The Causes of the Great Depression

By: Mary Anne Winslow
Submitted: 2007-01-17 16:25:20
Print this article | Tell a friend | For publisher |

Rating:

 

One of the most difficult times in the history of the United States of America is most obviously the Great Depression. It was a time of financial ruin for the majority of the American population, a time of poverty and bleakness, of no hope for a better future. Could it have been prevented? Was there a way in which the government could have averted such a financial tragedy? And most importantly, could it happen again?

Balancing the Budget

Personally, the poor state of economic intelligence during the late 1920s and the 1930s is in my belief one of the greatest contributors to the Great Depression. Take this statement from President Hoover:

"It would steady the country greatly if there could be prompt assurance that there will be no tampering or inflation of the currency; that the budget be unquestionably balanced even if further taxation is necessary."

Mr. Hoover's (as well as Franklin Roosevelt's from 1932 onwards) aim of achieving a balanced budget and not tampering with the economy was one of many primary causes for aggregate demand falling during the 1930's. These Presidents thought that if the budget was steady and balanced, the economy would also be steady and balanced. From 1930s onwards the budget was well out of balance, and the only way to achieve a balanced budget meant increasing taxes and/or reducing government spending. The effect of increasing taxes and/or reducing government spending in a time when consumer confidence was dwindling lead to a fall in aggregate demand. This initial fall in aggregate demand lead to a larger than proportional decrease in expenditure, this is known as the negative multiplier:

Low Consumer Confidence

"If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez faire to dig the notes up again . . . there need be no more unemployment . . .. It would indeed be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing."

During the Great Depression all the government needed to was fuel the economy with spending, and spending on anything would do. Though the government of the time just did not understand the damaging effect the balanced budget was causing the economy. This triggered Keynes to note, "In the long run, we're all dead". Meaning, if the governments of the world did not do anything to induce spending and reduce hoarding of money immediately, the population would not last in the long run.

Low Consumer Confidence continued

Hence, worried consumers then tried to endure the economic adversity by saving their money; therefore their marginal propensity to save was very high. But because my spending is part of your earnings, my decision to stockpile money makes things worse for you. And you, responding to your own difficult times, will start stockpiling money too, making things even worse for me. This is the vicious cycle that was at work during the Great Depression, as people accumulate money in difficult times, living becomes more and more arduous.

In this situation, Keynes suggested that government should do what the people were not: start spending. He called this "priming the pump" of the economy. The effect of 'priming the pump', as the initial increase in Government expenditure has lead to a larger than proportional increase expenditure, this is known as the Multiplier Effect:

Hoarding Funds

But why did consumers hoard money in the first place. Personally this is the most important question that required to be answered. Finding a solution to this question will be a major stepping-stone into stopping further depressions happening.

It must be noted that the Hoover Government of the time, in its aim to achieve a balanced budget, mistakenly tightened the money supply within the economy. This compelled people to hold on to money, as the supply of money was decreasing. In my belief, the stock market crash is a more visible event that lead to a huge loss in the confidence of consumers from 1929 onwards.

Had the economy been running effectively and efficiently at the time of the stock market crash, its affect may have been partial. Hence, the shock to confidence and the loss of spending by those who were caught in the market might soon have worn off. But business in 1929 was not sound; on the contrary it was exceedingly fragile. Hence it was vulnerable to the kind of blow it received from Wall Street. The fragile economy and the stock market crash worked hand-in-hand during the 1930s to dwindle consumer confidence, and bring on the hoarding of money.

The Economy from 1929 onwards

In, 1929 the economy was at full employment. Then aggregate demand fell; which was due to the low consumer confidence that sprang from the stock market crash, this lead consumers to hoard money hence consumption fell; also government spending was cut as the government of the tried to achieve a balanced budget; and animal spirits lead to decreases in investments. This decrease in aggregate demand is shown from 1929 to 1932. Then if labor were to do as commanded and take a pay cut, the economy would return to full employment in 1937 –1938.

Great Depression Cured

World War II cured the Great Depression; due to the large amounts of money being spent on defense. This is where the thought that 'wars are good for the economy' comes from. During World War II the Hoover Government unknowingly resorted to Keynesian spending, hence it can be said that wars are of economic benefit. Though it would be much more preferable for social programs to be put into place instead of war

Article source: Expert Articles