The Great Depression

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The Great Depression

The Great Depression is an economic collapse that occurred between 1929 and 1933. It led to the decline of the gross domestic product (GDP) to 30% of the original level and the rise in unemployment from 3.2% to 24.9% coupled with hunger (Walton and Rockoff 422). The industrial production index fell by more than a half (Reed 1) while unemployment rates rose from 1.5 million to 11.5 million (Walton and Rockoff 423). The national capital stock also declined. That trend continued until the beginning of World War II in 1941. The American society was unprepared to encounter the pressing problem as from the early 1920s, the citizens had confidence that their well-being was satisfactory and that the conditions would improve in the coming years (Walton and Rockoff 422). This essay examines the causes of the Great Depression as well as establishes the reasons of country’s long recovery from the economic challenges.

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The Main Causes of the Great Depression

The Stock Market Crash

In the 1920s, the economy of the United States experienced a rapid growth that made people believe that they could finally overcome poverty. However, during the last week of October 1929, the stock market collapsed leading to a decline in worldwide GDP (Walton and Rockoff 422). That event increased the uncertainty regarding the future of business. By 1924, twenty-five industrial stocks had an index of 110. Later, it rose to 338 in 1929 and to 452 in the end of the year (Walton and Rockoff 425). The development made it hard to buy a common stock that had a stable value forcing the investors to accumulate their wealth. However, government officials and certain investors worried about the trend predicting the possible danger of crisis (Walton and Rockoff 425). In August 1929, the Federal Reserve System raised the rate of lending to member banks by 6% to control the flow of credit in the market (Walton and Rockoff 425). On October 23rd and 24th, a trade grew to 13 million shares opposing to the usual 3 million shares (Walton and Rockoff 425). Investment houses and banks made the massive purchase of stock. However, by November 1929, the prices decreased by the half of what they were in August (Walton and Rockoff 425). The crash, however, did not impact directly the economy because, by 1930, the prices were still higher than they were in 1926 (Walton and Rockoff 427). Though, it still caused panic and lowered the consumer confidence as well as increased uncertainty. Thus, the demand for consumer goods as well as the overall investment reduced crippling the economy (Walton and Rockoff 427). The fall of the stock market influenced human behavior thus making them cut down their consumption and investment expenditure. As a result, it led to the decline of the economy.

Banking Crisis

By October 1930, many banks experienced complex problem. That situation was especially common in South and Midwest areas of the United States (Walton and Rockoff 428). The problem led to severe losses, but the Federal Reserve System overlooked its fierce impact on the economy similarly to the events happened in the 1920s (Walton and Rockoff 428). On December 11, 1930, the Bank of the United States in New York collapsed. It shocked the residents as they had never thought that the bank related to the government could fail (Walton and Rockoff 428). Due to its location, people were able to observe the crisis occurring at the heart of the United States. It became the signal that financial system of the country was under the threat (Walton and Rockoff 428). The Federal Reserve System failed to rescue the banks offering them credits. It argued that they failed because of incompetence. It made people doubt the reliability of banking system. Consequently, to the majority of them withdrew their bank deposits hence depriving the institutions of their reserves (Walton and Rockoff 429). In turn, the banks decided to build their reserve by not allowing to renew or issue new loans (Walton and Rockoff 429). Between 1930 and 1932, five thousand banks suspended their operations while four thousand of them closed (Walton and Rockoff 429). Clearly, the failure of the banking system, fear, and uncertainty led to the widespread disruption of trade and investment. The national economy eventually started to stagnate.

Income Inequality

The gap between the rich and the poor contributed to the fall of the U.S. economy in 1929. By the 1920s, income inequality was considerable (Walton and Rockoff 430). The richest 1% increased their percentage revenue from 14.5% to 18.4% between 1920 and 1929 (Walton and Rockoff 430). It implied that a fraction of people held a significant amount of national income. The uncertainty brought by the failure of the banks and by the stock market crash made the rich cut their spending (Walton and Rockoff 430). The control of that group deprived the economy of the large sum of money that could have boosted investments and growth. Thus, the issue of inequality contributed to the collapse of the financial system.

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Economic Distortions in the 1920s

The Austrian School of Thought blames the events that preceded the economic crash in the 1920s for causing instability (Walton and Rockoff 430). The scholars suggest that the real estate and the stock market boom caused the crisis (Walton and Rockoff 430). The researchers blame the Federal Reserve System for the inflationary policy that led to the increase in the prices of the real estate and stock. They argue that similar distortion requires a significant correction of the crisis, thus depression was a mechanism to solve the problem (Walton and Rockoff 430). Even though some scholars dispute the claim, the real estate boom and the financial crisis of 2008 validated the argument that the increase in the prices of stock and property result in the Great Depression (Walton and Rockoff 430). The Austrian School examined the facts and events which became the inevitable causes of the financial crisis.

The Smoot-Hawley Tariff

The tariff was passed in 1930. It is one of the factors which contributed significantly to the Great Depression (Walton and Rockoff 422). The law increased tariffs on a variety of goods, including the agricultural products. Economists argue that it lowered imports hence preventing foreign countries from buying the export of the United States (Walton and Rockoff 430). It also encouraged other countries, such as Great Britain, to raise the tariffs in retaliation and to pose a hindrance to the international trade. That attitude brought new obstacles that made it hard for people to export or import goods. The law, therefore, inhibited commerce and thus provoked the economic crisis.

Why Did the Depression Last so Long?

Discouraging Private Investment

The political climate that resulted from the reaction towards the Great Depression frustrated private investors. The government of Roosevelt launched the New Deal, a program to reverse the impacts of the Great Depression. The social security and freedom of labor influenced significantly the business community because the policy focused on common people (Walton and Rockoff 439). The government intervened substantially in the economy while creating a progressive tax system, increasing estate and gift taxes, and decreasing the income of corporations (Walton and Rockoff 439). The government controlled the taxation on the industries’ undistributed profit (Walton and Rockoff 439). Economists argue that that response hindered the development of business. Undoubtedly, the main objective was to help ordinary people, but it contributed significantly to slow recovery due to negative transformation in the private investment sector. The National Industry Recovery Act of 1933 and the National Labor Relations Act of 1935 aimed at increasing employment and guaranteeing decent prices and wages (Walton and Rockoff 430). However, economists argue that inhibiting the downward spiral made it impossible to achieve a full equilibrium of employment levels as it led to increased supply of labor when the demand was low (Walton and Rockoff 439), As a result, the unemployment problem remained. Moreover, the firms could not cut the wages and meet the labor-related expenditure. The government interference contributed to the Great Depression.

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Monetary and Fiscal Policy

The participants of the Keynesian School of economic thought argue that the steps taken by the government were not adequate to jumpstart the failed economy to its ordinary course (Walton and Rockoff 440). Moreover, that choice cut the government spending by 25% (Reed 8). The Keynesian School suggests that the government failed to offset the decrease in consumption thus creating an obstacle to full recovery (Walton and Rockoff 440). For instance, between 1929 and 1938, there was the decrease of $7.1 billion in investment. It was more than the government expenditure on the deficit (Walton and Rockoff 440). Thus, the impact of the federal funding of individual states was minimal as it created the multiplier that should encourage investment in the economy and increase in the spending (Walton and Rockoff 440). The multiplier can revive the economy, similarly to the event happened in 1941. However, unsustainable government monetary policy did not promote economic recovery during the Great Depression.

The Failure of the Federal Reserve

By 1930, many banks collapsed in the United States. About 5,000 suspended their operations while 4,000 closed down (Walton and Rockoff 429). However, the Federal Reserve System did not notice the problem and failed to save the banks. Indeed, that system was meant to be the “lender of the last resort,” but it ignored the plight of the banks (Walton and Rockoff 433). It made the public lose confidence in the banking sector. The issue led to the mass withdrawal of deposits. As a result, the economy collapsed and the banks could not issue loans or renew old ones. When the crash ended, it was hard for the economy to recover as the banks had to reestablish relations with the clients.

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The 1937 Recession within the Great Depression

Before the full recovery of the economy, the country experienced a recession that had a substantial impact on the improvement of the situation. By 1937, the industrial yield exceeded the profit in 1929 (Walton and Rockoff 437). It meant that the process of recovery accelerated gradually. However, the development reversed abruptly in May 1937 causing deflation characterized by low prices (Walton and Rockoff 437). Retail business could not afford to hire. Additionally, the payroll shrunk substantially. The stock market price fell in 1938 by half comparing to the price in 1937 (Walton and Rockoff 437). The problem hindered the recovery of the country until 1941 when the government increased spending. The recession worsened the depression.

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The Great Depression occurred from 1929 to 1933, but its recovery dragged until 1941. Several factors contributed to the problem: the stock market crash, the bank failure, income inequality, economic distortions, and the Smoot-Hawley tariff. The government also prolonged the process of recovery making the economy stagnate for more than a decade. Thus, the discouragement of private investment, poor fiscal and monetary policy, the failure of the Federal Reserve System, and the 1937 recession influenced negatively the crisis. Unfortunately, the society overestimated own abilities and led to the collapse of the economy. It was vital to implement drastic measures to reform the economy of the country.