Submitted

Submitted to: Submitted

Prof. Chandan Sharma
The Great Depression Page 1
by:
Darrick Arora (91015)
Kuldeep Indeevar
(91027)
Sweta Agrawal (91059)
Varun Bansal (91060)
 ACKNOWLEDGEMENT

Behind every fruitful endeavor lie the advice, guidance and inspiration of all the people directly or
indirectly involved with the report. We wish to express our gratitude to all the people involved in the
completion of this report. We are thankful to all of them for their help and encouragement throughout the
completion of the report. They have been a constant source of support for me.

First of all we wish to express our deep sense of gratitude to Prof. Chandan Sharma, instructor for Macro
Economics, for making us aware of the importance of economics in the world and for a manager and also
proving his guidance and support throughout the report.

We will also like to thank my batch mates, for taking out their precious time to answer some questions
and providing an insight into the different facets of economics in the real world scenario and also for their
full support in making the report enriching and informative.

Their constructive criticism of the approach to the problem and the result obtained during the course of
this work has helped us to a great extent in bringing work to its present shape.

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 TABLE OF CONTENTS

Chapter 1...............................................................................................5

1.1 Introduction....................................................................................................5
1.2 Spread of Great Depression...........................................................................5
Chapter 2...............................................................................................9

2.1 Causes of Great Depression...........................................................................9

2.1 (a) Over Production and Under Consumption.................................................9
2.1 (b) Banking and Monetary Policy.............................................................11
2.1 (c) Stock Market Actions..........................................................................12
2.1 (d) Political Decisions..............................................................................14

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‘Most economists, to the extent that they think about the subject at all, regard the
Great Depression of the 1930s as a gratuitous, unnecessary tragedy. If only Herbert
Hoover hadn't tried to balance the budget in the face of an economic slump; if only
the Federal Reserve hadn't defended the gold standard at the expense of the
domestic economy; if only officials had rushed cash to threatened banks, and thus
calmed the bank panic that developed in 1930-31 ; then the stock market crash of
1929 would have led only to a garden-variety recession, soon forgotten. And since
economists and policymakers have learned their lesson... nothing like the Great
Depression can ever happen again.’ Krugman Paul in ‘The Return of
Depression Economics and the Crisis of 2008’

Definition of Recession and Depression

A recession is defined as the decline in the real GDP for the two consecutive
quarters.

However National Bureau of Economic Research (NBER) in U.S. does not

define a recession in terms of two consecutive quarters of decline in real
GDP. Rather, a recession is a significant decline in economic activity spread
across the economy, lasting more than a few months, normally visible in real
GDP, real income, employment, industrial production, and wholesale-retail
sales.

Depression by the economists is defined as the more severe version of

recession. Thus depression is thought to occur when GDP declines by 10
percent or more in a year.

A recession is when your neighbor loses his job; a depression is when you lose your job.
………………………………………………………………………………………………Anonymous

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 Chapter 1

1.1 Introduction

The Great Depression was the severest economic slow-down the world has
ever seen. The Great Depression was an economic slump in North America,
Europe, and other industrialized areas of the world that began in 1929 and
lasted until about 1939. It was the longest and most severe depression ever
experienced by the industrialized Western world.

The beginning of the Great Depression was marked by the catastrophic fall in
the stock market prices of the New York Stock Exchange in October 1929.
During the next three years the stock prices fell and by 1932 they had
dropped to 20 percent of their value in 1929. This decline in the value greatly
devoid banks and other financial institutions of their value and thus they
were forced to insolvency. By 1933, 11000 of the 25000 US banks were
insolvent and failed. The failure of so many banks combined with a general
and nationwide loss of confidence in the economy, led to much-reduced
levels of spending and demand and hence of production, thus aggravating
the downward spiral. The result was drastically falling output and drastically
rising unemployment; by 1932, U.S. manufacturing output had fallen to 54
percent of its 1929 level, and unemployment had risen to between 12 and 15
million workers, or 25-30 percent of the work force. Thus Depression gripped
the US economy.

The Great Depression which began in the U.S. quickly turned into a
worldwide economic slump because of the intimate relationships that had
developed between U.S. and European economies after World War I. As U.S.
emerged from victorious the war, it became the major creditor and financier

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of postwar Europe, whose national economies had been devastated by the
war, by war borrowings, and, in some other cases the need to pay war
reparations. So as Depression gripped US economy, the flow of American
investment credits to Europe dried up, prosperity tended to collapse there as
well. The Depression hit hardest those nations that were most deeply
indebted to the United States, i.e., Germany and Great Britain.

In Germany, unemployment rose sharply beginning in late 1929 and by early

1932 it had reached 6 million workers, or 25 percent of the work force.
Britain was less severely affected, but its industrial and export sectors
remained seriously depressed until World War II. Many other countries had
been affected by the slump by 1931.

1.2 Spread of Great Depression

The Great Depression had devastating effects in virtually every country.

Personal income, tax revenue, profits plunged while international trade
nosedived. Unemployment in US rose to as high as 37.6 percent in 1933.

Chart showing percentage of Unemployed across various countries in 1933

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The below map shows the main areas of North America hit by
Depression

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This map shows the Effect of Depression in Europe

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The below maps indicate the decline in exports from countries
trading in Primary Products

Thus it is evident from the above maps that Depression was wide spread and
it impacted the economies of the Industrialized Western World severely.

Chapter 2

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2.1 Causes of the Great Depression

There are several explanations and theories propounded for explaining the cause of
depression. But the causes of Great Depression have been broadly classified into 4
parts by the economists. They are

a) Over Production and Under Consumption

b) Banking and Monetary Policies

c) Stock Market Actions

d) Political Decisions

2.1 (a) Over Production and Under Consumption

Macroeconomic effects of money supply can be seen as the total realized income of
the US increased from $74.3 billion in 1923 to $89 billion in 1929. However this was
not shared equally among all Americans and the top 0.1 percent Americans had a
combined income equal to 42 percent. The same top people controlled 34 % of all
the savings. Thus, though the per capita disposable income rose by 9 percent in
‘the roaring decades of twenties’ the top 1 percent enjoyed the stupendous increase
of 75 percent in their disposable income. Also the average output per worker
increased 32 percent in manufacturing. During that same period of time average
wages for manufacturing jobs increased only 8 percent.

The increasing gap between rich and the poor made the US economy unstable. For
an economy to function well, the total demand must be equal to total supply. Since
this was not the case, what happened was the over-supply of goods because the
wage rate could not keep pace with the increased productivity and hence increased
output.

Also due to World War I, the production in Europe came to halt and European
countries became dependent on the imports from America. The farmers in America
enjoyed subsidies given by the government and thus they record huge profits.
However during late 1920s the farmers there suffered from depressed prices
because of over production and thus the cost of producing food grains became more

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 than the income earned from selling the same. Crop prices fell by as much as 60
percent.

This led to piling up of inventories and thus manufacturers were forced to lay off
people. Unemployment rose to as high as 25 percent. Since laid off workers could
not spend money, over production produced a ripple effect throughout the economy
and a uncontrolled chain reaction was triggered.
The same could be understood with the help of Philips curve which highlights the
inverse relationship between rate of unemployment and rate of wage increase.

Summary: High Demand for Consumer Goods and Agricultural Products led to Over
Production, but due to income disparity, widening gap between rich and poor and
failure of wage rate to keep pace with the increasing demand led to under
consumption.
‘True’ Phillips curve

B
n)
(inflatio
e
increas A
wage C ‘Illusory’ short-

Rate of run Phillips

Curve

Unemployment Rate

2.1 (b) Banking and Money Policies

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In view of Monetarists the Great Depression was mainly caused by monetary
contraction, the consequence of poor policy making by Federal Reserve System and
continued crisis in banking system. As the wages were not keeping up with the
prices of the goods and also the uneven distribution did not deter middle class from
wanting to possess luxury goods, these created problems.

As money required for payment of goods and services in the near future, the money
being equivalent to ‘M2’ (include savings accounts, money market deposit
accounts, small time deposits), was allowed to shrink by Federal Reserve and it
shrink by one-third from 1929 to 1933, thus transforming a normal recession into
the Great Depression. As the banks failed, it spread panic and fear on local banks.
With significantly less money to go around, businessmen could not get new loans
and could not even get their old loans renewed, forcing many to stop investing.

The solution adopted was to let products be purchased on credit, and the concept of
‘Buy now and Pay later’ caught on quickly. Though there had been credits and
loans given to businessmen for running their business but this was the first time
the personal credit or loans were available to buy goods and services. By the
start of 1930s 60 percent of the cars and 80 percent of the radios were bought on
installment.

As the Federal Reserve had the power to set the interest rates for the loans issued
by banks, it set very low interest rates which encouraged people to buy on
installment or credit.

More buyers meant more profit for companies, so they produced more and
more…so much that a surplus of goods was created!

Fearing a very rapid growth rate, Federal Reserve tried to tighten the money
supply by increasing the interest rates. Facing higher interest rates and
accumulating debt, people began to slowdown their buying of consumer goods
and services and also started defaulting. This proved to be the last nail in the
coffin and this act of Federal Reserve sent the economy spiraling down southwards.

Summary: Because of decreased ‘M2’ concept of ‘Buy now Pay Later’ was introduced.
Buying on Credit increased Personal Debt. Higher interest rates forced people to curb
their spending and also to default on their loans. Thus inventories piled up.
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2.1 (c) Stock Market Actions

As one could buy goods and services on credit, it was easy to borrow money in
stock market and the down payment during the time of purchase was significantly
lower. Known as ‘Margin Investing’, it allowed investors to buy stock on credit and
small investors were more apt to invest in Stock Market in large numbers because
the ‘Margin Requirement’ was only 10 percent.

‘Margin Investing’ helped U.S. stock market to boom in the 1920s. Prices reached
levels, measured as a multiple of corporate dividends or corporate earnings that
made no sense in terms of traditional patterns and rules of thumb for valuation. A
range of evidence suggests that at the market peak in September 1929 something
like 40 percent of stock market values were pure air: prices above fundamental
values for no reason other than that a wide cross-section of investors thought that
the stock market would go up because it had gone up. Thus Margin functioned like
buying car on credit.

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The crucial point came when banks began to loan money to stock buyers and
investors were allowed to use the stocks as collateral. If the stock prices
dropped, banks would be holding nearly worthless collaterals in form of stocks.

But with the stock market crash of October 29, 1929 (the crash of the stock market
was due to very high speculations) the U.S. stock market lost approximately 90
percent of its value and over 16 million shares were sold in massive frenzy, leading
to a total loss exceeding $26 billion.

The stock market crash of 1929 greatly added to economic uncertainty: no one at
the time knew what its consequences were going to be. The natural thing to do
when something we do not understand what has happened, is to pause and wait
until the situation becomes clearer. So everyone followed their instinct, with the
firms cutting back their own plans for further purchase of producer durable goods.
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 Consumers cut back purchases of consumer durables. The increase in uncertainty
caused by the stock market crash amplified the magnitude of the initial recession.
After this the market went down from 381.17 in 1929 to 41.22 in 1932. That was almost a
90% drop.

Summary: Initial boom in the market, due to ‘margin investment’ and low ‘margin
requirement’. Banks gave loans and in return took collaterals in the form of stocks.
Crash of stock market left banks holding worthless collaterals. 90 percent dropped in
index. Panic grip and the uncertainty caused by the stock market crash amplified the
magnitude of the initial recession.

2.1 (d) Political Decisions

The Great Depression which began in the very first year of Presidency of Mr. Herbert
Hoover set the economy to test against his belief that there were technical solutions
to all social and economical problems. Mr. Herbert Hoover deeply believed in
Efficiency Movement, which was the measure component of the Progressive Era.

Look After Yourself

Herbert strongly felt that it was not the government task to look after the
individuals, rather it was the individual job to take care of himself because Herbert

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believed that any step taken by Federal to help an individual will demoralize him
and will make him dependent. Herbert was later on strongly criticized for this.

Steps taken by Herbert Government

Hoover government did take some action and tried to intervene but the steps taken
were too little and

they were too late. Some steps taken by Herbert government were:

a) Dramatic increase in the government spending for relief, dolling out

millions of dollars to wheat and cotton farmers.

b) Urged key business players and leaders to keep the wages high even
though prices and profits were falling. The motive behind this act was higher
the prices, harder the people will work to earn and this will bring out the
economy from recession.

c) Introduced Smoot-Hawley Act in 1930 which raised the tariffs on U.S.

import by more than 50 percent. This was done to discourage people from

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 using imported items and to encourage people to use American items. The
rationale behind this was more the domestic consumption, more
Americans will be employed back at home.

d) Tried balancing the federal budget by increasing the tax-rate. Income

taxes were raised from 1 percent to 4 percent at the low end and from 23
percent to 63 percent at the top of the scale.
Hoover’s advisors hoped this tax increase could cover the mushrooming
deficit of government spending for relief.

Actions which proved death-nail for Herbert Government

a) The Smoot-Hawley Tariff Act of 1930 proved to be a double edged sword as

the Federal ignored the principle of international trade i.e. it is a two way
street. It virtually closed our borders to foreign goods and ignited a vicious
international trade war.

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 Source: http://britannica.com

b) Increased in tax rates decision proved to be disastrous. The tax increase took
money out of the people’s hands which only curtailed their spending.

c) To add to the vows severe drought ravaged the agricultural heartland beginning
in the summer of 1930. It thus created the ‘Dust Bowl’ of unproductive eroded
farmland.

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 The combination of these factors caused a downward spiral, as earnings fell,
smaller banks collapsed, and mortgages went unpaid. Hoover's hold-the-line
policy in wages lasted little more than a year. Unemployment soared from
five million in 1930 to over eleven million in 1931. A sharp recession had
become the Great Depression.

Summary: Policies adopted by Herbert Government did not suffice for the deep
recession and any step that the federal took back fired them. The result of this was
people started clamoring for new government and F.D. Roosevelt of Democrat was
adorned as the President of the USA in 1932. Depression completely tarnished the
image of Republicans.

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