Macroeconomic Theory and Policy

Assignment – 2
Name: Siddharth Lilani Roll Number: B23049
Case Title: The Great Depression: Causes and Impact (Abridged)

Case Background
The American economy was strong and upbeat in the late 1920s after a decade of tremendous expansion,
supported by a rising stock market. However, structural weaknesses were silently arising below the surface.
The economic foundation was being strained by speculative activity, high borrowing, and an increasing
reliance on international trade, particularly with Europe.
This veneer of affluence was destroyed by the 1929 stock market crisis, which rocked the US economy.
Prices fell sharply, the GDP fell, and unemployment shot up, with industrial hubs like Ohio facing
astounding rates of unemployment. Authorities struggled with the extraordinary economic challenges as
the crisis spurred a variety of reactions at the municipal, state, and federal levels. The initial focus of
President Hoover's strategy focused on decentralized work relief initiatives and emphasized individual and
local accountability. But as the crisis worsened, he realized that the federal government needed to play a
more proactive role. Despite the fact that all of Hoover's efforts were unsuccessful, this change in strategy
resulted in the creation of the Reconstruction Finance Corporation (RFC), a crucial milestone in his attempts
to stabilize the economy and rebuild trust in American institutions.
Franklin D. Roosevelt's New Deal, which was implemented in 1933 after he was elected President, was the
culmination of numerous solutions to the crisis at the municipal, state, and federal levels. These occasions
paved the way for the Great Depression, one of the turning points in American economic history that
reshaped the country's economic environment and policy for decades.

3 Critical Issues and Challenges Discussed in the Case

These three challenges are the top critical issues because they collectively set the stage for the Great
Depression –
1. Speculative Mania and Stock Market Crash: The speculative fever that engulfed the American
economy in the late 1920s was one of the most urgent problems. A stock market bubble was produced by
the sharp rise in stock values that was fuelled by widespread speculation and accessible borrowing. Due to
the fact that it caused the notorious stock market crash of 1929, this problem became crucial. The Great
Depression was brought on by the crash, which destroyed vast amounts of wealth and destroyed public
trust. Because it signalled the start of the economic collapse and had far-reaching effects, this is a top
essential topic.
2. Structural Weaknesses in the Economy: The American economy's fundamental flaws in the 1920s
presented another significant obstacle. These flaws included a rise in speculative activity, extensive
borrowing that decreased the liquidity of the financial system, and reliance on foreign trade, particularly
with the unstable European economy. These structural problems were crucial because they increased the
American economy's susceptibility to shocks and the severity of the recession. They draw attention to the
underlying fragility of the decade's prosperity.
3. Maldistribution of Purchasing Power: A major issue was the unequal distribution of purchasing power
caused by the concentration of wealth among a small number of people. Despite the country's outstanding
economic progress, a sizable percentage of the populace lacked the resources necessary to engage fully in
the consumer economy. This turned into a serious problem because there weren't enough consumers to buy
the products made by American companies. As a result, there was an increase in both overproduction and
underconsumption, which led to the economic downturn. This problem highlights how important income
distribution is in addition to GDP.
Case Analysis
Introduction
The American economy entered an era of unrestrained optimism in 1929. The country was enjoying a
decade of unheard-of growth and wealth at the time. The industrial sector was expanding, the stock market
was booming, and people generally believed that better times were still to come. But although appearing
prosperous, the American economy was actually being slowly undermined by serious fundamental flaws.
This analysis will go into these important issues and the effects they had, which ultimately caused the Great
Depression.
Stock Market Speculation and Crash
An extraordinary increase in stock market speculating was seen in the late 1920s. Unprecedented daily
trading volumes were attained, and margin rates as low as 10% attracted thousands of new participants. The
enthusiasm and subsequent upheaval of the stock market during this time are shown in Exhibit 1 (of the
case). Stock values reached dizzying heights before collapsing in a tragic series of circumstances. "Black
Thursday" and "Black Tuesday" witnessed fortunes vanish, and by November 1929, stock values had
collapsed, generating a generalized economic panic and turbulence.
Structural Weaknesses in the Economy
Underneath the appearance of success, the American economy was hiding serious structural flaws that
would soon come to light as the most pressing problems. The financial system had become less robust and
more vulnerable to shocks as a result of the growing stock market's encouragement of excessive borrowing.
The country's economy was becoming more and more dependent on international trade, especially with
Europe, at a time when that continent was going through extreme turmoil. Additionally, statistics from the
case showed that the construction sector, which accounted for a sizeable share of total investment, displayed
an erratic trend.
Maldistribution of Purchasing Power
The unequal distribution of purchasing power was one of the most evident problems. Despite impressive
economic growth, a sizeable segment of the population was kept out of the benefits of this development.
This stark wealth discrepancy is highlighted in Exhibit 2 (additional), which also shows how income was
concentrated among a privileged few. Because of the income gap, a sizable segment of the population was
unable to purchase the goods produced by American companies.
Economic Impact
All facets of society were negatively impacted by the Great Depression's economic effects, which were
nothing short of devastating. The crisis took its toll heavily on the Gross National Product (GNP), which
had grown significantly during the 1920s, falling by a startling 25% between 1929 and 1932. This
demonstrated the exceptional severity of the crisis as a quarter of the country's economic output vanished
in a handful of years.
The consumer price index plummeted by 25% as the Depression deepened its hold. Deflation, or the
persistent drop in prices, had serious repercussions since it made it harder for people and businesses to pay
off debt and support their livelihoods. Even worse, the wholesale pricing index experienced a worrisome
32% decrease. The economic crisis was made worse by the significant drop in wholesale prices, which put
further strain on industry.
A catastrophic situation existed for the agricultural industry, which had already been having trouble during
the 1920s. Farmers faced declining farm prices, which further reduced their already meagre incomes. Many
farmers were on the verge of financial catastrophe due to the scary spectre of rising debt. The worst drought
in American history, which started in 1930 and rendered significant portions of the country's heartland
nearly uninhabitable, aggravated the agricultural situation. Due to this disaster, thousands of rural
Americans were compelled to work as migrant farm labourers for low pay or even as hoboes.
During the Great Depression, capital investment—a vital component of economic growth—came to an
abrupt halt. Due to the widespread anxiety and uncertainty that had overtaken both investors and businesses,
investment levels plummeted from a healthy $16.2 billion to a meagre $300 million. The economic
downturn was made worse by the paralysis of capital investment, which caused new projects to stop and
existing enterprises to struggle to survive.
The exponential growth in industrial unemployment was the most terrifying effect of the Great Depression.
By 1933, a startling 25% of the labour force was unemployed. The situation was even worse in some areas,
like Ohio's cities, where jobless rates had reached worrisome heights. Families all around the country had
to deal with the harsh reality of having no income and being unable to support their loved ones. The
breadlines and soup kitchens that provided meagre food to those in need stretched for blocks and were
omnipresent emblems of the time.
Causes of the Depression
Although the stock market fall garnered media attention, the real reasons for the Great Depression went far
beyond. Long before the crisis, warning signs of economic deterioration were beginning to emerge.
Automobile sales lagged behind production, and the building industry was in decline. Contrary to the
artificially inflated stock market, leading economic indicators like freight carloadings, industrial
production, and wholesale prices had already started to decline. The causes were also covered in the section
before this one.
Government Policies and Responses
Government policies played a pivotal role in either exacerbating or mitigating the crisis. The Federal
Reserve's missteps in the early stages of the crisis worsened the situation. The following is the analysis of
the government policies and responses –
1. Federal Reserve Missteps: The Federal Reserve's initial missteps, including failure to save banks,
hindered economic recovery and contributed to prolonged financial instability.
2. Tax System Inequality: The tax system's disproportionate burden on different income groups
exacerbated wealth inequality, impeding the redistribution of resources crucial for relief efforts.
3. Lax Regulation: Inadequate regulatory oversight allowed corporations and banks to engage in
reckless speculation, further destabilizing the economy.
4. High Tariffs: Protectionist tariffs, exemplified by the Hawley-Smoot Tariff of 1930, restricted
international trade and provoked retaliatory measures, intensifying the global economic downturn.
5. Reconstruction Finance Corporation (RFC): The RFC was established to stabilize financial
institutions and stimulate economic recovery by providing loans, serving as a key component of the
evolving government response to the crisis.
Exhibit 3 (additional) provides insights into government interventions through loans issued by the
Reconstruction Finance Corporation (RFC), offering a tangible view of the evolving response to the crisis.
Public Welfare and Relief Efforts
The pressures of the Great Depression severely exposed the shortcomings of the public welfare system of
the 1920s. Many humanitarian attempts failed due to the abrupt spike in demand for government aid.
Charity groups like the Red Cross and Salvation Army made an effort to close the gap, but they were
woefully unsuccessful. Exhibit 4's (additional) data, which includes unemployment statistics and
information on the difficulties of delivering help during the Depression, offers a clear picture of the grim
situation.
Election of 1932 and the End of the Hoover Era
By 1932, the economy had reached a critical point and public opinion of President Hoover and the
Republican Party had sharply shifted against them. A seismic shift was affected by Franklin D. Roosevelt's
electoral triumph. The overwhelming loss for Hoover highlighted the level of public dissatisfaction.
Roosevelt's election campaign's hazy promises of a "new deal for the American people" struck a chord with
a country in need of answers.
I believe that the Great Depression was a multifaceted catastrophe with underlying causes rather than a
sudden, singular occurrence. The analysis has looked into the significant issues that led to this disastrous
time in American history and highlights the vital role of governmental responses and policies.

Macroeconomics Theories and Tools which can Help in Analysing the Case
Analysing the Great Depression case necessitates the application of various macroeconomic theories and
tools to comprehensively grasp its intricacies. Keynesian Economics provides insight into the role of
aggregate demand and the significance of government intervention through fiscal policies during economic
downturns, aligning with efforts to combat the crisis. Monetarism, as advocated by Milton Friedman,
allows for an assessment of how the management of the money supply by the Federal Reserve influenced
the Depression's depth and duration. The framework of Aggregate Demand and Supply Analysis helps
uncover the interplay of factors such as consumer spending, investment, and government policies in shaping
the economy's trajectory during the Depression. The Phillips Curve aids in understanding the relationship
between inflation and unemployment, shedding light on labour market dynamics during the crisis.
Comparative International Trade Analysis enables an evaluation of the Depression's global implications
by assessing the impacts of protectionist policies like the Hawley-Smoot Tariff on international trade.
Furthermore, a detailed examination of data, such as RFC loans, offers crucial insights into the
government's evolving response and its effectiveness in stabilizing financial institutions. Together, these
macroeconomic theories and tools provide a comprehensive framework for a nuanced analysis of the Great
Depression, facilitating a deeper understanding of its causes and the efficacy of policy responses.

My Learnings from the Case as a Business Manager

The Great Depression instance offers a business management priceless lesson that is applicable in today's
dynamic economic environment. It is essential to be aware of macroeconomic vulnerabilities, which
emphasizes the necessity for diversification and adaptation to changing economic tides. Innovation and
quick adaptation to changing conditions are essential survival techniques. The case's emphasis on the effects
of government policies and regulations shows how important it is to understand them. For stability to be
maintained during economic downturns, prudent debt management and cash reserves are essential. Putting
the needs of the customer first encourages loyalty and gives a competitive edge. Due to the case's emphasis
on how interrelated the world's economies are, it is important to think globally and be ready for changes in
the economy. The value of utilizing data analytics for well-informed decision-making is demonstrated by
the data-driven insights in this scenario. Scenario planning gives firms the ability to create solid backup
plans and stress-test their models, including preparedness for economic downturns.
The Great Depression scenario serves as a sobering reminder that modern corporate managers must be
adaptable, resilient, forward-thinking, and data-driven when navigating challenging economic times. In the
face of economic difficulties, these lessons help people make wise decisions and develop effective
strategies.
Appendix (for Exhibits)

Exhibit 1: An Economic Profile of the 1920s (Indexes with 1920 = 100)

Exhibit 2: Distribution of Wealth in the USA since 1917

 Exhibit 3

Exhibit 4: Unemployment rates during the Great Depression in USA