Great Depression

The Great Depression was the longest and deepest downturn in economic activity in modern history. It has had a profound influence upon both economic theory and the practice of economic management.

In 1929, the United States experienced a deep decline in prices and production. Businesses and banks closed, people lost their jobs, homes, and savings; and in the absence of welfare programmes, many depended on charity to survive. At its worst, in 1933, unemployment reached a poverty-inducing 25 per cent of the working population: and in the ensuing recovery, it did not fall below 15 per cent until the beginning of the second world war.

At about the same time, the German and Canadian economies suffered downturns of comparable severity; the British economy experienced a substantial though comparatively short-lived downturn; the French economy suffered a modest but prolonged decline; and most of the other industrialised countries and their suppliers experienced downturns in economic activity that caused hardship and political unrest.

Subsequent investigations have attempted to discover why the downturn in economic activity had been so deep and so prolonged, why there it had happened in so many different countries, and what policy actions might have been effective in combatting it. The answers to those questions remain incomplete but there is a limited consensus among economists concerning its principal features, and concerning the appropriate policy response to a threat of a comparable downturn.

Links and subpages

For an annotated chronology of the main events in the countries affected, see the Timelines subpage;

for a summary of the statistics of the Great Depression in the United States, go to [4]

for more about events within the United States, see the article on the Great Depression in the United States;

for more about the events in countries outside the United States, see the Addendum subpage; and,

for a discussion of economic theories concerning causes and remedies, see the Tutorials subpage.)

Overview

In the United States, the Great Depression began in 1929, reached its deepest point in 1933 and lasted until 1939. It was accompanied during that period by the stock exchange crash of 1929, the banking crisis of 1931, a credit crunch, and a severe deflation; and it resulted in a massive loss of output, persistently high unemployment and widespread deprivation. Downturns of differing severity also occurred in many industrialised and commodity-producing currencies, and there was a general collapse in international trade. Some years after its outset there was a general return to previous levels of economic activity, but the economies of the United States and of several other countries did not fully recover until the outbreak of the Second World War.

The resulting hardships had significant political repercussions, including the replacement of existing national governments - notably in Germany - and a deterioration of international relations, but besides causing widespread human suffering, the great depression stimulated major investigations into its causes; gave birth to macroeconomics as a distinct field of study, and the genesis of the rival theories Keynesianism and Monetarism; and led to the systematic collection and publication of economic statistics. It has exerted a major influence upon political beliefs and ideologies and despite continuing controversy, it has generated major changes in the consensus views of economists and politicians. It has also led to international agreements on economic issues, such as that reached at the Bretton Woods Conference, and to the creation of instruments of international cooperation such as the Bank for International Settlements, the International Monetary Fund, the World Bank and the World Trade Organisation.

The development of the depression

(The chronological list of the events referred to in this paragraph that appears on the Timelines subpage and, together with the Tutorials subpage, that subpage provides links to the sources of the statements below)

Although it ended eleven years earlier, there are reasons to suppose that the economic disruption created by First World War played a part in the development of the Great Depression. The war had produced disruptive changes to the economic systems that were so severe they required a long and difficult period of adaptation. The American economy was much stronger and European economies were much weaker than before the war, and Britain and France had incurred huge debts to the US for the war. In most countries, membership of the international gold standard had been suspended during the war, and in its absence, many of them experienced bouts of inflation. Economists and politicians at the time believed that a return to the gold standard was necessary in order to re-establish financial stability, but economists have now come to believe that attempts to do so prolonged the disruptive influence of the war.

After a turbulent post-war period during which there were deep but short-lived recessions on both sides of the Atlantic, economic growth had returned to the United States and Europe, although attempts to reflate the German economy had led to its interruption by the German hyperinflation of 1923. After the restoration of price stability, German economic growth resumed in 1924 with the assistance of Dawes Plan loans from the United States.

Britain rejoined the gold standard in 1925 at an exchange rate that overvalued the pound, and France rejoined it in 1928 at an exchange rate that undervalued the franc. There followed a series of British trade deficits and gold outflows and a series of French trade surpluses and gold inflows. By 1927, the Bank of England's gold reserves were running low and its Governor persuaded the Governor of the Federal Reserve Bank of New York to help by organising a major addition to the United States money supply. There followed a sharp increase in America's output growth rate (prompting John Maynard Keynes to remark that "...the world was enormously enriched by the constructions of the quinquennium from 1925 to 1929; its wealth increased in these five years by as much as in any other ten or twenty years of its history" .) and an even sharper increase in the the growth of prices on the New York Stock Exchange.

In the United States the downturn in activity that was to became the Great Depression began at the end of the 1920s following restrictionary policies in the United States and in Germany (said to have been prompted both by a wish to restrain stock exchange speculation and by concern about gold outflows). Both downturns were comparatively mild at first, but they became exceptionally severe after. Their severity was increased by the stock exchange crash of 1929 and the unusually severe banking US banking crises of 1931-33. The recovery began in 1933 after the election of a new administration under the Presidency of Franklin D. Roosevelt. The new government left the gold standard, imposed a brief banking "holiday", sponsored the insurance of bank deposits, and provided the banks with substantial financial assistance. The Federal Reserve Bank began to expand the monetary base, and there followed a limited and delayed increase in the money supply . Confidence in the banking system returned, but the credit shortage was only very gradually relieved, and small firms continued to experience credit difficulties for several years after 1933. The government also introduced a modest fiscal stimulus and introduced a programme of public works known as the New Deal. There was a slow recovery in economic activity, interrupted by a brief downturn in 1937, but it was not complete until the outbreak of the second world war.

There were depressions of comparable severity in the industrialised economies of Canada and Germany, and of lesser magnitude in Britain, France and Scandinavia. There were major price reductions in the international commodity markets, and severe downturns in the commodity-producing economies of Australia and South America. Recovery from the recession began in 1931 in Britain, Scandinavia and Japan following currency devaluations made possible by departures from the gold standard. In Germany, the Nazi government under the Chancellorship of Adolf Hitler repudiated all international obligations and adopted a varied programme of reflation and rearmament, which was immediately effective in reducing unemployment and restoring economic growth. Recovery did not begin in France until its departure from the gold standard in 1936.

Explanations

The question of causation

There have been a great number of attempts to establish the cause of what has come to be seen as an unprecedented self-inflicted injury, and a great deal of disagreement. However, the unprecedented feature of the great depression was not its initiation (there had been a succession of recessions in the United States throughout the previous eighty years , and it was no worse in its early months than the preceding recession of 1921 ) - but, rather, its unprecedented severity and persistent depth. That consideration and others suggest that any search for a single cause is likely to be confusing and inconclusive. For example, although the popular view that it was initiated by the stock market crash can be shown to be mistaken , the crash must be presumed to have contributed to its subsequent severity. Similarly, it can reasonably be presumed that although the 1931 banking panic could not have started the great depression, it intensified its subsequent severity. However, the term "cause" is often used loosely, and - as will be seen - neither of the proponents of the principal rival explanations suggests that no other factors contributed to the great depression. Subsequent studies - other than those that sought to elaborate on one or other of the rival hypotheses - have mainly been attempts to assess the importance of various contributory factors. However, the fact that something has been treated as a "contributory factor" rather than a "cause" does not exclude the possibility that its contribution to the depth or length of the depression might have been greater than that of something else that has been assigned the role of cause.

Rival Hypotheses

(This paragraph is a summary of the account of economists' hypotheses that is set out on the tutorials subpage. See that page for references to sources).

It is widely believed that the Great Depression was started by the bursting of a speculative bubble on the New York stock exchange and that it spread abroad from the United States, causing the collapse of a hitherto well-functioning system of international finance. Those beliefs have been challenged by the eminent economists who have studied the evidence. According to Ben Bernanke there is a consensus that the picture of a stock exchange "bubble" that had been verbally painted by John Kenneth Galbraith and others is mistaken, and that the stock prices did not at that time overstate the value of the issuing companies . Moreover, neither John Maynard Keynes nor Milton Friedman considered the stock exchange crash to have started the downturn, although they both recognised that it must have contributed to its severity. The belief that the depression originated uniquely in the United States has been challenged by Peter Temin, who has identified evidence that it had an independent origin in Germany, and has suggested that it developed jointly from both origins. The belief that the the depression put an end to what had been a stable international financial system has been challenged by Charles Kindleberger, who argues that, although the gold standard system had worked well before the first world war, its post-war version had a bias toward deflation that made it inherently unstable. PeterTemin Has argued that the belief that the depression had been intensified by economic nationalism should be qualified by the consideration that the "trade war" could not have had much effect upon the United States because international trade had occupied too small a part in its economy; and the belief that trading had been hampered by the competitive devaluation of national currencies has been challenged by Barry Eichengreen on the basis of evidence that it had contributed to world output.

The belief that policy mistakes had contributed to the disaster is generally accepted by economists, but there is disagreement among them concerning the nature of those mistakes, and concerning the economists' beliefs upon which they had been founded. The belief that had been current at the time that economic instability results from government attempts at regulation and that action to counter recessions makes them worse, is not widely accepted nowadays, except by some economists of the Austrian School, and there are few who now believe that maintenance of a balanced budget and adherence to the gold standard are essential for the maintenance of price stability. The principle remaining controversy concerns the roles of fiscal and monetary policy. In their time, Friedrich Hayek had laid the blame for the depression upon the Federal Reserve's 1924 monetary expansion, whereas John Maynard Keynes and Milton Friedman had held its 1928 monetary contraction to have been partly responsible. Milton Friedman blamed the Federal Reserve for continuing to restrict the money supply after the depression had started, whereas John Maynard Keynes had warned President Roosevelt against reliance upon expanding the money supply and voiced concern about what he considered to be the President's reluctance to introduce an adequate fiscal expansion.