Causes of the Great Depression
After reading Chapter 7 and Special Topic 6, write a 2-page paper answering the following question:
Contrary to a popular view, the Great Depression was not caused by the 1929 stock market crash. We have had similar reductions in stock prices to those in 1929 before and after the Great Depression. What historical events took place that directly led to the prolonged depressed conditions like those of the 1930s?
Cite your sources as needed. Use APA formatting
Key Points
The Great Depression was a severe economic plunge that resulted in unemployment rates of nearly 25 percent during 1932–1933 and rates of more than 14 percent for an entire decade. It was the longest, most severe period of depressed economic conditions in American history.
Contrary to a popular view, the Great Depression was not caused by the 1929 stock market crash. We have had similar reductions in stock prices to those of 1929, both before and after the Great Depression, without experiencing prolonged depressed conditions like those of the 1930s.
There were four major reasons why the Great Depression was long and severe:
Monetary instability: The money supply contracted by 33 percent between 1929 and 1933, and it took another tumble during 1937–1938.
Smoot–Hawley trade bill: This 1930 legislation increased tariffs by more than 50 percent and led to a sharp reduction in world trade.
1932 tax increase: This huge tax increase reduced demand and undermined the incentive to invest and produce.
Structural policy changes: Persistent major changes, particularly during the Roosevelt years, generated uncertainty and undermined investment and business planning.
The budget deficits and increases in government spending were relatively small and failed to exert much impact on total demand and the level of economic activity during the 1930s.
lessons from the Great Depression
The Great Depression provides several lessons that can help us avoid severe downturns in the future. First, the Great Depression clearly indicates that a prolonged period of monetary contraction will undermine time-dimension economic activity and exert disastrous effects on the economy. We seemed to have learned this lesson well. As the severity of the 2008 downturn increased, the Fed injected abundant reserves into the banking system and shifted to a highly expansionary monetary policy. However, it is also true that Fed policy during 2002–2006 contributed to the housing boom and bust and, thereby, the Crisis of 2008. Monetary and price stability is crucially important for the smooth operation of markets. The Great Depression, along with experience since that era, vividly illustrates this point.
Second, the Great Depression illustrates the fallacy of the “trade restrictions will promote domestic industry” argument. Policies that reduce imports will simultaneously reduce exports. Foreigners will not have the dollars to purchase as much from us if they sell less to us. Trade restrictions will not save jobs. Instead, they will shift employment from sectors in which we are a low-cost producer to those in which we are a high-cost producer. The results are fewer gains from trade, a smaller output, and lower income levels. Both economic theory and the experience of the Smoot–Hawley trade restrictions are consistent with this view.
Third, raising taxes in the midst of a severe recession is a bad idea. Pushing taxes to exceedingly high rates is a recipe for disaster. All of the major macroeconomic theories—Keynesian, new classical, and supply side—indicate that tax increases will be counterproductive during a severe downturn. The experience with the tax increases during the Great Depression reinforces these views.
Fourth, the political incentive structure during a severe downturn is likely to encourage politicians to “do something.” Even bad policies are likely to be popular, at least for a while. A better strategy would be the oath of the medical profession, “do no harm.” The constant policy changes under both Hoover and Roosevelt created uncertainty and froze private-sector investment and business activity. Everyone waited to see what the next new policy regime would be; and, as they did so, the depressed conditions were prolonged.
The experience of the 1930s highlights the importance of economic literacy. The decadelong catastrophic decline did not have to happen. It was the result of wrong-headed policies based on the economic illiteracy of both voters and policy-makers.
Finally, as we noted in Chapter 1, good intentions are no substitute for sound policy. The Great Depression provides a vivid illustration of this point. There is every reason to believe that Presidents Hoover and Roosevelt, Senator Smoot, Congressman Hawley, other members of Congress, and the monetary policy-makers of the 1930s had good intentions. But, it is equally clear that their actions tragically turned what would have been a normal business cycle downturn into a decade of hardship and suffering. The good intentions of political decision makers do not protect the general citizenry from the adverse consequences of unsound policies. This was true during the Great Depression, and it is still true today. If we do not learn from the adverse experiences of history, we are likely to repeat them.
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