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Cycles of Depressions: Macroeconomics
Cycles of Depressions: Macroeconomics
Cycles of Depressions: Macroeconomics
Macroeconomics
Cycles of Depressions
Coordinator: Student:
Brasov
-2017-
Contents
Chapter 1 –Inducement. Introduction.....................................................................................................2
1.1 Inducement...................................................................................................................................2
1.2 Introduction..................................................................................................................................2
Chapter 2 – The Great Depression..........................................................................................................4
2.1 Starting point of The Great Depression........................................................................................4
2.2 Genesis.........................................................................................................................................5
2.3 Demand-driven.............................................................................................................................7
2.3.1 Keynesian model...................................................................................................................7
2.3.2 Breakdown of international trade...........................................................................................7
2.3.3 Debt deflation........................................................................................................................8
2.4 Monetarist model..........................................................................................................................9
2.5 New classical approach..............................................................................................................10
2.6 Austrian School..........................................................................................................................11
2.7 Crossroads and recovery.............................................................................................................11
Chapter 3 - Conclusions.......................................................................................................................13
3.1 World War II and recovery.........................................................................................................13
3.2 Effects........................................................................................................................................13
3.3 Other "great depressions"...........................................................................................................13
List of tables.........................................................................................................................................15
Bibliography.........................................................................................................................................16
1
Chapter 1 –Inducement. Introduction
1.1 Inducement
The reason why I have chosen to speak about The Great Depression is because
recessions and business cycles are thought to be a normal part of living in a world of inexact
balances between supply and demand. I find it very interesting how the entire world can
switch from prosperity and wellfare to recession and crisis in a really short period of time.
Also it is absorbing how economists, monetarists and so on could not find an answer to a
worldwide problem.
1.2 Introduction
The Great Depression may also refer to The Great Depression (1873 - 1896), which
was an economic recession that coincided with the Second Industrial Revolution. Also may
refer to the Financial Crisis (started in 2007) which is sometimes called Second Great
Depression or Great Depression II or Global Financial Crisis, it is considered by
many economists to be the worst financial crisis since the Great Depression of the 1930s. It
resulted in the collapse of large financial institutions, the bailout of banks by national
governments, and downturns in stock markets around the world.
In the 21st century, the Great Depression is commonly used as an example of how
far the world's economy can decline. The depression originated in the U.S., after the fall in
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stock prices that began around September 4, 1929 and became worldwide news with the stock
market crash of October 29, 1929.
Cities all around the world were hit hard, especially those dependent on heavy
industry. Construction was virtually halted in many countries. Farming and rural areas
suffered as crop prices fell by approximately 60%. Facing plummeting demand with few
alternate sources of jobs, areas dependent on primary sector industries such as cash
cropping, mining and logging suffered the most.
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Chapter 2 – The Great Depression
Economic historians usually attribute the start of the Great Depression to the sudden
devastating collapse of US stock market prices on October 29, 1929, known as Black
Tuesday; some dispute this conclusion, and see the stock crash as a symptom, rather than a
cause, of the Great Depression.
Even after the Wall Street Crash of 1929, optimism persisted for some time; John D.
Rockefeller said that "These are days when many are discouraged. In the 93 years of my life,
depressions have come and gone. Prosperity has always returned and will again." The stock
market turned upward in early 1930, returning to early 1929 levels by April. This was still
almost 30% below the peak of September 1929.
Together, government and business spent more in the first half of 1930 than in the
corresponding period of the previous year. On the other hand, consumers, many of whom had
suffered severe losses in the stock market the previous year, cut back their expenditures by ten
percent. Likewise, beginning in mid-1930, a severe drought ravaged the agricultural heartland
of the US.
By mid-1930, interest rates had dropped to low levels, but expected deflation and the
continuing reluctance of people to borrow meant that consumer spending and investment were
depressed. By May 1930, automobile sales had declined to below the levels of 1928. Prices in
general began to decline, although wages held steady in 1930; but then a deflationary
spiral started in 1931. Conditions were worse in farming areas, where commodity prices
plunged, and in mining and logging areas, where unemployment was high and there were few
other jobs.
The decline in the US economy was the factor that pulled down most other countries
at first, then internal weaknesses or strengths in each country made conditions worse or better.
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Frantic attempts to shore up the economies of individual nations
through protectionist policies, such as the 1930 U.S. Smoot–Hawley Tariff Act and retaliatory
tariffs in other countries, exacerbated the collapse in global trade. By late 1930, a steady
decline in the world economy had set in, which did not reach bottom until 1933.
2.2 Genesis
There were multiple causes for the first downturn in 1929. These include the
structural weaknesses and specific events that turned it into a major depression and the
manner in which the downturn spread from country to country. In relation to the 1929
downturn, historians emphasize structural factors like major bank failures and the stock
market crash. In contrast, monetarist economists (such as Barry Eichengreen, Milton
Friedman and Peter Temin) point to monetary factors such as actions by the US Federal ( is
the central banking system of the United States) Reserve that contracted the money supply, as
well as Britain's decision to return to the gold standard - a monetary system in which the
standard economic unit of account is a fixed weight of gold- at pre–World War I parities
(US$4.86:£1).
Thus, the personal political and policy viewpoints of scholars greatly color their
analysis of historic events occurring eight decades ago. An even larger question is whether the
Great Depression was primarily a failure on the part of free markets where prices are
determined by supply and demand, with little or no government control or a failure of
government efforts to regulate interest rates, curtail widespread bank failures, and control the
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money supply. Those who believe in a larger economic role for the state believe that it was
primarily a failure of free markets, while those who believe in a smaller role for the state
believe that it was primarily a failure of government that compounded the problem.
Current theories may be broadly classified into two main points of view and several
heterodox points of view. There are demand-driven theories, most importantly Keynesian
economics, which is group of macroeconomic schools of thought based on the ideas of 20th-
century economist John Maynard Keynes, but also including those who point to the
breakdown of international trade, and Institutional economists (focuses on understanding the
role of the evolutionary process and the role of institutions in shaping economic
behaviour) who point to underconsumption and over-investment (causing an economic
bubble), malfeasance by bankers and industrialists, or incompetence by government officials.
The consensus among demand-driven theories is that a large-scale loss of confidence led to a
sudden reduction in consumption and investment spending. Once panic and deflation set in,
many people believed they could avoid further losses by keeping clear of the markets.
Holding money became profitable as prices dropped lower and a given amount of money
bought ever more goods, exacerbating the drop in demand.
There are the monetarists, who believe that the Great Depression started as an
ordinary recession, but that significant policy mistakes by monetary authorities (especially the
Federal Reserve), caused a shrinking of the money supply which greatly exacerbated the
economic situation, causing a recession to descend into the Great Depression. Related to this
explanation are those who point to debt deflation - a theory of economic cycles, which holds
that recessions and depressions are due to the overall level of debt shrinking (deflating):
the credit cycle is the cause of the economic cycle - causing those who borrow to owe ever
more in real terms.
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2.3 Demand-driven
Keynes' basic idea was simple: to keep people fully employed, governments have to
run deficits when the economy is slowing, as the private sector would not invest enough to
keep production at the normal level and bring the economy out of recession. Keynesian
economists called on governments during times of economic crisis to pick up the slack by
increasing government spending and/or cutting taxes.
Many economists have argued that the sharp decline in international trade after 1930
helped to worsen the depression, especially for countries significantly dependent on foreign
trade. Most historians and economists partly blame the American Smoot-Hawley Tariff
Act for worsening the depression by seriously reducing international trade and causing
retaliatory tariffs in other countries. While foreign trade was a small part of overall economic
activity in the U.S. and was concentrated in a few businesses like farming, it was a much
larger factor in many other countries. The average ad valorem rate of duties on dutiable
imports for 1921–1925 was 25.9% but under the new tariff it jumped to 50% in 1931–1935.
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In dollar terms, American exports
declined from about $5.2 billion in 1929 to U.S. Farm Prices (1928-1935)
Irving Fisher argued that the predominant factor leading to the Great Depression was
over-indebtedness and deflation. Fisher tied loose credit to over-indebtedness, which fueled
speculation and asset bubbles. He then outlined 9 factors interacting with one another under
conditions of debt and deflation to create the mechanics of boom to bust. The chain of events
proceeded as follows:
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During the Crash of 1929 preceding the Great Depression, margin requirements were
only 10%. Brokerage firms, in other words, would lend $9 for every $1 an investor had
deposited. When the market fell, brokers called in these loans, which could not be paid back.
Outstanding debts became heavier, because prices and incomes fell by 20–50% but
the debts remained at the same dollar amount. After the panic of 1929, and during the first 10
months of 1930, 744 US banks failed. (In all, 9,000 banks failed during the 1930s). By April
1933, around $7 billion in deposits had been frozen in failed banks or those left unlicensed
after the March Bank Holiday or Emergency Banking Relief Act (an act of the United States
Congress spearheaded by President Franklin D. Roosevelt during the Great Depression. It was
passed on March 9, 1933. This act allows only Federal Reserve-approved banks to operate in
the United States of America).
Bank failures snowballed as desperate bankers called in loans which the borrowers
did not have time or money to repay. With future profits looking poor, capital investment and
construction slowed or completely ceased. In the face of bad loans and worsening future
prospects, the surviving banks became even more conservative in their lending. Banks built
up their capital reserves and made fewer loans, which intensified deflationary pressures.
A vicious cycle developed and the downward spiral accelerated.
The liquidation of debt could not keep up with the fall of prices which it caused. The
mass effect of the stampede to liquidate increased the value of each dollar owed, relative to
the value of declining asset holdings. The very effort of individuals to lessen their burden of
debt effectively increased it. Paradoxically, the more the debtors paid, the more they owed.
This self-aggravating process turned a 1930 recession into a 1933 great depression.
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2.4 Monetarist model
Monetarists, including Milton Friedman and current Federal Reserve
System chairman Ben Bernanke, argue that the Great Depression was mainly caused
by monetary contraction, the consequence of poor policy-making by the American Federal
Reserve System and continued crisis in the banking system. In this view, the Federal Reserve,
by not acting, allowed the money supply as measured by the M2 to shrink by one-third from
1929–1933, thereby transforming a normal recession into the Great Depression. Friedman
argued that the downward turn in the economy, starting with the stock market crash, would
have been just another recession.
The Federal Reserve allowed some large public bank failures – particularly that of
the New York Bank of the United States – which produced panic and widespread runs on
local banks, and the Federal Reserve sat idly by while banks collapsed. He claimed that, if the
Fed had provided emergency lending to these key banks, or simply bought government
bonds on the open market to provide liquidity and increase the quantity of money after the
key banks fell, all the rest of the banks would not have fallen after the large ones did, and the
money supply would not have fallen as far and as fast as it did.
With significantly less money to go around, businessmen could not get new loans
and could not even get their old loans renewed, forcing many to stop investing. This
interpretation blames the Federal Reserve for inaction, especially the New York branch.
One reason why the Federal Reserve did not act to limit the decline of the money
supply was regulation. At that time, the amount of credit the Federal Reserve could issue was
limited by the Federal Reserve Act, which required 40% gold backing of Federal Reserve
Notes issued. By the late 1920s, the Federal Reserve had almost hit the limit of allowable
credit that could be backed by the gold in its possession. This credit was in the form of
Federal Reserve demand notes.
A "promise of gold" is not as good as "gold in the hand", particularly when they only
had enough gold to cover 40% of the Federal Reserve Notes outstanding. During the bank
panics a portion of those demand notes were redeemed for Federal Reserve gold. Since the
Federal Reserve had hit its limit on allowable credit, any reduction in gold in its vaults had to
be accompanied by a greater reduction in credit. On April 5, 1933, President Roosevelt
signed Executive Order 6102 - "forbidding the Hoarding of Gold Coin, Gold Bullion,
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and Gold Certificates within the continental United States" - the order criminalized the
possession of monetary gold by any individual, partnership, association or corporation.
This study suggests that theories of the Great Depression have to explain an initial
severe decline but rapid recovery in productivity, relatively little change in the capital stock,
and a prolonged depression in the labor force. This analysis rejects theories that focus on the
role of savings and posit a decline in the capital stock.
In the Austrian view it was this inflation of the money supply that led to an
unsustainable boom in both asset prices (stocks and bonds) and capital goods. By the time the
Fed belatedly tightened in 1928, it was far too late and, in the Austrian view, a significant
economic contraction was inevitable. According to the Austrians, the artificial interference in
the economy was a disaster prior to the Depression, and government efforts to prop up the
economy after the crash of 1929 only made things worse.
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2.7 Crossroads and recovery
In most countries of the world, recovery from the Great Depression began in 1933. In
the U.S., recovery began in early 1933, but the U.S. did not return to 1929 GNP for over a
decade and still had an unemployment rate of about 15% in 1940, albeit down from the high
of 25% in 1933. The measurement of the unemployment rate in this time period was
unsophisticated and complicated by the presence of massive underemployment, in
which employers and workers engaged in rationing of jobs.
There is no consensus among economists regarding the motive force for the U.S.
economic expansion that continued through most of the Roosevelt years (and the 1937
recession that interrupted it).
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returned to its upward slope in 1938.
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Chapter 3 - Conclusions
The rearmament policies leading up to World War II helped stimulate the economies
of Europe in 1937–39. By 1937, unemployment in Britain had fallen to 1.5 million. The
mobilization of manpower following the outbreak of war in 1939 ended unemployment.
America's entry into the war in 1941 finally eliminated the last effects from the Great
Depression and brought the U.S. unemployment rate down below 10%. In the U.S., massive
war spending doubled economic growth rates, either masking the effects of the Depression or
essentially ending the Depression. Businessmen ignored the mounting national debt and
heavy new taxes, redoubling their efforts for greater output to take advantage of generous
government contracts.
3.2 Effects
The majority of countries set up relief programs, and most underwent some sort of
political upheaval, pushing them to the left or right. In some states, the desperate citizens
turned toward nationalist demagoguery - the most infamous example being Adolf Hitler -
setting the stage for World War II in 1939.
British economic historians used the term "great depression" to describe British
conditions in the late 19th century, especially in agriculture, 1873–1896, a period now
referred to as the Long Depression.
14
The fall of communism in the Soviet Union led to a severe economic crisis and
catastrophic fall in the standards of living in the 1990s in the former Eastern Bloc, most
notably, inpost-Soviet states, that was almost twice as intense as the Great Depression had
been in the countries of Western Europe and the U.S. in the 1930s. Even before
Russia's financial crisis of 1998, Russia's GDP was half of what it had been in the early
1990s, and some populations are still poorer as of 2009 than they were in 1989, including
Ukraine, Moldova, Serbia, Central Asia, and the Caucasus.
List of tables
15
1. link\tabel1.jpg (Real gdp/year unemployment)
Bibliography
16
The Great Depression, Pierre Berton(1990)
https://www.khanacademy.org/economics-finance-domain/microeconomics
http://www.economicshelp.org/microessays/
http://www.economistsdoitwithmodels.com/microeconomics-101/
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