Great Depression was a worldwide economic decline that affected different countries between 1929 and 1930. It is believed to be the worst and longest economic depression that ever affected the world to date. It is currently used as a lesson to show how world economy can decline causing suffering to all people in the world.
Major causes of Great Depression
Many researchers believe the great depression that occurred in 1929 was a result of stock market crash that occurred on 29 October 1929. Stakeholders lost more than 40 billion dollars two months after the original crash. Despite the stock market regaining slowly by slowly later great depression continued to take place. During this period, many people had invested heavily in stock market. Therefore, collapse of stock market made many people lose every investment they had.
Collapse of banks led to great depression. More than 9,000 banks were closed making the investors to loose all their savings. This is because this banks were not insured leading to total loss to any one who had invested his money in those banks. This brought money in circulation to reduce drastically affecting businesses.
The few banks, which were operating, found it hard to lend money to the public. This aggravated the problem making great depression to occur. People lacked confidence in the banks making them demand their savings. The banks having no liquid money to their disposal were forced to close.
Decrease in purchasing power of people. As a result of stock market crush, individuals developed fear for further economic problems. Many people ceased to buy products leading to low production of the products. This led to closure of industries rendering people jobless. The unemployment led to people purchasing power diminishing thus making the economic situation worse.
Drought conditions in Mississippi are a cause of great depression. The drought make people fail to repay their loans, pay taxes and even sell their lands at a price through. Food was expensive to purchase making people spend most of their money on food at the expense of savings and investment.
This led to collapse of industries increasing unemployment rate. Unemployment led to inability to purchase goods and services provided by few industries operating making them close their operations. This led to further loss on the side of government as taxes reduced drastically.
Mechanization in industries led to many people being rendered jobless. Industries produced many products thereby making supply exceed demand significantly. This led to low markets as laid down workers could not purchase the produced products. Industries were frustrated with this low demand of their products.
Decrease in population as a result of world war 11 led to reduction of labor force and market for industries. The war killed many youths thereby disrupting family structures. People were concerned with war at the expense of marrying and getting children. The disease outbreaks such as the 1918 flu led to low demand for housing and housing loans. Household markets failed drastically making the industries producing such products close.
The 1930 enactment of Smoot- Hawley tariff: this policy was meant to protect farmers from international competition. Agriculture products from other countries were taxed heavily making them become expensive in American market. This made the demand of American agriculture products to be cheaper thus be preferred to foreign products by consumers.
The countries, which exported products to America, retaliated and started putting restriction on American products. This led to lose of market for American industries and led to trade disagreements among nations. The problem led to collapse of many industries as demand decreased amicably.
International debts: many countries had borrowed money to rebuild their nation after World War 1. These countries were later unable to repay their loans and begged America to cancel these loans. The countries had no choice when America refused to cancel the loans and they had to pay at the expense of boosting economic development in their countries.
Federal Reserve decisions: despite the fact that lack of confidence in banks had led to rise in currency-to-deposit ratio to rise significantly making money supply in U.S. to reduce. Federal Reserve contracted money supply deliberately and increased interest rate. Scholars’ believe that this move by Federal Reserve led to rise of great depression. This is because reduction in money supply affected spending of individuals.
As a result of actual price fall and money supply decline, many people in business and customers expected deflation. They feared to take loans as they thought future profits would not be enough to cater for the loans acquired. This led to low spending by consumers and business spending too. Moreover, failure of numerous banks hindered lending minimizing the capital needed to finance investments (McElvaine 58).
Reasons why Great Depression lasted long
The great depression lasted for longer periods because of several factors. Some of these factors include:
Government policies that interfered with labor markets. Government introduced policies which forced industries to pay workers high wages. Government policies curtailed forces of demand and supply to work independently forcing industries incur many expenses in paying employee wages. Workers unions were empowered through inaction of National Labor Relations Act making them agitate for higher wages to their members. Employee working hours were not increased despite higher wages employee gets.
Continuous workers unrest led to workers wasting a lot of time away from their work. This led to workers spending more time outside their work. This lead to few production of products which made economic recovery hard making great depression to last for long. The workers’ unrest discouraged investors to establish new industries.
Unevenly distribution of income made great depression to last long. This is because government encouraged establishment of industries as well as mechanization of these industries. This led to many people being rendered jobless and thefore their purchasing power reduced. The products produced by the industries lacked market-making production unprofitable.
Federal government introduced high tax rate of 79%, which discouraged investors to establish industries. This led to lack of job creation making many people fail to be involved in any productive activity. The unemployment made people purchasing power low thus incapable of driving the economy forward resulting to great depression to last long.
High tariffs imposed on imports from other countries developed bad trade relationship with trading partners making international market to deteriorate. Countries were unable to sell their products leading to supply in the domestic market to flood leading to price fall and wastage. This discouraged producers and they opted to reduce their production rate making great depression last long.
New Deal policies campaigned for individuals to establish industries but failed to give private investors confidence to invest. This made private investors reluctant to put their investment in the economy and prefer holding their money. This reduced job creation thereby people’s purchasing power reduced.
This brought great hindrance for economic recovery. New Delphi policies benefited only the few workers and ignored the majority of people who were not employed. The few employed employees who benefited from this policy could not drive the economy making the Great Depression to last for longer time.
Work Cited
McElvaine, Robert. The Great Depression:America 1929-1941. London: Times Book Publisher, 1993.Print.
At the end of the second decade of the twentieth century, countries were hi t by a staggering depression in their economies. The severity of this depression was particularly pronounced in the United States.
In 1929, October, there was a serious fall of the values of common stock which caused crash of the stock market. In this situation, politicians tried to remain calm and exercise optimism but this was to no avail. The situation worsened and people lost their confidence in the government as they bid the last dollars of their savings goodbye.
By the year 1932, an approximate quarter of United States population was unemployed. Factories had been shut down due to the harsh economic climate, banks had failed in their operations and businesses had been closed. As 1933 approached, stock exchange in New York was barely a fifth of its 1929 peak. The Great Depression, as this is what it was called, had a number of causes and a lot of effects on American economy and the world as a whole (Smiley, 2008, p. 1).
Causes of the Great Depression
The main problem behind the stated Great Depression experienced in the United States in 1929 was the mismatch between the consuming capacity of the population of the United States and the production capacity of the country.
After the WWI, the country had undergone a serious revolution in innovative production that had seen its output surpassing the purchasing capacity of the people of the U.S. at the time. The inadequate demand of products was the one that led to closure of businesses and the subsequent failing of banks (Temin, 1991, p. 41).
Another contributing factor was the investment habits of Americans at the time. The middle class and the wealthy had actively invested in stock market speculations and real estate. With the collapse of the stock market, the middle class and the wealthy lost billions of dollars to their investment naivety (Amadeo, 2010, p. 1).
Analysts have attributed the crash of the stock market and the Great Depression that followed to tight monetary policies instituted by the Federal Government at that time. Some of the mistakes that the Federal Reserve made include the following.
The federal government raised their funds rate in1928, in August of the year 1929, the rate was still raising. This culminated in the crash in the stock market that occurred in October the same year. Another mistake was the preservation of the gold value of the dollar by the feds by an increase of interest rates. This is discussed in detail below (Amadeo, 2010, p. 1).
Prior to 1929, the Franc and other currencies ware undervalued after adopting floating rates for some time. At the end of WWI, countries with devalued currency wanted to return to the gold standard.
On the other hand, courtesy of holding on to a fixed gold value for the dollar, a large number of gold deposits had been made to the United States by investors from a number of countries. With this situation the Great Britain and the United States offered to redeem gold for t pounds and dollars respectively. This led to an increase of gold demand.
In the year 1928, the French government lowered interest rates which increased interest rates in America. This led to more gold being shipped to the U.S. Other countries initiated policies aimed at lowering economic activity through deflation and reducing price levels. This started the Great Depression. This cause of the Great Depression explains why the United States was among the countries that were affected the most by the depression (Smiley, 2008, p. 1).
Effects of the Great Depression
The most profound and lasting effect of the Great Depression is the way it changed the involvement of the federal government in economic matters. It occurred due to public demand ignited by the dissatisfaction of the public towards the extent to which the Depression had affected the United States and the fact that recovery was painfully slow.
This was despite the fact that people with business interest resented the involvement of the government in these matters. The response of the federal government was the creation of compensation for the unemployed as well as Social Security for the elderly (Amadeo, 2010, p. 1).
The depression also brought a revolution in labor laws. The Wagner Act was introduced which introduced the safeguarding of the interests of employees. This was achieved by its intervention in labor negotiations and the promotion of unions. This necessitated an expansion of the federal workforce which also created employment (Smiley, 2008, p. 1).
The Great Depression had an impact on the philosophy of economics. This is due to the fact that scholars and economists had associated the Great Depression with the inadequate demand that prevailed in the period.
There was, therefore, the need to look for scholarly solutions to avoid the occurrence of such depressions in the future. This was responded by the development of the idea that governments should control demand in a bid to prevent occurrence of such depressions in the future. This was summarized as the Keynesian theory (Smiley, 2008, p.1).
The end of the Great Depression
With the election of Franklin Roosevelt as the president of the United States, in 1932, a new chapter in the efforts of ending the Great Depression was opened. Roosevelt got most of his votes due to his policies regarding the creation of programs with the Federal Government to help in fighting the depression.
Within a period of less than three months, his policy was incorporated into law. This saw the creation of about forty-two agencies meant to create jobs. The agencies were also meant to provide insurance against unemployment and allow the formation of labor unions.
A large number of the programs that were put in place this time are still in force today and they are very instrumental in protecting the economy against downturns. Examples of the discussed programs include the Federal Deposit Insurance Corporation (FDIC), the Social Security and the SEC (Amadeo, 2010, p. 1).
Despite Roosevelt’s efforts, the economy was faced with seemingly insurmountable problems that made the recovery process considerably long. For instance, the rate of unemployment was unbelievably high in the decade between 1930 and 1940. It remained more than 10% until the start of the Second World War when some jobs related to defense were created (Smiley, 2008, p. 1).
President Roosevelt was, however, quick to react to these challenges in a constructive way. For instance, after the occurrence of a third banking panic in 1933 March, President Roosevelt announced a Bank Holiday that stopped a run for financial institutions after their closure.
This ensured that people did not withdraw and hold the finances they had in the banks and kept money in circulation. He also rejected Keynes’ idea of implementing heavy deficit spending and implemented his idea of wealth redistribution that was a great effort towards the fight against the depression (Temin, 1991, p. 39).
With the start of World War II, the depression began to end as countries were concerned about the coming hostilities and they had to prepare. Roosevelt adopted a strategy of deficit spending in a bid to arrest the economy. This had an enormous effect on the economy making the United States register record growth rates.
This is evidenced by the fact that President Roosevelt achieved a higher economic growth than President Ronald Reagan. Notable among the historic economic figures is the fact that the rate of growth during Reagan’s administration in the “Seven Fat Years!” (Temin, 1991, p. 23) was lower than the growth realized during the Great Depression.
Although most of President Roosevelt’s policies and strategies worked for the economic prosperity of the United States, he also made some mistakes. An example is when he reduced deficit spending after the remarkable growth of 14% in the year 1936. His reason for the decision was because he thought that the economy could grow to be imbalanced and so he wanted to balance their budget. The effect of this decision was the recession that took place in the year 1938 (Temin, 1991, p. 32).
The Congress also had considerable input to the end of the Great Depression. It helped to foil coup de tat plans by the rich which were organized as a reaction to Roosevelt’s idea of wealth redistribution. It also passed several acts that made economic recovery easier. Examples of such acts are the 1935 Banking Act, the Social Security Act and the National Labor Relations Act (Temin, 1991, p. 11).
The World War II was the greatest calamity the world has ever seen, it brought economic advantages to the United States. After becoming the world’s only superpower, America underwent a quick economic recovery registering more attractive ratio of debt as a percentage of their GDP after deficit spending. The tax rate was also significantly lowered with America experiencing an economic boom as from the year 1963 (Temin, 1991, p. 18).
Conclusion
The Great Depression was inevitable with the limited monetary policies and non-coordination of countries in making economic decisions. There was also limited protection of the workforce which was the reason that the depression hit countries hard. Policies in one country were responded by other countries with desperate counter-policies like currency devaluation that left the latter countries in problems.
These problems made them to make more economic mistakes in a bid to reduce the effect s of the mistakes they made earlier. This had a great effect on the world’s economy as a whole. The most affected countries in such cases were the most developed ones.
The occurrence of the Great Depression made the world learnt a very important economic lesson. Since then every country’s central bank, inclusive of the Federal Reserve in United States have been always aware of the essence of monetary policies in maintaining economic stability. Economists have over the years argued that it is impossible for a Great Depression of the same magnitude as the 1929.
This is because the world’s economy is unified and therefore the central banks of different countries coordinate their operations to make sure that such an occurrence does not happen again. We should thus be thankful that the Great Depression occurred this early because it is the reason we have commendably stable economies.
Reference List
Temin, P. (1991). Lessons from the Great Depression. New York. Barnes & Noble.
The government plays a very important role in the regulation of a country’s economy by regulating and authorizing the amount in circulation and the amount held by banks and other financial institutions.
This process can be done in two different ways which include monetary policy and fiscal policy (Frank & Bernanke 42). Monetary policy is the process where the government intervenes by administering and controlling the amount of money in the economy using the Central Bank in many countries and the Federal Reserve in the United States.
This is effected in several ways which include buying of government securities in the open market operations, interest rates, discount window rate and controlling the minimum reserve requirement ratio. Fiscal policy is where the government does not directly affect the supply of money in the economy thus it affects the amount of money by use of taxes and government spending (Friedman and Schwartz 79).
In the 1930s the U.S economy almost collapsed when most civilians lost their jobs and the stock market crashed due to the persistent fall in stock prices which led to increased sale of stocks but with the forces of demand and supply, supply was way greater with no demand. This led to a financial panic since everyone wanted to sell their stocks.
Banks had also invested a large portion of their clients deposits into the stock market which rendered then bankrupt forcing them to close down. People ran to the remaining banks to try and salvage the remaining amounts of money before they could close down. This affected other countries although not as much as it did in neighboring countries. This led to the intervention of the government to restore the economy since unemployment increased at an alarming rate (Bernstein 53).
Many economists especially the classicals advocated for minimal if not all government intervention and claimed that the forces of demand and supply would adjust themselves until the economy was at equilibrium but with government intervention, the forces would be disrupted and slowed down thus, would not work effectively. This theory was overruled by the John Maynard Keynes who developed the Keynesian theory which argued otherwise (Glasner 40).
He proposed government intervention to correct the economies instability especially in the case of correcting inflation and recession. The government through the Federal Reserve uses various tools to affect the economy which mainly focus on the rate of interest prevailing in the market, the amount of money in the economy through money supply and the aggregate expenditure.
The main question to ask is what caused the great depression? It is believed that the crash by the stock market was caused by the stringent monetary policies which were set by the Federal Reserve. Some of the policies were persistent increase in the Fed Funds rate which led to stock market to crash. This led to investors selling their dollars in exchange for gold while others withdrew their funds and exchanged it to other currencies (Bordo et al 78).
The government tried to preserve the value of dollar from depreciating by raising the amount of interest rate which caused further bankruptcy to the businesses.
The proper way to help fight deflation was to adjust the amount of money supply in the economy but instead the Federal Reserve restrained from increasing money supply. As investors withdrew money from banks causing financial plight, others exchanged the dollars to other currencies and invested them in other countries, a move which the Fed did not bother with it thus, led to further decrease in money supply in the economy a process known as contractionary monetary policy.
Money supply dropped dramatically to low levels of up to thirty percent. Instead the Fed should have used expansionary monetary policy where it should have increased the amount in the economy through increase in government spending, reduction in taxes and reducing the interest rate so as to increase the amount of money in circulation (Mankiw 45).
The great depression was tackled by the introduction of new policy makers where Franklin Roosevelt succeeded Herbert Hoover who was blamed for the cause of the depression. Roosevelt stabilized the economy by introducing new policies and rules. Banks that had closed down were reopened once they seemed to be stable enough. He signed the “new deal” to create new programs to combat the great depression into laws which were used to create jobs and provide unemployment insurance (Hall and Ferguson 59).
These programs alone could not combat the great depression alone and so this led to the entry of World War II that helped to create defense related activities. U.S and other countries affected turned to currency devaluation and expansionary monetary tactics in recovery of their economies. U.S recovered later than other countries like the Britain and the Argentina because it did not devalue its currency and abandons the gold standard until 1933 and recovered later on.
Monetary expansion was from the gold inflow into the country from Europe due to the rise in political tension which broke to World War II. Interest rates were lowered and investors encouraged taking up loans since credit was made to be readily available to all (Klein 30).
This stirred up expectations of inflation a sign to fight deflation building confidence to investors that they would earn enough profits and wages to help repay the loans which they were to borrow. Many consumers and businesses responded well and it was evident in the increase in interest sensitive investments such as fixed assets like motor vehicles, machinery and trucks.
Fiscal policy on the other hand was not as much effective as the monetary policy. Taxes were highly increased when the government tried to balance its budget when it reviewed the revenue act of 1932. This was a blow to the recovery as it discouraged spending which was a contractionary process. Many unemployed persons were offered jobs in government projects and farmers encouraged by being paid large amounts of money through the Agricultural Adjustment Administration.
Some of the effects of the recovery from the great depression were human suffering due to the wars. Many were left in poor living standard conditions due to lack of jobs. It led to the end and use of gold standard internationally. Many countries also aborted the system of fixed exchange rate regime and preferred the floating rates although the fixed currency exchange rate system had been brought forward under the Bretton Woods System (Eichengreen 48).
During this period, labor unions were formed and grew drastically as it promoted collective bargaining. This led to the introduction of unemployment compensation and even old age insurance via the Social Security Act.
The Securities and Exchange Commission was established in order to monitor and regulate the stock issues and trading practices. Banking act of 1933 was established which introduced Deposit insurance that helped kill banking plights and panic and also prohibited banks from underwriting or dealing with stocks and securities.
Another effect is that policies led to a decrease in savings both government and private savings, which means that a higher fraction of output would be used to pay the debt thus consumed abroad and less if not any consumed at home (Hansen 89).
The great depression was a very good lesson to the Federal Reserve and other Central Banks in the monitoring and regulation of the economy through the intervention of the government. If the U.S government did not intervene the effects would have been worse according to Keynes, and the economy would have collapsed maybe to worse extent.
Other economists such as the classical learned from Keynes theory and most of them up to date advocate for the intervention of government in stabilizing the economy. The only thing to disagree about is the tools to be used and which one is more effective, appropriate or do not lag. In some cases it is best if both fiscal and monetary policies are used together in order to prevent both inflation and depression.
It also led to the development of new macroeconomic policies which did not exist or were not familiar to the policy makers. In Keynes General Theory of Employment, Interest and Money (1936), he suggested that use of fiscal policies which increased government spending, reduction in taxes and monetary expansions could prevent depression and recover an economy (Temin 22).
Works Cited
Bernstein, Michael. The Great Depression: Delayed Recovery and Economic Change in America, 1929-1939. New York: Cambridge University Press, 1987. Print.
Bordo, Michael D., Claudia Goldin, and Eugene N. White. The Defining Moment: The Great Depression and the American Economy in the Twentieth Century. Chicago: University of Chicago Press, 1998. Print.
Eichengreen, Barry. The Gold Standard and the Great Depression, 1919-1939. New York: Oxford University Press, 1992. Print.
Frank, Robert & Bernanke, S. Principles of Macroeconomics. Boston: McGraw-Hill, 2007. Print.
Friedman, Milton, and Schwartz, Anna . A Monetary History of the United States, 1867- 1960. Princeton: Princeton University Press, 1963. Print.
Glasner, David. Free Banking and Monetary Reform. New York: Cambridge University Press, 1989. Print.
Hansen, Alvin. Full Recovery or Stagnation? New York: Norton, 1938. Print.
Hall, Thomas, and Ferguson, David. The Great Depression: An International Disaster of Perverse Economic Policies. Ann Arbor: University of Michigan Press, 1998. Print.
Klein, Lawrence.The Keynesian Revolution. New York: Macmillan, 1947. Print.
Mankiw, Gregory. Macroeconomics. New York: Worth, 2003. Print.
Temin, Peter. Lessons from the Great Depression. Cambridge: MIT Press, 1989. Print.
Economic depression is defined as the sustained and prolonged down-turn in the economy of a country. Depression is considered more extreme and severe than economic recession. Though depression is considered a form of recession only that depression is characterized by its length, the abnormality of economic factors like rising cases of unemployment, decline in credit availability and also shrinking output and highly volatile monetary value.
Depression is linked to the following two indicators; decline in the Gross Domestic Product by a margin of more than 10% and secondly a recession period exceeding 2 years. According to Foldvary, recession is derived from the word recede that implies falling back and it lasts for a very short time and depression is understood based on the degree of output fall and the extend of the down-turn (Foldvary 3).
An economic depression happens when there is fall in output below the long-run trend.
The Depression of 1873-1879
This depression was as a result of the bankruptcy of the railroad investment firm of Jay Cooke and company and particularly the restrictive monetary policy of the federal government; this is whereby the gold standard increment could not maintain the pressure for money demands that could enhance the growth of the economy. Deflation is also a factor that led to this depression (Watkins and Allay 1)
The Depression of 1893-1898
This was considered to be the worst form of depression ever witnessed in the US before the 1930. It first emanated from the agricultural crises that affected the southern cotton belt and the Great Plains in 1880s and it later hit the Wall Street and the urban areas in 1893.
This from of depression led to a massive unemployment which is still considered the highest in the US history at 20-25%, the depression resulted in widespread poverty among the Americans of various income levels. The magnitude of the depression was so acute that by 12896, it was made a popular subject of political campaigns (Edwards 1)
The Great Depression of 1929-1933
The United States of America experienced the worst, the longest and the most severe economic depression in the year 1929. This depression led to an acute decline in output, extreme unemployment and drastic deflation in the USA and it has been ranked the second calamity to the civil war.
This depression was largely associated to several factors like the reduced consumer demand, great financial panic and misplaced government spending that forced a fall in economic output.
This depression led to the reduction in industrial production by 47% and the subsequent reduction of the Gross Domestic product (GDP) by 30%, it also resulted in the decline in the wholesale price index or otherwise referred as deflation by 33%; also the unemployment rate reached 20% which was considered the highest point at that time (Romer 1).
This depression is just considered severe when compared to the next depression to hit America in the year 1981-82 that resulted in the decline of GDP by 2%. The USA recovery from this depression began in 1933 when the GDP began to improve at 95 per annum (Romer 3).
The 1930 depression saw the increased level of unemployment characterized by a lot of labor force but no work to do and the worst part of depression was in 1933 when the unemployment rate fall below 10%. Recession appeared twice during the great depression, in the august of 1929 and March of 1933 between as indicated by the following graph;
Concerning unemployment, the high rate of unemployment is demonstrated by the following graph.Another main indicator of the great depression is the GDP which was greatly affected as seen in the following graph.
During the great depression, the most hit sector was the banking sector. The following table is an indication of how banks were affected including the number of suspended banks and also indicates the decrease in the number of banks as a result of merger, failure or collapse and voluntary liquidation.
Number of banks and bank suspension
Year
Number as of 12-31
Suspensions
1929
24,633
659
1930
22,773
1350
1931
19970
2293
1932
18,397
1453
1933
15,015
4000
1934
16,096
57
Causes of the Great Depression
The most critical cause of the great depression in the USA was the reduction in spending or otherwise referred as the reduced aggregate demand; this resulted in decline in production since manufacturer noticed an anticipated rise in inventories. This was reflected in other countries due to the factor of gold standard. Other factors that necessitated the great depression are:
The stock market crash: the great depression is associated with the tight US monetary policy that targeted the limitation of stock market speculation; this was due to the mild recession that had been witnessed between 1924 and 1927 that had witnessed the massive rise in the stock prices in 1920 and reached the optimum in 1929 and as an immediate measure, the federal reserve had raised the interest rates in order to stop this spiraling stock prices and this largely affected the construction and the auto mobile industries.
The fall in the stock prices in 1929 to extend that could not be justified by the anticipation rate resulted to the loss of investor confidence and subsequent bubble burst in the stock market.
This led to the panic selling on black ‘Thursday’ on October 24, 1929. The previous rise on stock prices had triggered a massive purchase of stock by the investors using loans and hence this price decline forced some investors to liquidate their holdings thus worsening the fall in prices. This crash in the stock market led to the considerable reduction in the consumer aggregate demand especially in the area of durable goods and investments and great fall in output.
Banking panic and monetary contraction: this was experienced in the year 1930; banking panic occurs when “many depositors lose confidence in the solvency of banks and simultaneously demand their deposits be paid to them in cash” (Romer 8); this can lead to those banks that hold deposits as cash reserves to liquidate loans so that they be in position to pay the cash demands. This process of immediate liquidation can force any solvent bank to collapse.
This continued till 1933 when President Franklin Roosevelt proclaimed the ‘bank holiday’ in 1933 that involved the closing of all banks and could only re-open upon being considered solvent by the government inspectors. Economists largely associate this bank panic to the “increased farm debt in 1920” (Romer 8) and government policy that encouraged “small and undiversified banks” (Romer 8).
The gold standard: economists largely associate the 1929-1933 great depression to the Federal Reserve; they accused the federal reserve of causing a big decline in the American money as a measure to preserve the gold standard. The gold standard implied that each country should fix the value of its currency based on the standard of gold.
International lending and trade: the USA had expanded its foreign lending to Germany and the Latin America, this declined in the 1928 and 1929 due to the high interest rates and the flourishing stock market; “this reduction in foreign lending resulted in credit contraction and the reduction in the output of borrower countries” (Romer 8).
Economic impact of the Great War: when the first broke, no one expected that it would be of the magnitude witnessed; no one predicted the length of the war, the economic expenses of the war and the degree of destruction.
The war caused a lot of infrastructural destruction, loss of lives and monetary value in the countries of Europe; this on the other hand precipitated a period of economic boom in the countries of Canada, USA and Latin America since the countries of Europe exhausted their gold reserves to borrow money, other countries also printed extra money. This war interrupted with patterns of domestic and international trade which preceded the economic depression.
Sources of Recovery
The two main ways of curbing the inflation were indentified as the currency devaluation and monetary expansion. Devaluation “allowed countries to expand their money supplies without concern about gold movements and exchange rates” (Romer 8). Another way of curbing the crises was through the imposition of protectionism measure; this led to the launch of various tariffs, the 1988 US presidential seat was won through protectionist ticket.
Economic Impact of Depression
The depression influenced the US economy in a great way; some of them include the following:
Human suffering: for the very short time of the depression, there was drastic increase in the output and the standard of living also a substantial fraction of the labor force could not find employment.
Change on world economy: the great depression brought to the end the international gold standard era.
Increased government involvement in the economy: after the depression, there was an increased government participation in the economy particularly in the financial market; evidence was the establishment of the Securities and Exchange Commission by the USA.
Development of macro-economic policies: most of these policies were aimed at curbing the downturns and the upturns.
Conclusion
Depression is considered one of the worst macroeconomic aspects that can befall a country; the effects of economy are so devastating since its impact can be felt across the world. The US have experienced a lot five depressions of different magnitude and that has equipped it with experience on the various macroeconomic issues that are required to tame any further depression. The US has on the recent past experienced only recessions which are considered mild form of depression.
It is worth mentioning that from the five economic depressions to have hit the US, all the possible remedies have been tried and applied, despite all the efforts it is not clear whether the business cycle that lead to depressions has been removed. Depression an also be considered a natural economic aspect that can be beyond government intervention. This is exemplified by the economic depression of 1907 and 1920 which was eliminated within a year without the government intervening.
Works Cited
Edwards, Rebecca. The depression of 1893. Projects, 2000. Web.
Foldvary, Fred. The Depression of 2008 2nd edition. The Gutenberg Press, 2008. Web.
In the year 2000, United States economy experienced a period of slow growth that was characterized by financials crisis. The main cause of this recession was the housing bubble which burst during that time. When recession takes place in any economy, it usually comes along with very many complications. For instance, the level of unemployment increases rapidly because production is usually very low. The recession was a major blow to the U.S. economy as it cost the economy a significant amount of time and financial resources to recover.
When there is an economic problem like recession, the situation can either be rectified through a monetary policy or a fiscal policy. However, both policies are used in combination in order to come up with the most effective effects. Both monetary and fiscal policies act by reversing the negative effects impacted by the condition on the economy.
For instance, since recession slows down the economy, the monetary and fiscal policies should be aimed at reviving the economy. Therefore, the decisions made should be geared towards the expansion of the economy. In order to solve this problem, the US government came up with expansionary monetary and fiscal policies. Expansionary policies help in reviving an economy after a recession.
Expansionary Monetary policy
An expansionary monetary policy is any action by the Fed that results in an increase to the total output or aggregate demand in an economy. An expansionary policy conducted during recession is aimed at stimulating economic growth. During recession, economic activities are generally slow and the entire economy comes into stand still (Cummins & Cohen 13).
In such a situation, any monetary decision should be directed towards the revival of the economy. This is achieved by ensuring that every monetary decision made is targeted towards the expansion of the economy.
One expansionary monetary policy which Fed conducted during the great recession is cutting down the interest rates. This policy leaves the level of inflation unchanged in the long run. However, the level of output will increase gradually in the long run. When the interest rates are low, people will tend to increase the amount borrowed since borrowing is now inexpensive.
As a result, the level of investment will increase hence promoting expansion in the total output. In 2008, the US government applied unique mechanism in an effort to solve the financial situations during that time. The fed government made an aggressive reduction in interest rates in 2008 going down to zero rates by the end of the year (Blinder & Zandi 10). This increased the level of production in the economy hence creating employment.
Later, the government was also engaged in other expansionary measures in order to boost the economy further. For instance, it bought treasury bonds. This also had a significant impact increasing the output during this time.
The fed also purchased Fannie Mae and Freddle Mac mortgage-backed securities (MBS) in an effort to lower the long term interest rates (Blinder & Zandi 15). When the government purchases securities, it increases the money in circulation. For instance, the bank will have more money to lend to the people. This acted by generating the economic growth hence solving the problem of recession.
However, increase in the interest rates will have the opposite impact on the economy and will worsen or trigger recession. When the rate of interest is high, the cost of borrowing will increase. Borrowers will be forced to pay back with more interest. This will discourage investors from borrowing. As a result, the level of investments will drop hence reducing the total output. In other words, all the monetary policies employed during recession should be aimed at reducing interest rates rather than increasing.
High interest grates will also have an impact on consumption. For instance, the consumption of durable products is sensitive to interest rates. In some cases, individuals requires some financing to be able to buy expensive durables like automobiles, Electronics like computers, house furniture among other things.
When the interest rate is high, then individuals will tend to cut down on consumption of such goods. In other words, the households will take into consideration the level of interest rates while making decisions to purchase durables.
In other words, the Fed government used expansionary monetary policy which left the level of interest at a low level. This acted by stimulating both consumption and investment. These activities had a significant impact in generating consumption in the economy.
Expansionary Fiscal Policy
Expansionary fiscal policy is any policy by the government that is aimed at generating economic expansion. During a recession, the total output in an economy usually falls as a result of slowed economic activities. The aggregate demand curve will therefore shift to the left.
The total output will fall below the potential level (American Century Investments par 5). This implies that the economy will be producing below its potential output. As a result, inflation will fall with time. In order to solve the situation, there is a need to implement an expansionary monetary policy.
During the great depression, fiscal policy played an important role in reviving the US economy. In this case, an expansionary monetary policy also was employed in the fight against the great recession. These include the decisions the government makes regarding spending and taxation. The US government employed the fiscal policy in its effort to bring the economy back to its original position. Fed also attempted to cut down taxes in order to expand the economy.
During the great recession for instance, the Fed government was expected to use an expansionary fiscal policy to solve the problem. Therefore, the government increased its spending. The government expenditure stimulated economic growth hence solving the major problem of recession. In other words, increase in government purchase led to increase in the aggregate demand which resulted in an increase in the total output.
The Ricardian equivalence theory helps in understanding how the fiscal policy interacts with decisions that consumers make in a certain economy. “This theory known as Ricardian equivalence implies that the impact of taxing and spending decisions on the economy may be counter-intuitive to what we would expect from our basic IS-LM analysis” (Weerapana par13).
In the Ricardian equivalence, it is assumed that in case the government cuts down taxes using a debt, such an act cannot lead to an increase in consumption. In other words, the spending increases and tax cuts, which are funded through a debt, cannot have any impact on the economy (Weerapana par 15). Therefore, this policy cannot be fully reliable in case of a recession where there is a need to expand production.
Ricardian equivalence indicated that the future budget situation can have a significant impact on the current budget situation. For instance, an announcement of a future increase in government spending will lead to a decrease in current spending because the government will increase taxes. When people expect the tax rate to rise, they will tend to cut down their spending as they expect their disposable income to fall in future from increased tax.
In some cases, the government purchases may have opposite effects. While this increase in the government purchases lead to an increase in demand for the goods and services, this may also lead to a rise in interest rates (Mankiw Taylor 35). High interest rates will result into a fall in the level of spending on investment leading to a drastic fall in the aggregate demand. The situation where a fiscal expansion lead to an increase in the interest that results in a fall in the aggregate demand is referred to as crowding effect.
Conclusion
In conclusion, this discussion has clearly shown that expansionary, fiscal and monetary policies played a pivotal role in saving the US economy from the great depression. During the period, the economy experienced slow growth. Expansionary monetary policy acted by reviving the economy hence increasing the output. Increase in production also helped in generating employment activities hence lowering the level of unemployment in the economy.
Works Cited
American Century Investments. “Monetary and Fiscal Policy.” American Century, 2011. Web.
Cummins, Jason and Cohen, Darrel. “A Retrospective Evaluation of the Effects of Temporary Partial Expensing.” Federal Reserve Board. No. 2006-19 (2006).
The recent recession triggered by the housing market, bubble bust in the United States cases a negative ripple effect in the world’s financial markets. It triggered a recession that led to loss of millions of jobs in the world. Many governments had to institute bail out to save companies from collapsing.
The governments also instituted austerity measures that necessitated the slashing of national budgets effectively laying off millions of government workers globally. The US mortgage crisis that was the genesis of the financial crisis is blamed on the laxity of law enforcers or failure of the laws that have governed the financial market in the US. After the great depression in 1933, the US enacted laws that aimed to stem another crisis of the Great Depression’s magnitude.
Though the great recession was not as serious as the Depression, it cased major financial imbalances that will take years to recover. It’s therefore safe to assume that the laws that have been crafted over time since the Great depression to guard financial markets against such crises have failed to work, or so it seems. The administrations of both Presidents Obama and Bush ensured the enactment of laws that stemmed the crises and stopped the bleeding of jobs.
This action by the two administrations is reminiscent of the many that have characterized the formation and adoption of public policies especially those that are business oriented. The motivations behind the laws of this nature is the perceived gap created by business practices that are likely to result in uncouth business practices or complications in the financial system that lead to such crises. The laws are also crafted to protect investors from losing their money when these transactions are not carried out within the law.
One such act is the Gramm–Leach–Bliley Act (GLB), also referred to as the Financial Services Modernization Act of 1999, (Pub.L. 106-102, 113 Stat. 1338). The paper will focus its analysis on this law, its history, the rationale behind its enactment, its implementation, its impacts and the policy analysis.
This a federal act of the United State enacted in the year 1999 and signed to law by President Bill Clinton. The law sought to regulate the dealings of financial institutions regarding the private information of their clients (Ingersoll et al. 1999, p. 48). To effectively work, the law included three parts i.e. The Financial Privacy Rule that governs the collection and use of private information, the Safeguards rule that governs the implementation of security programs by financial institutions.
On that bit, the law requires the financial institutions to implement security systems that ensure effective security of clients’ private information. The last component of the law is the Pretexting provisions, which aims to curb access to client information through false pretence and /or impersonation. Additionally, the law makes it mandatory for financial institutions to serve to customer written notices that explain in detail their institutional practices about sharing information (Rezaee, 2001, p. 106).
The above however was not the main reason why this act was passed. The main reason for the enactment of the law was to facilitate the opening up of the market among companies in the larger financial sector mainly; banking companies, securities companies and insurance companies.
Through the Gramm–Leach–Bliley Act (GLB), curbs imposed by the Glass–Steagall Act of 1933 prohibiting companies to offer banking, insurance and brokerage services were removed.. The act in effect opened the gate for the merger of the companies operating in the three sections described above.
The removal of the regulations however presented major gaps that potentially put customer private information at risk. Because of the mergers that were anticipated, there was a feeling that the companies may access, consolidate the customer information they had and sell it for other purposes other than for business. For instance, insurance companies were largely in control of most health records while banks maintained a huge database of financial information.
Brokerage firms on the other hand had significant information on investment activities of their clients. A merger of the three of even two of them will have therefore exposed the customers to greater risks of illegal access and use of information. That is why the act contained the privacy provisions that regulate the use and sharing of private information of customer of companies that needed to merge.
Need for Enactment
The need to enact the Gramm–Leach–Bliley Act (GLB) act was due to both business and government failures (Biegelman, 2009, p. 76). The US lawmakers referred to the law as a modernization law that meant to unlock the potential that financial companies had.
Through that argument, Congress passed the law that repealed sections of the Glass–Steagall Act of 1933 and the Bank Holding Company Act that forbade banking companies from carrying out activities deemed to belong to the insurance sector. Congress therefore felt some potential for economic growth was inhibited by the absence of such a law. Through the GLBA act, banks were eligible to engage in a variety of financial services.
At the same time, mergers taking place at the time in other industries apart from the financial sector in Europe especially led to the inclusion of the privacy elements of the law (Axelrod, 2009, p. 59). The European Union enacted the Data Protection Directive that required non-EU companies that dealt with EU citizens’ data to provide the same protection that these citizens were afforded in the EU zone.
The self-regulatory system in the US was especially not favored by the EU hence the need to enact legislation in the US that provided the same protection as the EU. At the same time, there was overwhelming public opinion in the US that demonstrated dissatisfaction on the way banks and other financial institutions handled private information.
Furthermore, there were scandals that served to highlights the risks involved in the breach of privacy. For instance, there was a scandal involving the Charter Pacific Bank of Agoura Hills, California and an adult website company. The bank illegally sold private credit card information of its clients to the company. The company then debited the accounts of the clients for services not rendered.
In 1998, NationsBank was charged and fined millions for selling customer information to an affiliate investment company. The affiliate used the information to market its high-risk products to low risk borrower who in turn lost millions of dollars. Another case involved U.S. Bankcorp and the Minnesota Attorney General when he sued it for selling customer private information with third party marketers.
The increasing private information violations and the expected avalanche of merger needed to be controlled. The GLBA provided the solution.
Implementation
The GLBA is a federal act and therefore it’s enforced by federal agencies (Dunham, 2000, p. 98). The various federal agencies are in charge of enforcing the GLBA law. The agencies are those that are involved directly overseeing regulation of financial institutions and other companies deemed to be financial institutions as specified by the GLBA act.
The most important institution that is involved in the implementation is the Office of the Comptroller of the Currency. Other are the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation, both of who should work together with the comptroller of currency.
Other agencies tasked with implementing the law include the Office of Thrift Supervision, The Securities and Exchange Commission, and the National Credit Union Administration. Additionally, the individual State Insurance authorities and the Federal Trade Commission (FTC) also have a hand in enforcing the GLBA act. According to the GLBA, financial institutions are companies that avail financial services to individuals. These services may include and not limited to loans, financial and/or investment advice, and insurance services.
According to the act, all institutions that meet the definition of a “financial institution” directly or by incident fall under the jurisdiction of the Federal Trade Commission. Non-bank mortgage lenders, real estate settlement service providers, banks, debt collectors, financial and/or investment advisors, loans brokers and real estate appraisers fall under this category that is directly administered by the FTC.
For the enforcing institutions mentioned above to effectively exercise their jurisdiction, it’s important that the financial institutions must be significantly be engaged in financial services or production that clearly makes them financial institutions. In the insurance sector, the GLBA states that jurisdiction is first enforced by the state so long as the law of the state minimally complies with the Act. Further, the state law can only enact provision for stricter compliance and not less than what the GLBA requires.
It is important to note that the law sets the floor and ceiling that state laws can reach. It therefore means that the states can pass laws stricter than the federal version but not less.
Impact on Business and Society/Successes
Since its passage, the GBLA law has registered mixed success. Many companies have taken the advantage to merge while client’s private information is safer than it used to be. At least the occurrence of scandals involving divulging of client information has been minimal. There is a feeling however that these success have not been realized optimally. It’s therefore important that the hurdles that are preventing more companies merging be eliminated before considerable success id realized.
The Department of treasury says that the reaction to the GLB act has been evolutionary rather than radical. In 2003, the Department of treasury reported that out of the 6415 banking institutions in the US at the time, only a handful-633 had taken advantage of the act to transform to financial holding companies (Moeller, 2005, p. 76). Moeller (2005, p.76) says that consolidation took place but not in the scale and speed that nay analysts has predicted.
This was due to a number of factors. According to (Winston & Winston, 2009, p. 64) retail, banks have difficulty in buying insurance underwriters as opposed to brokerage of insurance services. Lack of experience in these banks that would have wanted to engage in wide financial services contributed to the lack of enthusiasm form these financial players. Similarly, there was slow venturing into banking by brokerage firms owing to their diminished branch network, and lack of back shop footprint.
There have been some mergers since the enactment of this law, for instance the 2004 merger of Bank of America with Fleet Boston. Despite the merger however, the conglomerates have experienced problems concerning difficulty in integrating investiments and insurance services. Additionally many other banks have had trouble with packaging of investiments and banking services to an extent that some of them have had to engage in questionable arrangements that have caused scandals.
Despite the look warm reception, the treasury reported that the financial sector that has experienced the most significant change since the introduction of the Act is the securities, underwriting and dealing sectors. In these sectors, Department of Treasury says that banks have increased their ownership and as well as activities. Similarly, banking involvement in the insurance industry has experienced significant changes as a direct result of the enactment of this law.
According to Moeller (2005, p.85), the GLBA legislation introduced significant alteration to the legal framework that governs activities of financial organizations and their affiliates in the United States. The alterations were chiefly brought by the repeal of the some sections of the Galss-Steagall Act as well as the Bank Holding Company act of 1956.
(Rezaee, 2001, p. 120), states that the law has had limited impact on the Federal Home Loan Bank provisions. The act had provisions whose aim was to expand the FHLBank system for the smaller depository institutions in the US. Under the law, eligibility of several collaterals was extended for the advancement of loans to small businesses. The provisions collectively are thought to have positively impacted small businesses.
Policy analysis
The enactment of the GLBA act opened the markets for mergers and acquisitions in the financial sector (Winston & Winston, 2009, p. 64). Many companies in the industry favored the passage of the act at the time. One argument that they put forwards was that after the passage individuals will be able to carry out their financial transactions at one go instead of doing savings and investiments at different institutions.
One of the earliest beneficiaries of the passage of the act was CitiGroup, which had merged with traveler insurance. However since the law at the time could not allow, the new entity had to be issued with a forbearance until the act was passed hence acquiring full legal status (Mayer et al 1999).
Weaknesses
There has been a lot of analysis on the effects and effectiveness of the GLBA act. However, the law is criticized by as having a number of flaws that contribute to its weaknesses (Schell, 1999, p. 56).
The Act according to (Schell, 1999, p. 60), GLBA does not protect consumers. The opt out standards has been cited as one of the many provisions so GLBA that unfairly places on an individual to protect privacy. The opt-out standard effectively puts the customer on weaker position to control their financial information that they may consider private.
The provision assumes that the financial institutions will share the customer information unless they are told not to. Additionally it assumes that financials institutions are free to share the customer information incase of non-response from customers when the institution communicates to them.
The enforcement mechanisms of the GLBA have also come under attack.. (Rezaee, 2001, p. 130) asserts that enforcement and compensation mechanism laid out in the act are quite weak. He says that the mechanisms are weak to a point that they cannot assure compliance even in the face of the existing weak privacy protection mechanisms. The fact that enforcement largely rests with federal agencies leaving the individual with virtually no right of protection is a weak point that does not adequately address the problem at hand.
Another weakness of the GLBA is the fact that it leaves a gap under the service provider/ joint marketing exemption. Under this exemption, the financial institutions can freely share private customer information with third parties even if the customer has opted out. This gap can easily be exploited by companies who may misuse customer information under the pretext of joint marketing.
Customer control of affiliate marketing information sharing is severely hampered. Customers who may be engaged in affiliate marketing have little control over sharing or their information since they have not been considered under the opt out provision. (Benson et al. 1999, p. 79) says that financial institutions can easily amass hundreds of affiliates, which may not be dealing in financial services. They can then share customer information since customers will not be having an opt out right.
The notices that will be issued under the third provision of the privacy section are written in legal jargon, that most ordinary people won’t understand. The law assumes that companies will assists customers by explaining the complex legal information that will help a customer make an informed choice. There is also the concern over the convoluted and confiding opt out notices and policies. The confusion that more often misleads clients is purposely done to serve the issuing entity’s interests.
The act provides little room for maneuver of customers in the cases where the notices lack transparency. Additionally, the notices that GLBA demand be issued state the companies inform customers of their intention to share the information. However, they do not provide for a provision that requires the companies to reveal with whom they are sharing the information (Schell, 1999, p. 99).
Many financial sector critics including President Obama have hit out at the law as the main cause of the 2007 financial crisis that almost led to the collapse of the global financial system.
According to the critics, the law led to the deregulation of the financial industry. Deregulation facilitated the formation of gigantic companies that were obsessed with the “too big to fail” attitude. Furthermore, the law necessitated less oversight on sensitive financial dealings such as derivatives that were later taken advantage of by unethical financial dealers.
Recommendations
In the face of the above weaknesses, there is a need for the amendment of the GLBA act to institute changes that will ensure better protection of consumers and security of the financial system.
There is need for financial institutions to implement an opt out approach that defines the use of personal information. That way, accidental, unwanted or disclosure through negligence will be avoided besides placing the burden on the actors who will be receive and gain from the disclosed information.
This way the financial institutions will be protecting themselves and the privacy of their customers. Failure to implement and use of the opt out provision for advancement of corporate interests is likely to adversely affect the companies (Benson et al. 1999, p. 47).
Additionally, financial institution should consider availing and accept alternative opt out methods in cases where an opt out framework is maintained by the institution. An amendment requiring the financial institutions to avail the opt out process through local branch offices or through the internet needs to be done.
This will help customers make an informed decision when opting out. On the same note, the financial institutions should be required to provide simple and coherent privacy policies. The law should ensure these policies follow universal standards of readability for the enhancement of transparency (Benson et al. 1999, p. 47).
It’s important that the amendments to the GLBA law require financial institutions ton disclose that the information that they collect will be used for. This can be availed in the privacy reports and will greatly enhance transparency and accountability in these institutions.
Furthermore, the amendments should require financial institutions to grant customers rights to statutory access to be enlightened about industry practices. As a result customers will be informed on the information collecting process as well as their uses. It will come in hand in making decisions.
One of the most glaring omissions by the GLBA is the failure to give state authorities power to oversee the transactions carried out by these financial institutions. It is therefore important for any amendments to include provisions that will grant state authorities concurrent jurisdiction for the effective enforcement of the law. Given that all companies are situated in individual states, the states’ law enforcement agencies will be better placed to implement the law’s provisions (Schell, 1999, p. 101).
The law will also need to have provisions that will make it easier for offended clients to seek redress when privacy rights have been violated. Currently the law does not give a private right of action, which greatly hampers individuals in seeking redress especially if there are issues with opting out. Additionally, the amendments should consider giving the individual the right to access and review the information so that he/she can help in correction in cases of inaccuracies and/ or incomplete data.
There needs to amendments that help in the regulation of sensitive financial market practices such as trading in derivatives. Former president Clinton admitted that he was wrong and probably he may have been misled to accept the provisions of the law on the matter such as derivatives. The law as it is gives too much autonomy to financial companies. The autonomy has been unethically used and contributed to the fall of the housing market in 2008.
Many analysts believe the law should have been implemented in bits. The provisions contained in the law gave too much freedom to the financial sector in a sudden manner that clearly overwhelmed many institutions.
They also contend that the scope of operation given to these financial institutions should be reduced probably to more or less, to what it was under the Glass–Steagall Act of 1933. Its safe to assume that the provisions of this law that were repealed when the GLBA came to law played a crucial role in stemming a crisis of similar to the great depression and the 2008 financial crisis.
References
Axelrod, W. et al. (2009). Enterprise information security and privacy. New York: Thomson learning.
Benson et al. (1999). Financial services modernization: Gramm-Leach-Bliley Act of 1999. Washington: Routledge.
Biegelman, T. M. (2009). Identity Theft Handbook: Detection, Prevention, and Security. New York: Cengage Learning.
Dunham, B. W. (2000). After the Gramm-Leach-Bliley Act: a road map for insurance companies. Burlington: Thomsons Learning.
Ingersoll et al. (1999). Gramm-Leach-Bliley Act. New York: Routledge.
Mayer et al. (1999). The Gramm-Leach-Bliley Act: executive summary & review and analysis. New York: Sage.
Moeller, R. R. (2005). Brink’s modern internal auditing. Los Angeles: Routledge.
Rezaee, Z. (2001). Financial institutions, valuations, mergers, and acquisitions. New Jersey: Cengage Learning.
Schell,J.M. (1999). Private equity funds: business structure and operations. New York: Infobase Publishers.
Winston,J. & Winston, A. (2009). Complete Guide to Credit and Collection Law. New York: Sage Publishers.
Microeconomic indices are the indicators that demonstrate the economic status of a country (Mankiw, 2006). They give a direction as to how the economy would grow in the future. The governments, private investors and other organizations use this information as a key business decision making tool. It gathers historical data that relates to the economy and compares it to current trends. This enables the investor to compile a snapshot of economic fluctuations.
The changes in the economy may affect the direction of an indicator. It may be lagging, coincident or leading (Mankiw, 2006). Lagging indicators remain the same until after the economy has changed, whereas, leading indicators change before the economy has recognized the change. However, coincident indicators move at the time the economy changes.
Example of the coincident indicator is the Gross Domestic Product (Economic About, 2006). Examples of macroeconomic indicators include retail sales, real GDP, inflation rates, unemployment rates, savings rates and housing rates (Mankiw, 2006).
Real Gross Domestic Product (GDP)
Real (GDP) is described as the most comprehensive measure of United States economic performance (Mankiw, 2006). It is mostly used by the Federal Reserve Bank whose duty is to sustain the level of growth with stable prices and full employment. American policy makers are able to evaluate the performance in relation to the banks primary goal. They achieve this objective by monitoring trends in the overall growth rate. Other economic variables like rate of inflation and unemployment are also studied.
The gross domestic product measures services and products that are purchased or sold in the American economy. The National Council of Economic Education (NCEE) confirms changes in the economic sector are of significance. The changes to GDP provide the actual figures of what has happened. It provides a clue as to the qualities of American commodities without any change in the inflation level.
According to the article under review, the U.S.’s GDP would fall by 25% from its current $ 14 trillion to $ 10.5 trillion if the country is to go through a depression similar to that experienced in 1929 (Amadeo, 2011). The U.S has always been ranked fast in economic growth except for the period between early 2008 and late 2009 that there was a negative growth as indicated in the country’s GDP.
This was the first time the real GDP has slacked to a negative since 1993. It is clear that most countries in the world are going through tough times at the moment and it all depends on the economic principles adopted by the U.S. that will save it from such an experience. In this regard, the article indirectly presents the following principle.
A country’s standard of living depends on its ability to produce
Economic growth can be affected by public policy that encourages saving and investment. A higher savings rate can provide funds for loans and investment in capital equipment and the development of new technology for both new business opportunities and for increased productivity. Alternatively, countries with stable political and legal systems can encourage domestic and foreign investment in their countries for increased productivity and wealth creation for local residents.
The current situation in the U.S. is frustrating as outlined by Amadeo in her article. Banks are unwilling to lend money to business people and the same applies to the Federal Reserve that has been hesitant to launch QE3 even after QE2 has expired (Amadeo, 2011). As a solution, Amadeo advices American citizens to invest in education ensuring that they have at least a college degree to be assured of a job in the current economy.
A country’s Gross Domestic product is affected by the government policies that encourage acquisition of education. Educated individuals can apply new knowledge for more efficient production practices. They can also earn higher incomes and start new businesses, which can elevate a country’s GDP. Education has also been found to have an inverse relationship on a country’s birth rates. A smaller population can allow for a higher GDP and less stress on education systems and natural resources.
Similarly, governments also can play a role in the promotion of quality health habits and practices to allow for maximized human contribution and productivity. Finally, to gain the benefits of comparative advantages, governments can act to facilitate free trade.
As we have learned in the past modules, by specializing and leveraging natural resources, countries can incorporate their unique or more efficient practices to gain other goods and services that they are not as efficient in producing. Through comparative advantage and trade, countries can, therefore, enhance their GDP.
Unemployment Rate
This is one of the indicators economists observe to foresee the possibility of the economy diving in to a recession, or is already on the way to recession. It is used to show if the business cycle is in the downward or upward movement in the economic activity. Employment rate is defined as a percentage of people in the economy who are, qualified and willing to work but who are not working (Colander, 2004). It is affected by various economic conditions.
Unemployment rises if the economy is in recession. During expansion, the level of unemployment falls. In the study, there are two notable forms of unemployment to consider. Fluctuation of economic activity leads to cyclical unemployment while elimination of a position that is no longer needed in a company leads to structural Unemployment.
According to Amadeo’s article, approximately 14 million people in the U.S. are currently job seeking and more that 40% of this figure have been seeking employment for the past six months (Amadeo, 2011). Another 8.4 million people in the U.S. are on part time employment because they are not able to find full time jobs (Amadeo, 2011).
Unemployment rate in the U.S. has been on the rise and this raises concern to any economic analyst. As many graduate from universities and colleges yearly to join the job market, where is the economy headed to?
There are various reasons that explain the increase in the unemployment rate in the U.S. Some companies laid off their employees on a temporary basis, or permanently following the 2008-2009 economic recession. Some were as a result of structuring of the company while others were occasioned by companies inability to fund a program.
Most of these factors have a profound impact on the larger economy. This must have definitely increased the number of people fired from jobs and the overall unemployment rate as well. Even before the 2008 economic recession, unemployment rate was already in the rise.
Those fired from their jobs from March 2005 to March 2006, has risen from 2.3% to 2.8% (Congressional Budget Office, 2005). This, therefore, calls for adequate policies to ensure that unemployment rate is checked as it can have a negative impact in the general economy.
If we consider the use of monetary policy in establishing long-run trends while dealing with short-term challenges, we are confronted with one of the classic economic principles between inflation and unemployment. This leads us to Phillips curve as the economic most principle applicable.
The Phillips curve depicts that trade-off between inflation and unemployment in the short-run
Through government policy, expansion or contraction of aggregate demand can impact the inverse relationship between inflation and unemployment. For example, when the Fed reduces growth in the money supply to reduce inflation, it results in higher unemployment in the short-run.
In the long-run, the market adjusts through price reduction, which drives demand and production to increase employment. Economists agree that trade-offs between inflation and employment are not permanent, but they can be tools to deal with unexpected shocks to the economy. What is happening in the U.S. currently as depicted in Amadeo’s article is possibly the Fed’s strategy to curb inflation by reducing lending to the public.
Throughout history, the Fed has attempted to handle short-run economic shocks. In the 1970’s the price of oil dramatically increased. To compensate for the higher level of prices caused by the price of oil, the Fed increased the supply of money which led to higher inflation and higher unemployment.
In the 1980’s with inflation spiraling out of control, the Fed began to remove money from the economy, causing a drop in inflation but a large increase in unemployment. In 2001 with the terrorist attacks, corporate accounting scandals, and the dot-com bust, aggregate demand dropped and unemployment rose.
Under this scenario, the Federal Reserve Bank used expansion monetary and fiscal policies to return unemployment to its natural rate. Faced by the recent worldwide economic collapse attributed to problems in the housing and financial market sector, the U.S’ government reacted by increasing government spending, making transfer payments, and providing large loans to expand the economy.
The worry now, as economic principles foretell, is that inflation is around the corner for the US, therefore, it will depend on the ability of the Fed to make money supply adjustments carefully as it monitors consumer spending and saving and bank lending.
One last, but not insignificant, component of economic well-being is human behavior. The faith or trust that people have in what their governments is expected to do for economic prosperity have an impact on the realization of that belief. If a nation’s government can be trusted to respond in the benefit of its people, the people will accept trade-offs today for future prosperity tomorrow.
Unfortunately, history reflects more errors in judgment than successes in the government’s or the Fed’s ability to make accurate adjustments. Nonetheless, economics show that, despite the short-run fluctuations or trauma experienced in the market, in the long-run, in free economies, natural equilibriums do return as people adjust their behavior and expectations.
Inflation Rate (CPI)
Inflation rate is defined as general and continuous increase in the price level of commodities in the economy. A base price must be established first before determining the actual amount of increase in the price level.
The economists, therefore, require a price index that would enable them measure the level of inflation. Colander2 (2004) defines price index as “a number that gives a summary of what would happen to a weighted composite of prices of selected goods” ( p.21).
In Amadeo’s article, price index in measured by oil prices. The high oil price is a clear indication of inflation in her view as the world’s economy rests on oil as its foundation. High oil prices, therefore, will not only affect the U.S. economy, but the world as a whole hence the possibility of a worst depression.
Inflation also takes its roots from economic principle;
Prices rise when the government prints too much money
The concept of money is that it is something people use to represent a store of value that we use regularly to purchase commodities. It functions as a medium of exchange, so that we can trade it for goods and services, and as a unit of account in which economic values and prices are recorded.
The control of the money supply is handled by the Federal Open Market Committee (FOMC). The FOMC is the Fed, but includes just five of the twelve regional Fed bank presidents. Through the decisions made by the FOMC, the Fed can control the money supply.
To increase the money supply, the Fed can print dollars and buy treasury bonds from the public through the New Yolk Stock Exchange markets. Or, if the Fed wants to lower the money supply it sells treasury bonds from its portfolio to the public. Money supply in the economy is reduced through the process. This lessens the strain on the prices of commodities.
Banks themselves can participate in the control of the money supply. They can do so by increasing the reserves and deposits to enact the money multiplier effect. While the Fed controls the required reserve rates of banks, it does not prevent banks for holding more than the required rate nor from reducing the funds that it lends out.
As we have seen in recent times, banks may hold plentiful reserves on deposits yet not lend to the maximum that they could be under Fed regulations. This action, while conservative, may then adversely impact the supply of money, requiring the Fed to put money into the system through other means such as the purchase of bonds.
It also does not have control over how the general population saves or spends or takes out loans on money. Therefore, without perfect control, the Fed cannot fully control the money supply, and that can contribute to short-run fluctuations in the economy.
Housing Starts
This economic indicator provides a track at how many single family buildings or homes are constructed within a month. In the survey, each single apartment or each house is counted as a single housing start. One building that contains 200 apartments is referred to as 200 housing starts. The count incorporates both public and privately owned units. Mobile homes are exempted from this count.
A housing start indicates a measure of residence houses on which construction started each month. Under construction terms, a start is defined as the beginning of excavation as a foundation for the building or house that is meant to be a residence. Most of the data is available from the applications and construction permits for building homes. It is often offered in a seasonally adjusted format and an unadjusted.
The housing starts committee breaks down the monthly national report according to regions: Midwest, Northeast, West and South. During briefing, it is recommended to analyze the regional data. Such recommendation is the high degree of volatility. This level of volatility is normally attributed to the weather changes or natural disasters. A tsunami or floods warning could delay most of the housing starts in the regions.
In Amadeo’s article, the country is currently experiencing low housing prices. While this may be an incentive for U.S. citizens to own houses, the general economy remains at risk. Bank’s risk losing money through bad debts as home owners may find it difficult to pay their mortgages.
Better still, people are obviously reluctant to sell their houses at the current rate or even acquire bank loan for construction. Unless people are assured of better times, banks will be reluctant to fund housing projects and the impact will be worse on housing starts. Housing starts detect trends occurring in the economy as housing starts become the leading indicator.
A declining housing starts exhibit a slowing economy while increases in the housing start activity indicate a growing economy. The close relationship between housing starts and mortgage has a massive impact on the activities of the bond market. It affects the interest rates and the forecasts on its movements. An increase in interest rates leads to a decline in the housing starts.
Conclusion
The above economic indicators, such as unemployment rate, real GDP, housing starts, and inflation rate, are used as measuring tools in monitoring the economy as a whole. These indicators are also used to foretell the future growth of a country’s economy. They also help the governments, investors and other non-governmental organizations make the proper decision and necessary adjustments.
The information can be used to avoid a recession or depression by viewing and understanding the various economic trends. Amadeo’s article provides some insights as to the direction the economy might be headed to if no actions are taken. However, concluding that the U.S. is headed for a great depression could an overstatement of the situation.
References
Amadeo, K. (2011). “Is the U.S. headed towards the second great depression?” Web.
Colander, D. (2004). Economics. Supply and demand: Macroeconomic variables. New York: The McGraw-Hill.
Colander, D. C. (2004). Economic Growth: Business Cycles, Unemployment, and Inflation. New York: The McGraw-Hill.
Congressional Budget Office (2005). The Budget and economic outlook: Fiscal Years 2005-2014. Web.
History of great depression began in 1929 and lasted up to 1939. It was the longest and most severe depression experience in the industrialized western country. It originated from U.S and had grave impacts on the level of output, led to unemployment, and acute inflation spreading across countries on the globe (Christina, 2003).
However, in Canada, its impacts were severe as it indented and affected almost all aspects of life. The depression had both social and cultural costs. This paper therefore, discusses some of the causes of the great depression in Canada and highlights some of the recovery mechanism.
Literatures on this topic will be used in developing the arguments and explaining the cause of depression in Canada.
Literature review
Economic history
The severity and timing of great depression varied across countries. However, the depression was relatively severe and longer in United States and Europe. The cause of the depression stemmed from a variety of factors. For instance, decline in consumer demand, financial panics, and inappropriate government policies led to the fall of economic output in the U.S (Christina, 2003).
The gold standard that linked almost all countries across the globe to a network of fixed exchange rate also contributed in the escalation of the downtown to other countries. However, as mechanism to recover from the downtown intensified, gold standard was abandoned to ensure expansion of monetary policies.
Even though its effects were devastating, it led to introduction of changes in the operations of economies. Some of the fundamental changes included changes in economic institutions, policies in macroeconomic and economic theory.
Causes of great depression
The fundamental causes of great depression in Canada were the decline in the spending (aggregate demand). The level of production and manufacturing of new products reduced with inventories increasing as a result. This reduced spending, which varied in duration later culminating to the whole state.
Furthermore, the gold standard principle facilitated the spread of the effect to other countries leading to the great depression. However, apart from this, other causes contributed to the great depression as discussed below.
Crash in the stock market in the United State and Canada contributed to the great depression. This resulted from the tricks in monetary policy aimed at limiting the stock market speculation. Prior to this, the state had performed well realizing booms as stock markets rose to their peak.
This led to the raising of interest rates by the Federal Reserve with the aim of slowing this rapid rise in the stock price that depressed spending in areas of construction and automobiles leading to reduced production. Therefore, in 1929, the stock price reached unjustifiable levels due to anticipations of future earnings (Christina, 2003).
However, due to minor event, price reduced gradually leading investors to lose confidence. The fall of stock prices ushered panic among investors leading some to liquidate their holding, an action that worsened the situation further. The crash further reduced the aggregate demand as consumer purchases of durable products diminished, which saw business investment fall drastically. This occurrence made people feel poorer.
Monetary contraction and banking panics also contributed to the great depression in Canada. Depositors lost confidence in the solvency of banks hence demanded their refund of their deposit in cash. Therefore, this caused panic in banks as they were forced to liquidate loans for them to raise the required cash to refund their customers.
This hasty liquidation constrained the operation of most banks hastening their collapse. Further, the decline in money supply further depressed spending among the people in a number of ways. People and business expected deflation due to actual price decline and decline in supply of money; hence, they expected that wages and salary would be lower as a result in future.
This caused people to be hesitant to borrow even though the interest rates were low. This fear stemmed from the expectation that the profits and wages will be inadequate to cover the loans repayments. This also contributed to the reduced consumer spending and spending in business investment hence exacerbating the decline and leading to loss of confidence and pessimism.
According to Amaral and MacGee, Canada suffered a major great depression from 1929 to 1939, a depression that was at the same per in terms of time and magnitude to that of U.S (Amaral & MacGee, 2002). Like US, decline in productivity, output and employment rhymed with that of Canada.
However, when it came to their recovery in terms of output, differences emerged with U.S recording an output of 25% below the trend with Canada 30% below the trend. Therefore, the total factor production (TFP) of Canada was below that of U.S throughout the great depression period.
Furthermore, during this period, the consumption rate in Canada fell and remained below that of United States throughout the period (in 1930s). Similarly, the level of investment in 1933 fell to 15% of its trend value and recovered at a slow pace, but remaining at 50% below the trend in 1939.
Depressions in Canada contributed in the great depression by interrupting credit market through debt deflation and financial crisis. According to Amaral and MacGee (2002), debt deflation contributed to the greater depression in Canada since deflation and high private debt levels reduced borrower wealth and constrained the level of lending.
Contrary , Amaral and MacGee (2002) argue that the debt crises was not severe in Canada as compared to U.S and that there is no enough evidence to suggest or prove that debit crisis caused or contributed to the great depression in Canada (cited in Haubrich 1990). Despite this, Canada’s great depression was characterized by insolvencies under provisional company act, bankruptcies, and other proceedings like tariff sales and bulk sales that contributed to the loss of creditors.
These episodes rendered Canada to have a debt; therefore, making its investors and lending parties lose trust and confidence in Canada, hence resulting to their economic downtown. Furthermore, this led to the deterioration of trade leading to the depreciation of the Canada dollar exacerbating further their volatility.
Banking crises also played a significant role in the transformation of the 1929 downtown into great depression. According to Amaral and MacGee, the financial crisis of 1930-33 affected the macro economy by reducing the quantity of financial services, primarily credit intermediation” (cited in Bernanke 1983, p.262).
This therefore depicts that monetary shocks in Canada mattered and contributed to the great depression. The surprise deflation and the sticky wage story in the labor markets are also considered to have caused the great depression.
Amaral and MacGee argue that the great depression was severe because it was unexpected (cited in Lucas and Rapping (1969), while (Cole and Ohanian 2000a) “for this claims to apply observant of low nominal interest rates in the 1920s and high nominal and ex post real interest rates in the 1932 need to be considered” (Amaral & MacGee, 2002).
The real wages varied across different sector in Canada and therefore, most researchers argue that the imperfectly flexible nominal wage is quantitatively unable to explain or even associated with the causing the great depression.
Furthermore, other causes of the Canada great depression is traced back in the early 1922s. The economy was performing well and there was overproduction and expansion taking place. Industry expanded as large amounts of profits accrued from the business and investments in existing factories and construction of new ones was at a high rate.
This led to huge supplies leading to stockpiles. This caused panics and slowed down the process of production with many companies laying-off its workers as a result (Jay, 1998). Less money was spend in purchasing, which slowed down further the profits and level of investments
Canada’s dependence on few primary products also contributed to the great depression. The economy of Canada depended on few basic products like wheat, minerals, fish, pulp and paper. The economy had thrived on its own earlier due to the high demand of these products but however, when countries around Canada were hit by depression, the products prices fell in their demand with fish and wheat in West being the hard hit.
Furthermore, Argentina was producing more wheat and this lead to further drop in wheat prices. This affected the economic position of Canada drastically.
In addition, the drought witnessed on the prairies destroyed crops making it hard for the farmers who had borrowed mortgagee to pay. This also saw various industries dealing in production of wheat, flourmills railways affected and slowed down further impacting to the economy.
Canada’s dependence on U.S was one of the factors that contributed in its great depression. Canada and U.S economy are closely linked and therefore, when US was affected by the depression the ailments extended to the Canada due to the relationship.
For instance, the U.S declined trading with Canada in the sector of fish, wheat, lumber, minerals and paper leading Canada to be part of the countries facing great depression. Furthermore, high tariffs contributed in the great depression of Canada. In the wake of the First World War, as countries recovered, many countries in need of Canada’s food products could not trade with it or afford their products due to high prices as a result of high tariffs levied on them.
This deterred trade with its countries. Consequently, many countries also levied high tariffs on imports as a mechanism to protect their home countries from collapsing (Ali & James, 1999). Therefore, these constraints affected the free trade and contributed to the great depression. Moreover, too much credit buying contributed to the great depression.
In early 1920s, credit buying became popular and this saw many people getting themselves into debts. This had effects in the long run as many people were unable to repay the loan and after their deaths or retrenchments. These debts contributed to a deficit and bankruptcy of several financial institutions hence contributing to the great depression.
Credit buying of stocks also contributed to the great depression. In 1920, people bought stock on margin. They only required 10% of their money and the broker loaned the rest on higher interest rate. This notion behind this was that as soon the stocks increased in value, they could be sold, the broker could be paid, and profits accrued benefits the investor.
This however, did not go as anticipated, and in 1929, panic cropped up leading to reduced prices. This affected the operation of these stock markets leading to great depression. Therefore, the great depression in Canada can be attributed to the four major interpretations.
First the classical economics or Australian school theory, whose arguments were and still hold to be as yet another phase in the business cycle, but whose effects were greatly exacerbated by interventions policies of the Hoover administration and the Roosevelt administration.
Hence, the New Deal made the great depression even greater than it was. Secondly, is the Keynesian theory (Marxist theory) that associated the cause of depression because of increased overproduction and under-consumption. These conditions could be solved by intervention of state in form of fiscal policy and deficit spending.
Thirdly, the Freidmanian theory that focused on the great contraction through sharp money shrink, the incompetent and non-interventionist behavior of the Federal Reserve systems contributed to the great depression.
Last is the Schumpeterian theory that focused on the maturity and temporary stagnation of the once new industries that had earlier contributed to the growth of economies in the early 1890 to 1920s. Industries under these categories included the automobile, electrical and chemical industries and radio industries (James, 2010).
Recovery
Canada like U.S fought to liberate itself from the great depression that had impacted negatively on its economy and the lives of its people. According to Amaral and MacGee (2002), employment recovered quickly compared to productivity, which remained below the trend.
The case was opposite to the U.S, which recorded a quick recovery in productivity and its labor force remained depressed. The decline in recovery in Canada was attributed to the reduction in the international trade in the early 1930s. The trade was affected by the high debts between Canada and other countries leading to lack of trust among its creditors.
Crown Council also assisted in reducing the effects of the depression through creation of Bank of Canada and Canadian radio broadcasting commissions (Fabio & Claudio, 2011). The radio, which was established in 1932, helped in unifying the country and uplifting the people through the harsh economic times as it restored many people lost hope and regained their hope that the future was bright.
The bank was used in regulating the currency and credit. It also served as private banker’s bank and assisted by providing advice to the government on the best policies concerning financial issues and debt issues. This enabled the government to adopt right policies in ensuring that the situation was managed and contained amicably.
Conclusion
To conclude, the causes of great depression in Canada vary and can be traced back to the early 1920s state of economy. Even though various researchers refute some reasons by other researchers, it is apparent that most of the reasons discussed in one way or another contributed to the great depression.
Among the factors contributing to the Canada Great Depression included drastic fall in stock prices, trade, bank debits among many other reasons as discussed.
References
Amaral, P.S, & MacGee, J.C. (2002). The Great Depression in Canada and the United States: A Neoclassical Perspective. Review of Economic Dynamics, 5(1): 45-72.
Ali, A., & James K. (1999). Nonmonetary effects of the financial crisis in the Great Depression, Journal of Economics and Business, 51(3):215-235.
Christina, R.D. (2003). Forthcoming in the Encyclopedia Britannica. Great Depression. Retrieved from https://eml.berkeley.edu/
Fabio, C. B., & Claudio, M. (2011). The Great Recession: US dynamics and spillovers to the world economy. Journal of Banking & Finance, In Press, Corrected Proof, (55)5: 1-13
James, K. (2011). A Tale of Four Crises: The Politics of Great Depressions and Recessions. Orbis, 55(3): 500-523
Jay, Z. (1998). Was depression era unemployment really less in Canada than the U.S.? Economics Letters, 61(1): 125-137.
At the beginning of the 20th century, the United States was one of the world’s leading and economically advanced countries. The US pace of growth was among the fastest as the volumes of production were large in the country. During the early 1920’s, the country’s position strengthened even more along with the development of the industrial output, the expansion of the fixed capital, and the increase in exports (Government Publishing Office). For this reason, the given historical period is named “the age of prosperity.” However, in 1929, the world economic crisis broke out and served as the beginning of an intense and protracted financial crisis throughout the capitalist world. The United States suffered the adverse consequences of the crisis most.
The Great Depression of the 1930’s is the most significant economic crises in the history of the modern world and the United States, in particular. As stated by Keynes, during those years, the world was “in the middle of the greatest economic catastrophe” (Crafts and Fearon 285). Keynes also correctly foresaw that the given economic downturn would be regarded by future economists as a mark of “one of the major turning points” (Crafts and Fearon 285).
If the beginning time of the Great Depression is known precisely, its ending is rather blurry. It is believed that the crisis ended in 1933, and the remaining years until the end of that decade were a way out of it. Therefore, many people consider the whole period during the 30’s as the time of the Great Depression. The victory over the crisis became possible due to a system of reforms implemented by the US government under Franklin D. Roosevelt, who came to power in the spring of 1933. The New Deal comprising a series of programs aimed to respond to the crisis is an excellent example of a successful exit from the deepest global financial turmoil. To understand why it was effective, it is essential to review the major causes of the Great Depression.
Causes of the Great Depression
Until now, economists have not come to a consensus on the origins of the Great Depression. Nowadays, a large number of theories on this subject exist. It is possible to say that the severe economic crisis emerged as a result of the combination of factors. They will be briefly discussed in the given paragraph.
Trying to identify causes of the crisis, many scholars make an emphasis on such a factor as the insufficiency of the money supply. During that period, the volume of printed money was correlated with the volumes of gold deposits, while monetary policies and interest rates were inseparably linked to the Gold Standard (Hermele 18). This correlation significantly limited the money supply. As a result of the given factor and the growth of the commodity mass, a strong deflation could be observed (Alcidi and Gros 677). The decline in prices, in its turn, led to the financial instability, the bankruptcy of enterprises, and the inability to pay on loans.
Secondly, the Great Depression could be caused by the stock market bubble and the widespread use of margin loans. During the 1920’s the share price index increased, and many people were interested in buying shares. The use of exchange credit was common at that time as well. Buyers of stocks could receive a loan from a broker to pay the value of these stocks. In the late 1920’s, the share that brokers lent to their customers comprised a more significant part of the total price, while buyers paid cash only a small value of total assets (White 74). Thus, many stocks and bonds, which were owned by clients, remained pledged to the brokerage firm. Since brokers did not have sufficient capitals to lend to their clients, they borrowed money from various banks on the security of the same stocks that actually belonged to their clients (White 74). The given vicious circle led to the formation of an economic bubble.
The United States During the Great Depression
Throughout the period from 1929 to 1933, the American economy broke all possible anti-records. The decline in industrial production from the peak to the bottom equaled 50% − more than in any other country affected by the crisis (“The Great Depression”). The import volumes decreased by 80% (“The Great Depression”). The rate of unemployed individuals reached the historical maximum of 31.4% in 1932 (Crafts and Fearon 286). Large numbers of people were unable to pay loans secured by their land and real estate. Homelessness and vagrancy became common phenomena among both children and adults (Smiley). Most of the enterprises across the states either significantly reduced production or completely halted it. The wave of strikes, demonstrations, and hunger marches rolled throughout the country. The horror and the fear of the future embraced even higher-income segments of the population.
The government was completely unprepared for the scale and nature of the crisis, which turned out to be not a regular cyclical downturn, but the first powerful systemic crisis. Before the Great Depression, it was considered that the economy can naturally recover without any governmental interventions and that the crises, in fact, destroy only weak and inefficient enterprises, providing more advantages for the strong and effective ones (Polanyi 242). The economic downturn of 1929 made economists and politicians revise their traditional strategies and change the perspective on the concept of self-regulating economy.
The New Deal
When Roosevelt won the election in 1932, he started to undertake actions to save the country from the crisis and its adverse consequences. With unprecedented speed, the Banking Act of 1933 was drafted and passed by the Congress. On June 21, 1933, it was signed by the president. This law is now the foundation of the US banks’ work. Its main provisions are aimed at strengthening the stability of the banking system and preventing banking crises. According to the act, commercial banks were prohibited from speculating with stocks, since such operations jeopardized the safety of depositors’ funds (Carpenter et al. 5). It meant the separation of commercial banks from the investment banks, which could issue shares for industrial corporations and trade them but could not accept deposits (Carpenter et al. 5).
The Fed was authorized to control banks and prohibited them from paying interest on current accounts. Moreover, the Fed set certain limits for the size of interest on time deposits. It severely limited the risk-taking behaviors of bankers willing to promise high interest rates for profitable speculation (Romer 765). Exchange credit was also subject to the regulation as it played a negative role in the stock market crash of 1929 (Romer 774). Additionally, in May 1933, the Security Act against dubious and fraudulent combinations exploiting the public’s confidence came into force. Companies issuing their securities to the market became liable to provide complete and reliable information about the state of their financial affairs (Kim 132). Later, these urgent measures were deployed into the system of legislation at the federal level and led to the creation of the Securities and Exchange Commission, which still plays the role of the state’s central instrument in controlling the issue and the securities market.
Conclusion
By 1938, the average annual increase in the national GDP was 8% (Crafts and Fearon 285). The statistical numbers make it clear that new reforms and measures undertaken by the US government to alleviate the negative consequences of the Great Depression were successful. The findings of the literature review and the evaluation of the economic crisis make it clear that the identification of the nature of economic crises is an important part of the economic analysis as such because it helps national authorities avoid mistakes committed by their predecessors.
The example of the Great Depression shows that during an economic crisis, many misbalances accumulated in the financial and economic systems during a boom period become escalated. It is apparent that measures, which monetary and fiscal authorities can undertake to overcome the crisis, largely depend on their economic views, as well as on the intellectual environment that supports these views. Moreover, the case of the Great Depression convincingly demonstrates that in addition to monetary, financial, technological and other factors, the expectations of the private sector regarding the success of the authorities’ policy to overcome the crisis have a significant influence on the dynamics of key macroeconomic indicators. The reduction in the uncertainty and the increase in the degree of trust to the authorities’ actions lead to a more rapid recovery of economic relations between economic entities and the resumption of economic growth.
Works Cited
Alcidi, Cinzia, and Daniel Gros. “Great Recession Versus Great Depression: Monetary, Fiscal and Banking Policies.” Journal of Economic Studies, vol. 38, no. 6, 2011, pp. 673-690.
Kim, Kab Lae. “A Study on Rule 145 of The Securities Act of 1933: How to Provide Clarity and Predictability in Rule 145 Transactions.” Akron Law Review, vol. 40, pp. 131-173.
Polanyi, Karl. The Great Transformation. Beacon Press, 1985.
Romer, Christina. “What Ended the Great Depression?” The Journal of Economic History, vol. 52, no. 4, 1992, pp. 757-784.
Smiley, Gene. “Great Depression.” The Concise Encyclopedia of Economics. Web.
White, Eugene N. “The Stock Market Boom and Crash of 1929 Revisited.” Journal of Economic Perspectives, vol. 4, no. 2, 1990, pp. 67–83.
The Great Depression is considered as being one of the worst economic periods in the history of the U.S., much greater than the 2007 financial crisis since it impacted multiple industries and sectors resulting in years of declined economic activity.
Stock Speculation
One of the causes behind the great depression was actually America’s unprecedented level of growth during the 1920s. During this period, America had just emerged victorious from World War I and was experiencing an influx of new domestic technologies in the form of home radio systems, automotive vehicles, and a subsequent “boom” in economic activity (Irwin 211). In fact, it was thought that this period of growth and prosperity would never end resulting in considerable levels of stock speculation on the part of corporate and small-time investors. Investment speculation is basically the act of investing in a particular form of stock-based on perceived future gains and not on the actual performance indicators of companies (Payne and Uren 358). This means that an investor is betting on the future rise of the stock due to its current rate of growth and not necessarily on current company revenues and operations.
Unrealistic Stock Valuations
The inherent problem with this practice in the 1920s was that speculation increased stock values well beyond realistic valuation. Some stocks were trending at 400 to 500 percent their actual market value which is indicative of the development of a stock price bubble.
Bad Bank Loans
Aside from this, banks were approving loans for stock price speculation based on the perception of continuous growth over the long term. It was believed at the time that even if a person failed to pay back their loan, the seizure of assets to cover the cost of the loan in the form of stocks would have more than paid for the loan in the future. It was due to this that banks continued to approve loans for stocks which further increased the amount of stock price speculation.
Bank Loan Restrictions
When the bubble finally “burst” banks found themselves with clients that we’re unable to pay back their loans and stock prices had declined by more than 300 or 400 percent of the value that they were purchased at. This caused the banks to tighten their loan practices due to liquidity shortfalls (Geschwind 598). Since many small to medium scale enterprises in the U.S. relied on short term bank loans in order to operate, this sudden absence of loan sources caused many of them to close down which further contributed to the rising levels of unemployment that the country was experiencing.
Decline in Consumer Spending
Since the health of a country’s economy is directly tied to consumer spending, the sudden spread of unemployment caused many consumers to save their assets rather than spend. This action further contributed to the decline of the U.S. economy and caused a cycle of declining spending, company closure, and unemployment.
External Trade Issues
Aside from the internal issues that were just mentioned, the U.S. also experienced a considerable decline in international demand for its various industrial goods and raw materials. This was due to the implementation of the Smoot-Hawley Tariff in the 1930s that was supposed to protect companies in America from cheaper foreign imports (Peicuti 55). This was done by adding higher taxes for imports in order to encourage people to buy locally made goods instead. The inherent problem with this strategy of protectionism is that it resulted in retaliatory practices by other foreign powers wherein additional tariffs were added on American goods entering into their country.
Companies Being Forced to Operate in the U.S. Domestic Market
Due to the high price of American goods, international demand declined significantly resulting in many companies having to contend with operating mostly in the U.S. domestic market. However, due to low consumer spending, even large corporations found themselves hard-pressed to make significant profits resulting in even more layoffs which contributed to the Great Depression.
Production of Goods
Another reason behind the Great Depression is, oddly enough, connected to local overproduction which caused systemic issues within various sectors of the U.S. economy. One of the factors that keeps a healthy economy running smoothly is the cycle of purchases and sales made by companies not only between themselves and consumers but also between businesses. Various manufacturers purchased raw goods and converted them into viable consumer items and then subsequently sold them in the open market. This creates a supply chain from raw goods all the way to the end product which can take a myriad of different forms.
However, due to industry-wide overproduction in numerous sectors, this healthy cycle was derailed with many companies having considerable levels of excess stock (Hill 169). It was due to this that purchases of raw materials and other contributing goods were often erratic resulting in some sectors experiencing “boom and bust” periods. With the advent of The Great Depression and the excess amount of stock that companies already possessed, demand for raw goods dropped abruptly, more so than usual, resulting in numerous sectors experiencing industry-wide closures (Ziebarth 185).
Works Cited
Geschwind, Carl-Henry. “Gasoline Taxes And The Great Depression: A Comparative History.” Journal Of Policy History 26.4 (2014): 595-624. Print.
Hill, Matthew J. “Love In The Time Of The Depression: The Effect Of Economic Conditions On Marriage In The Great Depression.” Journal Of Economic History 75.1 (2015): 163-189. Print.
Irwin, Douglas A. “Who Anticipated The Great Depression? Gustav Cassel Versus Keynes And Hayek On The Interwar Gold Standard.” Journal Of Money, Credit & Banking (Wiley-Blackwell) 46.1 (2014): 199-227. Print.
Payne, Jonathan, and Lawrence Uren. “Economic Policy And The Great Depression In A Small Open Economy.” Journal Of Money, Credit & Banking (Wiley-Blackwell) 46.2/3 (2014): 347-370. Print.
Peicuti, Cristina. “The Great Depression And The Great Recession: A Comparative Analysis Of Their Analogies.” European Journal Of Comparative Economics 11.1 (2014): 55. Print.
Ziebarth, Nicolas L. “The Great Depression Through The Eyes Of The Census”.
