The Great Depression

Group5

Introduction The Great Depressi

onWhat is Depression?

• A very large recession, period during which the real GDP is falling continuously. This also causes unemployment to shoot up rapidly and productivity goes down significantly.

What is a Recessionary Gap?• When the Real GDP is below the Potential Real GDP

Hence, 1930’s is regarded as an era of Economic Disaster.

Timeline The Great Depressi

on19

29 -

1933

Depression

1933

- 19

37

Recovery Period 19

38Recession

1939Recovery

Causes of The Great Depression

Stock Market Crash

Caused wealth effect (People became

poorer)

Decline in Money Supply

Lesser Consumer Spending and More

Savings

Less Deflation

If Deflation would have been enough then

Great Depression would have been contained

Policy Decisions

Hoover Tax of 1932

Smoot Hawley Tariff of 1930

Causes The Great Depressi

on

1. Stock Market Crash:Total value of the stock on NYSE declined to 20% of the amount they had been worth in September 1929.This was because: due to economic boom in 1920s there was over-production and hence the supply was greater than the demand.

Effects of Stock Market Crash:• People became poorer and hence consumption decreased (Wealth Effect)• People became more pessimistic and hence they increased saving

activities and reduced consumption.• Hence the aggregate demand fell as consumption and investment both

decreased.

Stock Market CrashCauses of the Great Depressio

n

Year Money Supply ($Bn)

1929 26.4

1930 25.4

1931 23.6

1932 20.6

1933 19.4

Causes of Great Depression2. Decline in Money Supply:Causes of Decline in Money Supply:• Margin Trading: People did not pay loans and let Banks keep

their ‘devalued’ stock.• Panic caused people to withdraw their money from the

banks as they were suspicious of sustainability of banks.

3. Less Deflation:• Recessionary gap was created because Real GDP was lower

than the potential Real GDP.• Proper deflation would have filled this gap.

Decline in Money Supply & Less Deflation

Causes of the Great Depressio

n

Causes of Great Depression4. Policy Decisions:• Hoover Tax of 1932

President Hoover increased taxes to meet budget deficits as according to classical theory it was bad for the economy and should never exist. This further increased unemployment rate.

• Smoot Hawley Tariff of 1930Congress imposed very high taxes on imported goods to encourage consumption of American goods and hence increase employment. But instead:• Other countries imposed high taxes on American products &• American producers incurred higher costs of production due to high taxes

on imported material used in production as parts.

Policy DecisionsCauses of the Great Depressio

n

Monetary system where a country's currency or paper money has a value directly linked to gold. Political leaders and central bankers continued to adhere to the gold

standard as the Great Depression intensified. It was expressed and reinforced by the discourse among these leaders. It was opposed and finally defeated by mass politics, but only after the

interaction of national policies had drawn the world into the Great Depression.

Gold Standard and The Great Depression

• June 17, 1930 - Breakdown of the anti-tariff coalition of the senate:• US Legislation raised import duties on 20,000 products to protect American

businesses and farmers. This Act contributed to the early loss of confidence on Wall Street and signalled U.S. isolationism. • By raising the average tariff by 20%, it prompted retaliation from foreign

governments and many overseas banks began to fail (the legislation set both specific and ad valorem tariff rates.)• 1929 & 1932 - U.S. Imports from and Exports to Europe fell by two-thirds.• 1934 - President Franklin D. Roosevelt signed the Reciprocal Trade Agreement Act,

reducing tariff levels & promoting trade liberalization and cooperation with foreign governments.

Smoot - Hawley Tariff Act (1930) Smoot Hawley

Tariff Act

• Classical Economists believed that recession should have gone automatically with the help of market forces i.e., demand and supply.

• No serious policies were undertaken by government because according to classical economics government didn’t see any need of intervention.

• Federal reserve system was more concerned about inflation that would have ideally taken place as per quantity theory of money .

• Prices did fall but not as much as required. Large corporations who had limited competition could establish a control over the prices. However, the production also fell extensively.

• Wages also fell, but not sufficiently enough to generate full employment. This was due to the power of big labor unions who wouldn’t let the wage rates fall beyond an extent.

Classical Economics Classical Economic

s

• The decline in the nominal interest rates couldn’t correct the fall in production.

As can be seen in table, the Real Interest Rates were higher, in the period of deflation, which will lead to further depression due to lesser economic activity.

Year CPINominal Interest Rate (%)

Real Interest Rate (%)

Wages ($/hour)

1929 100 5.85 5.85 0.571930 97 3.59 6.59 0.551931 89 2.64 10.88 0.521932 80 2.73 12.84 0.451933 76 1.73 6.73 0.441934 78 1.02 3.65 0.531935 80 0.75 3.31 0.551936 81 0.75 2 0.561937 84 0.94 4.64 0.621938 82 0.81 3.19 0.631939 81 0.59 1.80 0.631940 82 0.56 1.79 0.661941 86 0.53 5.40 0.66

Classical Economics Classical Economic

s

The Means to Prosperity (1933) John Maynard Keynes

Multiplier = 1 / (Sum of the Propensity to Save + Taxes + Imports)If Propensity to Save = 0.1, Propensity to Tax = 0.2, Propensity to Import = 0.2

Then the Multiplier = 1/0.5 = 2

JM Keynes advocates deficit spending by the government, which he calls “loan-expenditures”. The recipients of these loan-expenditures will themselves spend part of their new incomes, which will further stimulate further increases in output and employment. Ideally, the result would be a virtuous spiral upwards. At each stage the extra money flowing around the circular flow gets smaller

£200m Injection

• £20m saved• £40m taxed• £40m imports

£100m extra GDP

• £10m saved• £20m taxed• £20 imports

£50m extra GDP

• £10m saved• £20m taxed• £20m imports

The rate of leakage from the circular flow: Assume that for each Rs.100 of extra income • 10% is saved• 20% is taken in taxation • 20% leaks from the economy in imports

Open Letter to President Roosevelt John Maynard Keynes

JM Keynes indicated two technical fallacies in Roosevelt’s administration policies:

1. Policy to Increase the Prices: Rising prices are considered to be a symptom of rising output and employment. But to increase the prices at the expense of output (restricting the quantity) is not the way. It should be the other way around, which is stimulating output by increasing aggregate purchasing power to get prices up.

Recommendation: Deficit Spending by the government. Preferably in the area which can be made to mature quickly on a large scale, for example Railroads. Also by maintenance of cheap and abundant credit (by reducing long term rate of interest).

Open Letter to President Roosevelt John Maynard Keynes

JM Keynes indicated two technical fallacies in Roosevelt’s administration policies:

2. Quantity Theory of Money: If the quantity of money is rigidly fixed then sooner of later, rising prices and output will suffer a setback. Also, an early Roosevelt policy was involved in ongoing (and largely arbitrary) changes in the official gold price (linked with dollar price), which impeded the freedom of domestic price-raising policy and BOP with foreign countries.

Recommendation: Roosevelt should control the dollar exchange by buying and selling gold and foreign currencies at a definite figure so as to avoid wide and meaningless fluctuations.

• Classical Economists believed that recession should have gone automatically with the help of market forces i.e., demand and supply.• No serious policies were undertaken by government because

according to classical economics government didn’t see any need of intervention.• Federal reserve system was more concerned about inflation that

would have ideally taken place as per quantity theory of money .• Prices did fall but not as much as required. Large corporations who

had limited competition could establish a control over the prices. However, the production also fell extensively. • Wages also fell , but not sufficiently enough to generate full

employment. This was due to the power of big labor unions who wouldn’t let the wage rates fall beyond an extent.

Monetary Causes Of The Great Depression

The Great Depressi

on

A number of special monetary institutions were established such as Reconstruction Finance Corporation and the Federal Home Loan Banks.Powers of the Federal Reserve System were substantially modified.

Suspension of gold payments.A drastic modification of the gold standard.

The contraction shattered the long-held belief that monetary policy was a potent instrument for promoting economic stability.Opinion shifted to the opposite extreme that “money does not matter” and monetary policy is of extremely limited value in promoting stability.

The effects of returning confidence on the part of the public and the banks were largely offset by a reduction in the Federal Reserve credit outstanding. A second banking crisis started a renewed decline in the stock of money and at an accelerated rate.A renewed decline in the economic activity ended the hope of revival.

Effects Of Contraction Contraction

• The contrast between Federal Reserve policy before 1929 and after is the shift of power within the System and the lack of understanding and experience of the individuals to whom the power shifted.• The dominant figure, Benjamin Strong , if had been alive,

would have recognized the oncoming liquidity crisis and would have prepared by experience & conviction to take strenuous and appropriate measures to head it off and carry the System with him.

Reason for the Contrast Contrast

• The international economic & monetary system needs a country which can set standards of conduct for other countries, and get them to follow the same.• This will help in maintaining a flow of investment capital &

discounting its paper.• Britain performed this role in 1913, post which the US did it.

Charles Kindleberger Absence of a lender of last resort

Non-Monetary Effects of the Financial CrisesFriedman & Schwartz pointed out two ways in which these worsened the general economic contraction:• By reducing the wealth of bank shareholders• By lending to a rapid fall in the supply of moneyThe present paper builds on the existing work by considering a third way in which the financial crises may have affected the output. This includes debtor bankruptcies & failures of banks.

Ben BernankeNon-Monetary Effects of the

Financial Crises

• Saw decline in price and wages as cause rather than result of the problem• Safeguards and Laws:• National Industrial Recovery Act• Wagner Act• Agricultural Adjustment Act

• Created employment• Made Banks Safer for Depositors• Social Security• Cut off Connection with Gold

Roosevelt’s New Deal Eureka

Thank You Group5

Prepared By:1.) Aditya Raval2.) Akshatha Neeraje3.) Arjun Parekh4.) Naren Shetty5.) Ronak Sharma6.) Shaini Sachdeva