Reasons and Results of the Great Depression -1929-

 

Golden(!) Period of Expectations and Demand

The Great Depression was a very significant turning point for both almost all economies of the world and economics as a science also. Since there were loads of devastating effects of depression on most of economies over the world, it is still an important research topic for economists. Even there are still some ongoing arguments and disagreements about causes and onset of slumpflation, it could be firstly said that turning in a restrictive direction of U.S. monetary policy by increasing interest rate was starting effect of depression. This was directly related to FED's fearing of fast booming and unhealthy speculations in the stock markets. There was excessive credit creation at the start 1920s and it was fearful for FED. Then, along with increasing interest rate, a sudden restrictive monetary policy caused big stock market crash in 1929. Especially after World War I, US had become global net creditor and raising interest rate by US make debtor countries get into trouble because of golden standard regime. It could be said that deflation was a better situation than devaluation especially at the first days of depression for FED in that time because of golden standard.

On the other hand, in US, higher interest rates made investment and consumption decisions even worse and expectations got worse, as the time went on it became an aggregate demand shock and this insufficient demand caused deflation finally. Therefore, decreasing of prices had resulted decrease in output. So, deflation in the US caused price deflation abroad especially fragile countries, because US accounted for more than one of third of the global output demand. It is widely-accepted that even though onset of depression was related to stringent monetary policy, increase in the interest rate negative expectations about future and insufficient demand respectively, transmission of the depression to other countries was directly related to fixed exchange rate under gold regime.  In gold standards there was an inequality between countries’ balance of payment. For example, there were some gold rich countries and some countries which had not enough gold. Moreover, there was not a cooperation and solidarity institution like IMF in that time which could support countries which suffered from high interest rate and insufficient gold stocks. “In one of the most memorable acts of misguided monetary policy in history, the Federal Reserve raised interest rates sharply in October 1931 to protect the dollar in the midst of the greatest Depression the modern world economy has ever known. This action was not a technical mistake or simple stupidity; it was the standard response of central banks under the gold standard.” (Temin, 1993:10)

When US increased interest rate in 1929, in order to prevent outflow of golden, debtor and fragile countries had to increase their interest rate too in order to prevent depreciation value of their currency. Because of this, these countries also suffered from deflation and decreasing output, high unemployment and depression finally. “Monetary restriction by the Fed brought US foreign lending to a halt. “(Eichengreen, 1992:10) According to Temin, more than fixed exchange rates, commitment to the gold standard policy regime transmitted the Great Depression around the world. The single best predictor of how severe the Depression was in different countries is how long they stayed on gold. The gold standard was a Midas touch that paralyzed the world economy (Temin, 1993:13). For example, Spain did not suffer from the Great Depression because it was not on the gold standard.

Apart from that, recent studies have showed that in that time especially in US, there were not flexible wages as classical economists asserted. In first months of depression FED and government waited for an invisible hand and price mechanism to adjust markets. However, especially because of high rates of unionization and changing structure of economy after World War I had made wages rigid. Prices were decreasing because of dismal expectations also. As a natural result of these facts, depression got deeper and worse. Because of American roots of it, especially Japan and other European countries lived depression softer in comparison with United States even though they suffered high unemployment and deflation also. As a consequence of depression “Industrial production in the United States, in contrast, declined 21 percent in the first year of the Depression. Thus, the Depression was "great" in the United States sooner than elsewhere.” (Romer, 1993: 4) In 1931 and 1932 industrial production fall 62 percent in US also, unemployment reached 25 percent and almost one of third banks failed because of banking panic in the United States.

After 1930’s most of the countries which suffered from deep depression started to give up gold standard regime and implemented expansionary monetary policy along with expansionary fiscal policies in order to revive and increase effective demand as John M. Keynes suggested. So, Keynesian policies were very helpful and effective to overcome the Great Depression over the time and of course it is accepted that birth of macroeconomics was directly related to depression.