The Great Depression
The Great Depression was an economic crisis, which affected industrialized countries from the 1920s to the late 1930s. It began as a pool of unsolved recessions in the economy after the First World War. The economic crisis is the longest and severest depression that has ever been experienced by the industrialized countries of the Western world. As a result, there were massive layoffs, many economic entities went bankrupt, and the aggregate productivity declined in nations that were affected. For instance, in Germany and the United States, the total industrial output fell by almost 50%, which saw about more than 25% percent of the labor force layoff (Samuelson).
Most economists believe that the Stock Market Crash of October 29, 1929 was the most significant cause of the Great Depression. The Stock Market Crash, also known as the Black Tuesday was caused by speculative investors who anticipated an enormous boom in consumer goods after the emergence of new methods of production (Walton & Rockoff 412). For instance, since the beginning of the 1920s, the American economy grew significantly as a result of emergence of new industries and methods of production (Samuelson). As a result, the economy produced a high supply of raw materials that were used to produce chemicals, steel, machinery, and glass (Samuelson 2). Investors in the American and European markets invested heavily in stock markets, speculating to make high returns. However, in 1929 many investors began to fear that the boom was coming to an end, and as a result, the stock market crashed, and this marked the initiation of the US economy going into a long depression (Walton & Rockoff 418).
The second cause of the Great Depression is associated with the weakened purchase power of the consumer (Walton & Rockoff 411). As the stock market crashed, and the fear of more economic turmoil, individuals at all economic classes, stopped purchasing items since they were highly inflated and could not afford them. As a result, manufacturing firms reduced their output, which led to massive layoffs (Samuelson). As people were made redundant and could no longer work at firms, they were unable to sustain their life due to inflation. Additionally, items, which had been procured in installment, were reclaimed. These led to accumulation of inventory and a rise in the unemployment rate in the economy. For example, the agricultural sector faced a decrease in demand and, therefore, farmers lost their source of employment (Walton & Rockoff 437).
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Friedman and Schwartz emphasize that the Great Depression was caused by a failure in lending institutions, especially banks. Through the 1920s, over 9,000 lending institution failed. Banks did not consider ensuring their clients’ savings and, thus, most people lost their savings (Sullivan). Additionally, in order to ensure their survival, banks stopped issuing new loans. This worsened the situation and led to a decrease in aggregate expenditure in the economy. Structural weakness in the rural economy made local banks highly vulnerable. As a result of the 1919 bubble, land prices were highly inflated, and since their produce fetched little in the economy, farmers were unable to support their mortgage (Samuelson). Moreover, due to unsound financial practices, some of the largest banks in the city engaged in risky practices. They failed to maintain adequate reserves and opted to invest in the collapsed stock market. For example, New York City banks engaged in risky loans to the Germans and Latin America, and this shows how the financial institutions were unable to regulate the crisis, hence causing a financial crisis (Walton & Rockoff 427).
Another significant cause of the Great Depression was a result of policies adopted by the Western nations. For example, the economy faced inflations as a result of a decision made by the Western countries to return to the Gold Standard. However, most nations that had adopted the Gold Standard saw that the policy was not working towards a healthy economy and abandoned it. As a result of the hasty abandonment, the economy went into inflation (Samuelson). This worsened since the nations, which had engaged in the War, were embarking on an exercise to supply new money after a lot of it was spent during the War. Another policy that caused the Great Depression was the Protectionism policies, which saw the emergence of the Smoot-Hawley Tariff Act. This policy resulted in the “beg-your-neighbor policy”. The Western nations imported less than they exported. This caused an unhealthy balance-of-trade for most countries, resulting in an economic turmoil. Moreover, Protectionism policies were harmful since they caused farmers’ default on their mortgage (Walton & Rockoff 447).
After 1933, governments in the affected economies embarked on plans to recover their economies. They developed sound practices to foster productivity, improve liquidity ratio, and stabilize lending institutions. Consequently, inflation was eliminated for a while, and there were plenty of demand stimuli as a result of the federal government developing a strong monetary base. Despite all these efforts, effects of the Depression were felt until 1939. One of the general beliefs of economists concerning the persistent delay in recovering the economy was the economic ideology by the then president. President Hoover believed in the economy free from government interventions. For this reason, the president was not willing to enforce prudent regulatory financial policies (Samuelson).
A second mistake made by the president was his decision to placate labor and jobs. For example, despite the economic crisis, the president successfully persuaded business to inflate their wages in order to facilitate consumer purchasing power. This later came to be known as the classical Keynesian prescription. The president believed that if wages were kept high and people shared jobs instead of being laid off, consumer purchasing power would be retained, which would help in improving the economy. However, this move brought unintended results. For instance, inflation-adjusted value over time was high since there was no output to sustain the labor supply (Sullivan).
Another factor that influenced the prolonged economic depression was the Smoot-Hawley Tariff Act of June 1930 (Samuelson). Initially, it aimed at increasing the protection for farmers against agricultural imports. Tremendous expansion in the agricultural sector led to overproduction in the 1920s. In turn, this led to the decline in farm prices at the end of the decade, which steered the Depression (Sullivan).
Tax increases of the government also worsened the situation. In order to address public concerns and a result of the growing budget surpluses, President Hoover reduced all income tax rates by 1% in 1929. However, the decrease resulted in the deficit that grew rapidly, which worsened the economy. By the end of 1931, President Hoover recommended an increase in taxes in an attempt to have a healthy budget. For example, personal exemptions were cut to broaden the tax base. The lowest margin rate rose by 3%, while the top margin rose by 36% on taxable income, which was approved by the Congress in 1932 (Sullivan). An analysis of this situation shows that an increase in income tax reduced disposable income at the household level, which then led to a reduction in household spending and economic activities (Samuelson).
Lastly, it is expected that the market forces of supply and demand should restore the situation. What prevented this from happening were government policies. For example, the government enacted the national Industrial Recovery ACT (NIRA) in 1933, which was aimed at restoring prosperity and deterring sanctions that would have triggered prosperity. Many firms passed codes of fair competition as required by the NIRA and, as a result, prices and wages jumped following the government’s approval of the code. However, the overall economy suffered immensely with the GDP falling by more than 25%. In a situation when the wages were expected to fall, they stagnated at about 90% of what had been for more than two years in a row. After adjusting for deflation, they rose by 10% (Sullivan).
The Great Depression of the early 1920s, lasting all the way to the 1930s, was an economic crisis, which affected industrialized nations in the West and in Europe. The crisis was the result of an accumulating economic crisis, the effects of which had not been properly addressed. Due to ineffective fiscal policies, the Depression lasted longer than it was anticipated. Efforts to curb the effects of the Great Depression resulted in the worst case scenario of an economic crisis that lasted for ten years.