Economic Depression
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Great Depression
The Great Depression in Outline
The Great Crash
Even a Panic Is Not All Together a Bad Thing
Debt-Deflation
Golden Fetters
The Persistence of the Great Depression
The Great Depression in Outline
It is straightforward to narrate the slide of the world into the Great Depression. The 1920s saw a stock market boom in the U.S. as the result of general optimism: businessmen and economists believed that the newly-born Federal Reserve would stabilize the economy, and that the pace of technological progress guaranteed rapidly rising living standards and expanding markets. The U.S. Federal Reserves attempts in 1928 and 1929 to raise interest rates to discourage stock speculation brought on an initial recession.
Caught by surprise, firms cut back their own plans for further purchase of producer durable goods; firms making producer durables cut back production; out-of-work consumers and those who feared they might soon be out of work cut back purchases of consumer durables, and firms making consumer durables faced falling demand as well.
Falls in prices–deflation–during the Depression set in motion contractions in production which riggered additional falls in prices. With prices falling at ten percent per year, investors could calculate that they would earn less profit investing now than delaying investment until next year when their dollars would stretch ten percent further. Banking panics and the collapse of the world monetary system cast doubt on everyones credit, and reinforced the belief that now was a time to watch and wait. The slide into the Depression, with increasing unemployment, falling production, and falling prices, continued throughout Herbert Hoovers Presidential term.
There is no fully satisfactory explanation of why the Depression happened when it did. If such depressions were always a possibility in an unregulated capitalist economy, why werent there two, three, many Great Depressions in the years before World War II? Milton Friedman and Anna Schwartz argued that the Depression was the consequence of an incredible sequence of blunders in monetary policy. But those controlling policy during the early 1930s thought they were following the same gold-standard rules of conduct as their predecessors. Were they wrong? If they were wrong, why did they think they were following in the footsteps of their predecessors? If they were not wrong, why was the Great Depression the only Great Depression?
At its nadir, the Depression was collective insanity. Workers were idle because firms would not hire them to work their machines; firms would not hire workers to work machines because they saw no market for goods; and there was no market for goods because workers had no incomes to spend. Orwells account of the Depression in Britain, The Road to Wigan Pier, speaks of “several hundred men risk[ing] their lives and several hundred women scrabbl[ing] in the mud for hours searching eagerly for tiny chips of coal” in slagheaps so they could heat their homes. For them, this arduously-gained “free” coal was “more important almost than food.” All around them the machinery they had previously used to mine in five minutes more than they could gather in a day stood idle.
The United States Business Cycle, 1890-1940
The Great Depression has central place in twentieth century economic history. In its shadow, all other depressions are insignificant. Whether assessed by the relative shortfall of production from trend, by the duration of slack production, or by the product-depth times duration-of these two measures, the Great Depression is an order of magnitude larger than other depressions: it is off the scale. All other depressions and recessions are from an aggregate perspective (although not from the perspective of those left unemployed or bankrupt) little more than ripples on the tide of ongoing economic growth. The Great Depression cast the survival of the economic system, and the political order, into serious doubt.
The United States Business Cycle, 1950-1990
The Great Crash
The U.S. stock market boomed in the 1920s. Prices reached levels, measured as a multiple of corporate dividends or corporate earnings, that made no sense in terms of traditional patterns and rules of thumb for valuation. A range of evidence suggests that at the market peak in September 1929 something like forty percent of stock market values were pure air: prices above fundamental values for no reason other than that a wide cross-section of investors thought that the stock market would go up because it had gone up.
By 1928 and 1929 the Federal Reserve was worried about the high level of the stock market. It feared that the “bubble” component of stock prices might burst suddenly. When it did burst, pieces of the financial system might be suddenly revealed to be insolvent, the network of financial intermediation might well be damaged, investment might fall, and recession might result. It seemed better to the Federal Reserve in 1928 and 1929 to try to “cool off” the market by making borrowing money for stock speculation difficult and costly by raising interest rates. They accepted the risk that the increase in interest rates might bring on the recession that they hoped could be avoided if the market could be “cooled off”: all policy options seemed to have possible unfavorable consequences.
In later years some, Friedrich Hayek for one, were to claim that the Federal Reserve had created the stock market boom, the subsequent crash, and the Great Depression through “easy money”policies.
pp. 161-2: “[U]p to 1927 I should have expected that the subsequent depression would be very mild. But in that year an entirely unprecedented action was taken by the American monetary authorities [who] succeeded, by means of an easy-money policy, inaugurated as soon as the symptoms of an impending reaction were noticed, in prolonging the boom for two years beyond what would otherwise have been its natural end. And when the crisis finally occurred, deliberate attempts were made to prevent, by all conceivable means, the normal process of liquidation.”
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