2017

The Great Depression

Aakash Parajuli
PRN: 17020841001
Section A
11/22/2017
Table of Contents
Introduction .................................................................................................................................................. 2
Causes of Great Depression ......................................................................................................................... 2
I. Stock market crash of 1929: ............................................................................................................. 2
II. Decline in Money supply: .................................................................................................................. 2
III. High consumer debt:..................................................................................................................... 2
Effects of the Depression: ............................................................................................................................ 2
I. Decline in Wealth: ............................................................................................................................. 2
II. Rise in unemployment level:............................................................................................................. 3
III. Real Income declined: ................................................................................................................... 3
IV. Skepticism about the value of capitalist: ...................................................................................... 3
Measures used to Combat Depression:....................................................................................................... 3
I. Price and wage act: ........................................................................................................................... 3
II. Series of program. ............................................................................................................................. 4
III. Creation of FDIC: ........................................................................................................................... 4
IV. Creation of Welfare State: ............................................................................................................ 4
V. Connection to Gold: .......................................................................................................................... 4
Great Depression and Classical economic thought ..................................................................................... 4
I. Prices were supposed to fall: ............................................................................................................ 5
II. Interest rate were supposed to fall: ................................................................................................. 5
III. Wages were supposed to fall: ....................................................................................................... 6

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Introduction
Depression is a very long recession which occurs when real gross domestic product falls
behind the potential real gross domestic product. One of the depression began in 1929
and ended in 1933, after that the American economy was slowly rising but again it got hit
by the recession in 1938 and it lasted for the entire decade.

Causes of Great Depression

I. Stock market crash of 1929:
The stock market has crashed many time but the stock market crash of 1929 lasted for
very long time as compared to others which were quickly recovered. The value of the
stock on NSE was only 20% of the value it had in 1929 i.e. if stock was worth $100 in 1929
by 1932 it became $20.

II. Decline in Money supply:

The decline in stock prices led to the decline in the supply of the money. Bank gave loans
to the people who wanted to buy the stocks, nut one had to put 10% as a cash in a bank
and the remaining 90% could be borrowed and if one fails to pay the loan, bank in return
would get the stocks. And people started buying stocks by borrowing money from banks,
and whenever the stock prices went down, they used to declare themselves to bank that
they failed to pay the loan, and bank in return got the stock. But the stock that bank got
was worthless. And the people who realized that bank had a worthless stock, they started
to withdraw their money, and bank soon went out of the fund because of the more than
enough withdrawals and as a result money supply went down.

III. High consumer debt:

Consumer debt increased in 1920s and most of the people devoted their income in paying
off their debt rather than investing or spending. And as the spending of the people
decreased, the consumption of the people also decreased and this led to the decrease in
production.

Effects of the Depression:

I. Decline in Wealth:
The decrement in value of the stocks made many people poorer. Because most of the
people had made their investment in stocks. And the decline in stock prices caused the
decline in value of their wealth. And it made many people pessimistic about the stock

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 prices. They began to save their money instead of investing it in stocks or other things.
And on the other hand, Business also became pessimistic and did not make any
substantial investment in capital goods.

II. Rise in unemployment level:

Previously Unemployment rate in US exceeded 10% for a few months in the last 60 years
but the unemployment rate remained over 10% for the entire decade for 1930s. As the
production fell, many laborers were fired from the jobs and the entire economy witnessed
the heavy decline in wage rate.

III. Real Income declined:

As the unemployment level increased, it causes the decrement in Real income of the
people as well. People had money but it was not sufficient to buy things. The purchasing
power of the people declined.

IV. Skepticism about the value of capitalist:

The Great Depression brought skepticism among the Businesses and Industries. Many
industries did not hire any workers because they thought that products will not get sold
in the market. And on the other hand people were not buying any products because they
were unemployed and had no money.

Measures used to Combat Depression:

To combat the Great Depression Government interfered and took the steering wheels
into its hands and attempted to change the course towards the better economic times, it
played an activist role. The several reforms made by the Government were:

I. Price and wage act:

Government saw falling price and wage as the cause of the depression not the aftermath
of the depression. And as a result 3 major act were passed: National Industrial Recovery
Act, Agriculture Adjustment Act and Wagner act. National Industrial Recovery act set the
price floors on the product produced by the companies to help them survive in the
economy. Wagner act aided in the ability of the workers to form the labor unions, and it
was believed that with the stronger union wages would hardly decline. And Agricultural
Adjustment Act created the price floor for the agricultural products.

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 II. Series of program.
Government created the series of program to combat the depression and provide
employment opportunities to the people like building sewers, roads, bridges water
systems, post offices etc. And the agencies like: Works Progress Administration, Public
Works Administration and Tennessee Valley authority played greater role.

III. Creation of FDIC:

Government created FDIC (Federal Deposit Insurance Corporation) to make the banks
safer for depositors where FDIC insured bank accounts against the bank failures.

IV. Creation of Welfare State:

Government created Welfare State programs which included Unemployment
Compensation and Aid to Families with Dependent Children (AFDC).

V. Connection to Gold:
To control the supply of the money in the economy, government interfered and cut the
connection of gold in 1934 and US went off the Gold Standard. There was no relationship
between the Gold government held and existence of dollars in the economy. Money
supply is under the control of Federal Reserve System. And people were not allowed to
hold gold except for the uses such as: jewelry and dental filling until 1970s.

Great Depression and Classical economic thought

From the classical economic view, the recession of 1929 was supposed to last for few periods
only and because of that government did not interfere or took no nay actions. Classical put
forward 3 changes that needed to occur for recession to go away on its own, and those were:

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 I. Prices were supposed to fall:

Consumer Price Index

100 97
89 86
81 84 82 81 82
80 78 80
76

1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941

For the recession to go away the prices were supposed to fall and the price indeed fall
from 1929 to 1933 and again from 1937-1941 but this fall in price did not make the
recession go away because this fall in Price made the production fell greatly.

II. Interest rate were supposed to fall:

Interest Rate
7.00%

6.00%

5.00%

4.00%

3.00%

2.00%

1.00%

0.00%
1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941

For the recession to go away interest rates were supposed to fall. And nominal interest
rate indeed fell from 1929 to 1941 but this fall in rate did not make the recession go away.
Though the nominal interest were low people did not borrow money because they were

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 scared, they had a fear that they could lose their job in the near future and will not be
able to pay off the loans. On the other hand, Businesses were pessimistic as well
regarding the low interest rate and borrowing money. They thought they will not be able
to sell the products in the market and won’t be able to pay off the debts.

III. Wages were supposed to fall:

Wages
$0.70

$0.60

$0.50

$0.40

$0.30

$0.20

$0.10

$0.00
1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941

Wages fell to some extent but then again this fall in wages neither corrected the problem
nor swept away the recession. Because when the wages went down, people stopped
working and production stopped. And because the production stopped recession still
continued.

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