Examining The Great Depression and The Great Recession

MacroEconomics, Sem II
Teacher: Mrs. Hema Kapoor

Pratham Arora | Sujal Sharma | Md. Imran | Ojas Arora | Ameesha | Pallavi Jayant | Vanshika

Hansraj College, University of Delhi

Introduction
Giving a brief summary of our analysis into the GD vs GR

Slide Name Slide Summary – What does the slide aim to Communicate
What led to The Great Depression Exploring the causes of The Great Depression – Stock market crash of 1929,
Banking panics and monetary contraction, Gold Standard, and decreased lending
and Tariffs
Classical Economics Discussing the classical revolution that arose as an attack on Mercantilism, we delve
into the tenets of both, Say’s Law and a look at the key differences between classical
economics and Neo-classical economics
Exploring The Great Depression We look at the crippling effect of The Great Depression on the US Economy, its
distinct features from the other recessions, the failure of Classical economics in
explaining The Great Depression, and a look at the arising of The Keynesian
economics.
What led to The Great Recession Analyzing the causes of the great recession, how the financial sector failed, followed
by an analysis of the renewed interest in Keynesian Economics. 1. Staggered prices
2. Coordination Failure 3. Efficiency Wages
A thorough Contrast We look at the differences between The Great Depression and The Great Recession,
on factors Time Period, Organization Event, Economic Impact etc. We then look at the
similarities on the basis of the Economic Activity, Scapegoats and Causation
Key Learnings Learnings we acquire from the two events such as how recessions are hardest on the
poorest of people, how helping people is the best way to cure an economy, and how
tax cuts are not always the way out

3
What led to the Great Depression
Examining the rationale and causes behind the happening of the great depression and the impacts of the same
Roaring Twenties
Economic prosperity and cultural transformation.
Distinctive cultural edge in the United States and Europe.
Booming economy led to more leisure time and the rise of a consumer society.
Causes of the Great Depression
Stock Market Crash of 1929
Historic stock market expansion in the 1920s.
Overextended investments and widespread panic.
Stock prices fell 33% between September and November 1929.
Psychological shock led to reduced consumer spending and business investment.
Banking Panics and Monetary Contraction
Four extended banking panics in the U.S.
Fearful bank customers triggered withdrawals, leading to financial crises, 1/5 banks failed by 1933.
Franklin D. Roosevelt declared a "bank holiday" to restore confidence.
Reduced consumer spending and investment due to fewer banks and hoarded cash.
Federal Reserve increased the problem by raising interest rates and reducing the money supply.
Gold Standard
Declining U.S. output and deflation, Trade deficit, leading to foreign gold outflows.
Threatened devaluation of other countries' currencies.
Foreign central banks raised interest rates, reducing output and increasing unemployment globally.
Decreased International Lending and Tariffs
Decline in U.S. bank lending to foreign countries in the late 1920s.
Contributed to economic downturn in borrower countries.
Smoot-Hawley Tariff Act (1930) imposed steep tariffs on imports, output and global trade declined.
Classical Economics
Exploring Classical Economics, Neo-Classical Economics, and Say’s Law
Adam Smith’s “The Wealth of Nations” of 1776 is considered to be the starting point in classical economics
Supply creates its own demand
Output will generate enough revenue to make purchases
Two tenets of Mercantilism
• Bullionism, wealth and power of a nation were determined by its
stock of precious metals
• Need for state action to direct the development of the capitalist
system.
• Government should maintain an export surplus to accumulate wealth
Classical Economics – A revolution
• Importance of real factors as opposed to monetary factors in
determining the wealth of nations; economy grows through increase
in factors of production and advancements in techniques used
• A free market optimizes itself. Government policies are not needed
to propel the economy and are harmful
• The only role money serves is to be a means of exchange.
Jean Baptiste-Say’s beliefs under Classical Economics
Supply of X creates demand for Y, subject to
people being interested in buying X. The producer
of X can buy Y, if his products are demanded.
Money obtained from sale of goods can not remain
unspent, thereby reducing demand below supply.
Money is a temporary medium of exchange.
Neo-Classical Economics
Neoclassical economics is derived from classical economics with the
introduction of marginalism.
People make decisions based on margins, for example, MU, MC, MRS.
The process is known as the “marginal revolution.”
Key differences between Classical and Neo-Classical Economics
• While classical Economics states that price is independent of demand,
and production and other factors impacting supply are key drivers,
Neoclassical economics emphasizes the choices and preferences,
along with allocations being the drivers. Value of products is thus
higher than their costs
• Classical Economics is more empirical, and uses historical concepts,
for explaining the capitalist mode of production, while Neo-classical
economics depends on mathematical models 3
Exploring The Great Depression
Delving deep into the Great depression and explaining it’s distinguished features and it’s impacts on US economy

From 1929 to 1933 • According to classical economists, The

economy reaches the natural level of
Metric Effect
employment and potential output itself.
Decrease in Per Capita -40% • This process takes time and there may be
Income
periods when employment falls below
Increase in Unemployment +22% natural level.
Drop in Real GDP -30% • Classical Economists thus saw the massive
Mortgages Defaulted 50% slump as a short-run aberration, which of
course was not the case.
Lost Homes 270000
Estimated 19 recessions had occurred in 75 years before the Great
Depression, all for less than 2 years. On the other hand, the great
depression lasted for more than 10 years, thus its much stronger name Keynesian Economics
Keynes shifted focus from aggregate supply to demand
in macroeconomic thought.
Ricardo emphasized reaching potential output on the
supply side.
Keynes argued that shifts in aggregate demand create
recessionary or inflationary gaps.
Prices are sticky in the short run, hindering adjustments
to full employment.
Keynes dismissed achieving full employment in the long
run as irrelevant. Keynesian economics emerged,
highlighting gaps between actual and potential output.
Following the Pearl Harbour incident, government spending drastically Keynesian economists advocate using fiscal and
increased the inflationary pressures, taking the economy out of the recession monetary policy to address these gaps.

3
What led to the Great Recession, Renewed interest in Keynesian Economics
Describing the causes of the great recession and how the Keynesian Economics came into play thereafter

Causes of the Great Recession

1. First was an identified failure on the part of the government to regulate the financial industry.

2. The recession resulted from a combination of tax cuts, spending increases, and the devastating effects of a banking
crisis in the subprime mortgage market.

3. Other causes included excessive borrowing by consumers and corporations, along with lawmakers who did not fully
understand the collapsing financial system.

New Keynesian Economics is the school of thought in modern macroeconomics that evolved from the ideas of John
Maynard Keynes. Keynesian economics was later redeveloped as New Keynesian economics, becoming part of the
contemporary new neoclassical synthesis, that forms current-day mainstream macroeconomics

New Keynesian economics includes the following:

1. Staggered prices: Not everyone in the economy sets prices at the same time. Instead, the adjustment of prices throughout the
economy is staggered. Staggering complicates the setting of prices because firms care about their prices relative to those charged by
other firms. Staggering can make the overall level of prices adjust slowly, even when individual prices change frequently.
2. Coordination failure: Recessions result from a failure of coordination. Coordination problems can arise in the setting of wages and
prices because those who set them must anticipate the actions of other wage and price setters. Union leaders negotiating wages are
concerned about the concessions other unions will win. Firms setting prices are mindful of the prices other firms will charge.
3. Efficiency Wages: New Keynesian economists often turn to efficiency wages to explain why this market-clearing mechanism may
fail. They tell that high wages make workers more productive. The influence of wages on worker efficiency may explain the failure of
firms to cut wages despite an excess supply of labor.
3
A Thorough contrast between GD and GR
Diving deep into and decoding the similarities and differences between The Great Depression and The Great Recession

Differences Great Depression Great Recession

Time period August 1929 to March 1933, effects lingered till late 1930s. December 2007 to June 2009

Origination Event Major fall in stock prices during September 1929. Bursting of the US housing bubble during 2005–06.

The US GDP contracted by ~4%, global GDP declined

Economic impact
Unemployment Rate
Fed’s Response
The US GDP witnessed ~30% decline, global GDP fell ~27%
Unemployment in the US peaked at ~25% in 1933.
The Fed increased the interest rates to restrict speculation in
the securities market.
by ~5%
Unemployment in the US peaked at ~10% in October
2009.
Slashed the interest rates and pumped a significant
amount of liquidity into the system.

Similarities Great Depression Great Recession

Artificially low interest rates throughout 1920s were raised to Seeds were planted in 1990, with the government
Causation
be sky high choking off investment pushing homeownership for uncreditworthy people

Spending fails Unemployment remained high at 25% in spite of spending Similar unemployment trends were witnessed at 10%

Raising tax rates Both excise and tax rates were increased, ceiling at 79% 40 of 50 of US states imposed some sort of tax hikes

FDR blamed the wall street bankers, calling them “Economic Obama followed FDR’s playbook condemning the
Scapegoats
Royalists” for causing the Recession raises they receive and the profits they earn
Output declined steeply, employment, consumer spending,
Economic Activity Similar Economic slumps were witnessed
housing and business investments also fell sharply
3
Key learning from Great Recession
Exploring the major teachings from the great recession backed with data proofs

1 Recessions Are Hardest On People Already Working To Overcome Economic Barriers

Job losses and prolonged unemployment were far more prevalent for people who face greater barriers to education. Nationally, unemployment for
workers with less than a college degree topped out near 16 percent compared to roughly 5 percent for workers with at least a bachelor’s degree

2 Helping people is the best way to boost the economy

Federal policymakers tried a wide array of measures to jolt the economy back to life in the early days of the Great Recession, and supporting people and
public investments proved to be a more effective means of boosting the economy. By comparison, tax breaks for rich investors and large companies proved
to be a poor investment of public dollars.

3 Tax cuts is not always the cure to recession

The premature retreat from federal stimulus was compounded by budget cuts that further contributed to a slow, lopsided, and incomplete recovery. Instead of using a slowly
recovering economy to repair public programs that had been cut during the fiscal pinch of the Great Recession, wave after wave of tax cuts were introduced that mostly benefited
wealthy individuals and rich shareholders.