The Great Depression
The Great Depression was the longest ever depression felt by the Western World as it spread from December 1929 and lasted till 1939. Although it originated in the United States, but its ill effects were spread around the globe in the form of low production numbers, increased unemployment rates and high deflation rates. In this paper, we will focus on the factors that lead to the Great Depression and will also look for the real reason that forced it to continue for 10 long years.
Causes of Great Depression:
Stock Market Crash
The roots of the Great Depression were laid while early 1920’s when the stock market started to fuel with a bullish trend that continued till early 1929. However, by the fall of 1929, the stock prices had reached so high that they could not be justified by their fundamentals. As a result, in order to slow down the stock price rise, the Federal Reserve increased the interest rates, which resulted in depressed spending, in automobile sector and construction sector. These sectors were highly dependent on the performance of their stocks in the financial market and with the decline in stock prices; these industries started reducing their production and employees were started to get laid off. As a result, US financial market started to see a significant fall in the stock prices; and investor losing confidence in capital market which finally resulted in stock market bubble burst which ruled for 7 years. The day of October 24, 1929 is still marked as ‘’Black Thursday’’ in the history of the United States. However, the major source of the Great Depression was sourced from the margin purchase of stocks. Majority of investors had purchased their stocks on margin and when stock prices started to decline, more and more investors started to sell their holdings and with majority selling pressure, fall in prices further exacerbated and whatever price investors realized, were paid back in their margin requirements and they were left empty handed.
The stock market crash lead to depressed spending by the consumers which reduced the aggregate demand substantially. Americans were hurt financially by the stock market crash and because of uncertainty about their future income, which in turn lead consumers to put off their purchases or opt for the lower amount of purchases. As a result of low consumer spending, firms were forced to reduce their output and collective lay off of employees around the US. Thus, there is no doubt that stock market crash played an important role in causing the decline in production and employment in the United States.
Banking panics and monetary contraction
After the stock market crash, another blow to the aggregate demand was the waves of banking panics gripped in the United States. Banking panic arises when the depositors of the bank loses confidence in the banking structure and demands immediate repayment of their deposits. However, bank keeps only a small fraction of their deposits in cash reserves and thus, in order to satisfy the claims of their depositors, banks have to liquidate their loans so as to raise the required cash. This process of excess liquidation can even turn a bank to face insolvency. A similar situation was witnessed in the United States during late 1930’s which continued till fall of 1932. Such panic took a severe toll on the American Banking System and by the end of 1933; one-fifth of the US that existed till 1903, had failed. This panic leads Americans to hold high amount of currency in their hand than as deposits in the banks. As a result, throughout 1929 to 1933, the money supply in the United States declined by 31 percent. Later, the money supply was further reduced when the Federal Reserve deliberately raised interest rates during September 1931 after Britain was forced off the gold standard and investors feared that the United States would devalue as well. Thus, the extensive contraction of money supply also had a severe reduction in output levels. The figure below indicates as how the monetary policy collapsed during the Great Depression and the level of money supply and output in US.
The figure above indicates that during 1920’s the US economy prospered as both the money supply and output increased. However, with the beginning of 1929, both, money supply and output reduced significantly. As a result, both consumer and firm spending reduced substantially and with expectation of lower wages and income in future also; they refrained from increasing their spending. Interestingly, despite of low nominal interest rates, both consumers and firms did not borrow as they feared that future wages and profits would be inadequate to cover the loan payments. Thus, while consumers and firms were hesitant to borrow, this leads to severe reductions in both consumer spending and business investment spending and later, The Great Depression.
Thus, just as stock market crash and bank panics had an equal role in ensuring decline in consumer and firm spending and furthermore, the collective failure of so many banks reduced the funds available to finance investment.
Why the Great Depression last so long?
The Great Depression which after the stock market crash, reduced money supply and the consequently low consumer and firm spending, went on till 1939. Although many economists claim that there were signs of improvement during 1933 also as productivity growth was rapid, liquidity was plentiful and deflation was almost eliminated. However, despite of all such facts, US economy was never able to recover until 1939. So what lead the Great Depression last so long:
Low Growth in Working Hours and non-supportive Government Policies:
Many economists blame that although the production increased during 1933 but there was no improvement in working hours of the employees. Further, government policies were also the culprit behind long period of Great Depression. During 1933, National Industrial Recovery Act was passed with the objective of restoring prosperity, but it allowed the industries to collude and form cartels while sharing some of their monopoly profits with the workers. This resulted in substantial increase in the wage rates but no improvement in working hours. Soon with government approval to these codes, many industries in US passed codes of fair competition under the NIRA which resulted in increase in industry prices and wages. Later, NIRA was ruled unconstitutional but the consistent increase in wage rise persisted through National Labor Relations Act just before the 1937-38 recession and through the continuation of lax antitrust enforcement.
However, by the end of 1940, National Labor Relations Act was modified with Taft-Harley Act and soon the wages were back in line with the productivity and per capita hours worked were back to their normal level which finally ended the Great Depression.
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