 2.2925348 2.2823824 2.2925348 2.2925348 2.3025851 2.3223877 2.3223877 2.3125354 2.3223877 2.3125354

0 0 0 -12.2449 12.371134 12.244898 0 12.121212 0 12 -11.88119 0 -12 0 -12.12121 12.244898 0 12.121212 24 0 -11.76471 11.881188 -11.76471

0.9321124 0.9008819 0.8828642 0.8816631 0.8664812 0.8143972 0.8168724 0.8394642 0.8393096 0.8134123 0.7843797 0.7922235 0.8216523 0.8430313 0.8275738 0.8143972 0.8109272 0.8037929 0.7522003 #VALUE! #VALUE! #VALUE! #VALUE! 0.7132844

-0.070302 -0.104381 -0.124584 -0.125945 -0.143315 -0.205307 -0.202272 -0.174991 -0.175176 -0.206517 -0.242862 -0.232912 -0.196438 -0.170751 -0.189257 -0.205307 -0.209577 -0.218414 -0.284753 #VALUE! #VALUE! #VALUE! #VALUE! -0.337875

The Real Interest Rate and Business Investment

Business Investment, Billions of Dollars; Annual Data

12.0

Treasury bill yield minus inflation rate

14

10.0

11

8.0

Business Investment

6.0

4.0

Real Interest Rate

2.0 -1

0.0

-4

Money (M2) and Output Growth, 1929-41

A nnual G NP (nom inal), 1869-47, s ourc e -- s ee "quarterly data" work s heet $billions 1869 8.06 1870 7.83 1871 7.8 1872 9.02 1873 9 1874 8.79 1875 8.74 1876 8.84 1877 9.13 1878 9.04 1879 9.65 1880 12.14 1881 12.13

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

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?

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.

New Democracies are unstable (1914~1918)

Democratic parties gained enough power to overthrow leaders Kings, Queens, monarchs, Emperors were replaced Coalition Government

Weimer republic is weak

Germanys newest government Divided into small parties and big parties and caused many problems Citizens unsatisfaction for the government

Inflation causes Crisis in Germany

Germany in huge debt due to Treaty of Versailles Did not collect taxes, printed more money instead Value of currency deflated

Contd
Attempt at Economical Stability - Charles Dawes, American Banker - Loans $200 million dollars to Germany - Brought positive results for both Charles Dawes and Germany

Contd
Effort at a Lasting Peace - German Foreign Minister: Gustav Stresamann - French Foreign Minister: Aristide Briand - Signed Peace Treaty - Kellogg- Briand peace act (failed)

Contd
Recovery in the United States

Franklin D. Roosevelt New Deal project Stock markets and banks back on the track

The Great Depression

Worlds finances were balanced on American economies A Flawed US Economy - Gap between the wealthy and the poor - Overproduction - Lessening demands

Contd

Chain of Doom- The rich and the poor Chain of Doom- Agriculture

Stock Market Crashes

Black Tuesday (1929) Raising the price Down fall of the stocks Value of money decline

A Global Depression
Down fall in US influences other countries European goods on high tariffs in USA As a competition, other countries raised their tariffs High prices makes trading rate descend

Contd

Countries outside US in depression Europe, Asia, Latin America Copper, tin, sugar are not in interest

What Caused the Great Depression of 1929?

According to Ben Bernanke, the current Chairman of the Federal Reserve, the stock market crash and the subsequent Depression were actually caused by tight monetary policies that the Federal Reserve instituted at that time. Bernanke relates several key actions by the Federal Reserve: The Fed began raising the Fed Funds rate in the spring of 1928, and kept raising them through a recession that began in August 1929. This led to the stock market crash in October 1929. When the stock market crashed, investors turned to the currency markets. At that time, dollars were backed by gold held by the U.S. Government. Speculators began selling dollars for gold in September 1931, which caused a run on the dollar. The Fed raised interest rates again to try and preserve the value of the dollar. This further restricted the availability of money for businesses, causing more bankruptcies. The Fed did not increase the supply of money to combat deflation. As investors withdrew all their dollars from banks, the banks failed, causing more panic. The Fed ignored the banks' plight, thus destroying any remaining consumers confidence in banks. Most people withdrew their cash and put it under the mattress, which further decreased the money supply. Bottom line...thanks to the Fed, there was just not enough money in circulation to get the economy going again. Instead of pumping money into the economy, and increasing the money supply, the Fed allowed the money supply to fall 30%.