Great Depression


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Economic history

The timing and severity of the Great Depression varied substantially across countries.
The Depression was particularly long and severe in the United States and Europe; it was milder
in Japan and much of Latin America. Perhaps not surprisingly, the worst depression ever
experienced stemmed from a multitude of causes. Declines in consumer demand, financial
panics, and misguided government policies caused economic output to fall in the United States.
The gold standard, which linked nearly all the countries of the world in a network of fixed
currency exchange rates, played a key role in transmitting the American downturn to other
countries. The recovery from the Great Depression was spurred largely by the abandonment of
the gold standard and the ensuing monetary expansion. The Great Depression brought about
fundamental changes in economic institutions, macroeconomic policy, and economic theory.

Stock market crash

The initial decline in output in the United States in the summer of 1929 is widely
believed to have stemmed from tight U.S. monetary policy aimed at limiting stock market
speculation. The 1920s had been a prosperous decade, but not an exceptional boom period;
wholesale goods prices had remained nearly constant throughout the decade and there had been
mild recessions in both 1924 and 1927. The one obvious area of excess was the stock market.
Stock prices had risen more than fourfold from the low in 1921 to the peak reached in 1929. In
1928 and 1929, the Federal Reserve had raised interest rates in hopes of slowing the rapid rise in
stock prices. These higher interest rates depressed interest-sensitive spending in areas such as
construction and automobile purchases, which in turn reduced production. Some scholars believe
that a boom in housing construction in the mid-1920s led to an excess supply of housing and a
particularly large drop in construction in 1928 and 1929.

Banking panics and monetary contraction

The next blow to aggregate demand occurred in the fall of 1930, when the first of four
waves of banking panics gripped the United States. A banking panic arises when many
depositors lose confidence in the solvency of banks and simultaneously demand their deposits be
paid to them in cash. Banks, which typically hold only a fraction of deposits as cash reserves,
must liquidate loans in order to raise the required cash. This process of hasty liquidation can
cause even a previously solvent bank to fail. The United States experienced widespread banking
panics in the fall of 1930, the spring of 1931, the fall of 1931, and the fall of 1932. The final
wave of panics continued through the winter of 1933 and culminated with the national “bank
holiday” declared by President Franklin Roosevelt on March 6, 1933. The bank holiday closed
all banks, permitting them to reopen only after being deemed solvent by government inspectors.
The panics took a severe toll on the American banking system. By 1933, one-fifth of the banks in
existence at the start of 1930 had failed.