an overview of the great depression
DESCRIPTION
An Overview of the Great Depression. 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. - PowerPoint PPT PresentationTRANSCRIPT
An Overview of the Great Depression
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 government’s involvement in the economy.
• Useful for learning important macroeconomic 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
• 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.
• 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.
How Great was the Great Depression?
Why Did It Happen? Some Suggested Causes
• The stock market crash – end of the party
Stock Market Boom and Bust
0
5
10
15
20
25
30
35
Jan-21 Jan-23 Jan-25 Jan-27 Jan-29 Jan-31 Jan-33 Jan-35 Jan-37 Jan-39
Sept. 1929
July 1932
S&P Composite Index
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
0
500
1000
1500
2000
2500
3000
3500
4000
4500
1920
1925
1930
1935
1940
1945
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
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.
• 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.
The Fed’s Monetary Policy
Nominal Interest Rate, 1922-33
0
1
2
3
4
5
1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933
Percent
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
0
2
4
6
8
10
12
14
1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933
Percent
Nominal
Real
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
20000
25000
30000
35000
40000
45000
50000
55000
1929
1930
1931
1932
1933
1934
1935
1936
1937
1938
1939
$ m
illio
ns
10
11
12
13
14
15
16
17
18
19
20
cons
umer
pri
ce in
dex
(198
2-84
= 1
00)
money stock(left scale)
price level(right scale)
The Real Interest Rate and Business Investment
0.0
2.0
4.0
6.0
8.0
10.0
12.0
-4
-1
2
5
8
11
14
Real Interest Rate
Business Investment
Business Investment, Billions of Dollars; Annual Data Treasury bill yield minus inflation rate
Money (M2) and Output Growth, 1929-41
percent change: fourth quarter to fourth quarter
-30
-20
-10
0
10
20
30
40
1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941
GNP
M2
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%)
• 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.
Could It Happen Again?