Theories about the Great Depression
Abstract
Black Tuesday, October 28th, 1929, the second day
of double-digit declines in the stock market marks what is widely accepted as the
start of the Great Depression. The corresponding banking crisis made it worse,
but the causes were deeper than they appeared. Monetary policy contributed
greatly to the Great Depression.
There are several theories that try to explain the cause of
the Great Depression and they often focus on the crash of stock market crash
and the banking Crisis. So much so that when we hear the words Great Depression
it conjures images of October 28th, 1929 known as Black Tuesday when
the market dropped almost 12 percent marking the second day of steep decline
having dropped 13 percent on Monday. By the middle of November, the market had
fallen 89 percent below its highest point, bringing the Roaring 20’s to an end
to the Roaring Twenties and beginning what would be known as the Great
Depression.
However, this alone was not enough to bring about the Great
Depression. The banking crisis that followed was as much responsible as the
crash of the market. Banks had overextended credit during the boom of the
twenties, making risky investments and adding their customers to invest more in
the market complicated and already risky market. All of this was a disaster in
the making, a bubble waiting to burst if you will, and when the inevitable downfall
came, it hit the world hard. The shaky post-war economy plunged without credit
and loans, business came to a halt and just like that, the post-World War I
economic recovery ended.
“Bank Run,” in Wikipedia, January 30, 2024, https://en.wikipedia.org/w/index.php?title=Bank_run&oldid=1201002697.
While satisfactory, these explanations do not get to the root
causes of the Great Depression. These explanations explain what happened rather
than why it happened. That is not to say that there is not an understanding of
what actually caused the Great Depression. Much recent scholarship has focused
on trying to understand the great depression. One of the more recent schools of
thought has focused on monetary policy as a cause of the fall of the market and
the collapse of banking.
At a basic level the question around the Stock market has
been what was the cause of the market decline, why did the bubble burst? It has been put forward that the rapid growth
that encouraged the General public to invest in the market was a big part of
the problem. The more the market grew the happier investors, banks and
shareholders became, which fueled more speculative investment. Credit was
issued in a reckless manner. As brokers’ loans increased more and more, they became
dangerously extended into the market setting the stage for the catastrophic
fall. It was not these loans, but the demand for more credit that forced major changes
in the Market. This allowed more people to invest in the market which in turn incentivized
companies to offer more stock, which created an imbalance that the market couldn’t
maintain. When the market showed signs of recession, it triggered a panic that
the market was not prepared for or equipped to handle.[1]
A fair amount of research has centered on the monetary factors
involved with the downturn that caused the Great Depression. In short, the erratic
rise and fall of the money supply, output, and price during the post-World War
I recovery directly affected. Central to this argument is the gold standard, its
suspension during World War I, and its resumption after the war. The contraction
of the money supply has been viewed as a major source of issue during the
Depression and the problem can be seen readily in countries that returned to
and adhered to the gold standard[2] By resuming
the gold standard government had to ensure that the amount of currency remained
consistent with the amount of gold in its repositories. When faced with the
need for more currency to help deal with the banking panic, governments were
unable to respond. The resumption of the gold standard also played a role in the
decline of prices worldwide leading up to the depression and made it harder for
countries to deal with the crisis.[3]
Many believe that it was the spending growth as a result of
the coming of World War II that brought the world out of the Great Depression. In
some ways, the war did help the United States as an influx of deposits from war-torn
countries increased the available money supply. However, the key to ending the
depression was a change in monetary policy starting with the revaluation of gold
by the Roosevelt administration in 1934. The devaluations and change in monetary
policy that was the driving force behind the recovery from the Great Depression.
Bernanke, Ben S. “The Macroeconomics of the Great
Depression: A Comparative Approach.” Journal of Money, Credit and Banking
27, no. 1 (1995): 1–28. https://doi.org/10.2307/2077848.
Mazumder, Sandeep, and John H. Wood. “The Cause of the Great
Depression.” The Independent Review 26, no. 1 (2021): 133–51.
White, Eugene N. “The Stock Market Boom and Crash of 1929
Revisited.” The Journal of Economic Perspectives (1986-1998) 4, no. 2
(Spring 1990): 67.
[1]
Eugene N White, “The Stock Market Boom and Crash of 1929 Revisited,” The
Journal of Economic Perspectives (1986-1998) 4, no. 2 (Spring 1990): 67.
[2]
Ben S. Bernanke, “The Macroeconomics of the Great Depression: A Comparative
Approach,” Journal of Money, Credit and Banking 27, no. 1 (1995): 1–28, https://doi.org/10.2307/2077848.
[3]
Sandeep Mazumder and John H. Wood, “The Cause of the Great Depression,” The
Independent Review 26, no. 1 (2021): 133–51.
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