GENERAL INFORMATION
- Two Big Shifts in Aggregate Demand: The Great Depression and World War II. From 1929 to 1933 (The Great Depression), GDP fell by 27 percent. From 1939 to 1944 (World War II), the economy’s production of goods and services almost doubled
- The Great Depression was a severe worldwide economic depression in the decade preceding World War II
- it started in 1930 and lasted until the late 1930s or middle 1940s. This period consists of a decline in economic activity (1929–33) followed by a recovery (1934–39). It was the longest, most widespread, and deepest depression of the 20th century.
- The depression originated in the U.S., after the fall in stock prices that began around September 4, 1929, and became worldwide news with the stock market crash of October 29, 1929 (known as Black Tuesday). Sharp asset price declines: the stock market fell 13% on October 28, 1929, and fell 89% by 1932.
- Personal income, tax revenue, profits and prices dropped, while international trade plunged by more than 50%. Unemployment in the U.S. rose to 25%, and in some countries rose as high as 33%.
- Over 1/3 of all banks failed by 1933, due to loan defaults and a bank panic. Over 9,000 banks closed and money supply fell 28% from 1929-1933. This drop in the money supply may have caused the Great Depression. It certainly contributed to the severity of the Depression. During that period, business investment fell nearly 80%, consumption of durables goods declined almost 55%, consumption of nondurables goods and services declined almost 29%.
- A credit crunch and uncertainty caused huge fall in consumption and investment. Falling output magnified these problems. Federal Reserve allowed money supply to fall, creating deflation, which increased the real value of debts and increased defaults.
- US Real GDP Per Capita Trend (2000 dollar):
Great Depression on US Real GDP Percapita Trend
- Unemployment and Real GNP on Great Depression
US Great Depression and unemployment
CAUSES OF GREAT DEPRESSION
- One of many factors that was responsible for these large differences in the duration and scale of the depression is that the shocks—the unexpected changes in technology, preferences, endowments, or government pol icies that lead output to deviate from its existing steady-state growth path. Cole and Ohanian found that technology shocks may have contributed to the 1929–33 decline. Cole and Ohanian argue that The National Industrial Recovery Act (NIRA) of 1933 allowed much of the economy to cartelize. This policy change would have depressed employment and output in those sectors covered by the act and, consequently, have led to a weak recovery. For over 500 sectors, including manufacturing, antitrust law was suspended and incumbent business leaders
- Some economists, such as Friedman and Schwartz (1963), argue that monetary shocks were a key factor in the 1929–33 decline.
- Below are the Great Depression according book of “Macroeconomics” by N. Gregory Mankiw
The Spending Hypothesis: Shock to The Is Curve
There are several ways to explain a contractionary shift in the IS curve. No single explanation for the decline of spending. All these changes coincided and that together they led to massive reduction in spending.
The Money Hypothesis: Shock To The LM Curve
Central bank allowing money supply to fall by such a large amount.
Problems:
1. Behavior of real money balances. Monetary policy leads to a contractionary shift in the LM curve only if real money balances fall. In 1929-1931 real money balances rose slightly because the fall in the money supply was accompanied by an greater fall in the price level.
2. Behavior of interest rates. If a contractionary shift in the LM curve triggered the Depression, we should have observed higher interest rates. Yet nominal interest rates fell continuously from 1929-1933.
The Money Hypothesis: The Effects Of Falling Prices
1. The stabilizing effect of deflation
2. The destabilizing effect of deflation
Bank Panics
Early 1930s, bank panics caused 30% of banks to fail, contributing to the Great Depression
IMPLICATION
- The Aggregate Demand/Aggregate Supply (AD/AS) model is a by-product of the Great Depression
- In 1936, economist John Maynard Keynes published a book that attempted to explain short-run fluctuations
- Keynes believed that recessions occur because of inadequate demand for goods and services
- Therefore, Keynes advocated policies to increase aggregate demand
SOURCES
- “The Great Depression in the United States from A Neoclassical Perspective” by Harold L. Cole and Lee E. Ohanian
- “Macroeconomics” by N
- “The Great Depression” by John A. Garraty
- “Depression, You Say? Check Those Safety Nets”, New York Times. by Charles Duhigg
- “Principles of Macroeconomics” by Robert H. Frank and Ben S. Bernanke