Causes of Great Depression: A Review

The provided document is a review of the causes of the Great Depression. It discusses the banking panic and stock market crash as common factors that contributed to the depression. The Smoot-Hawley tariff and protectionist policies are also mentioned as potential reasons. The document references various studies and essays on the topic, providing a comprehensive analysis of the subject.

Running head: ECONOMICS
Economics
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Table of Contents
Introduction......................................................................................................................................2
Discussion........................................................................................................................................2
Conclusion.......................................................................................................................................6
Reference List..................................................................................................................................8

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Introduction
The great depression or the worldwide economic downturn started in the year 1929 and
lasted for nearly ten long years. This is still now regarded as the largest and most severe
depression ever experienced by industrialized western world (Irwin, 2017). The depression
originated in the United States, however it gave rise to severe decline in the level of outputs,
drastically high unemployment and an absolute deflation in almost all the countries around the
world. The timings and extent of severity caused by the depression varied across different
countries. It was longest and most severe in the United States and European countries while
Japan and the Latin America faced a comparatively milder impact (Tindall and Shi, 2016).
There, however, remains disputes among the scholars regarding the origin of the economic crisis
as there are several researchers who have argued that the Great Depression started in Europe in
the year 1928, which afterwards, spread to the United States. During the year of 1929 two
million people lost their jobs in the United States. By the end of the year 1932, the number of
jobless people crossed 13 million which is more than a 600% rise (Nanda and Nicholas, 2014).
There were other major consequences as well. This essay aims to discuss the major reasons
behind the Great Depression critically and in the final section aims to provide a concluding
remark regarding the same.
Discussion
Still now the economists continue to study Great Depression as there are still so many
debates regarding finding the actual factor that caused it. Numerous economic theories have been
advanced but there remains no single, universally accepted explanation of why the great
depression took place (Coen-Pirani and Wooley, 2017).

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While tracing out reasons behind the great depression, the stock market crash of 1929 is
often considered responsible for it. The crash significantly destroyed large amount of wealth.
Some of the economists argue that the crash, more importantly affected the health of the
economy which in turn convinced the consumers and the organizations to pull back their
expenditures specifically over the luxury goods like cars and expensive appliances. However,
following Ohanian (2017), it can be stated that the crash, though being one of the significant
causes of the Great Depression, was not the only reason and the depression occurred as a
cumulative outcome of many other factors.
There are theorists who believe that the great depression was mainly caused by the tight
monetary policy adopted by the United States to restrain the stock market speculations. As
during the year of 929 the United States stock process had reached a level that the reasonable
anticipations about the future earnings could not justify, the investors lost their confidence as a
result of which the bubble of stock market burst. On October 24th of 1929 panic selling started
and that day has still been regarded as “Black Thursday” (Temin, 2014). This crash of the U.S.
stock market contributed substantially in the reduction of aggregate demand of the country. The
demand for durable goods and business investments fell sharply right after the crash. The most
suitable explanation behind this is that the financial instability gave rise to substantial uncertainty
about the future income of the population which as a result compelled the firms as well as the
consumers to put off their spending on durable goods. However, the loss of wealth due to the fall
in the stock price was comparatively lower, the crash may have reduced the level of spending by
making the people feel that they are poor. As a result of the dramatic fall in the consumer and
firm spending, the real output of United States have depicted a sharp decline in the year 1929 and
kept on falling throughout 1930 (Benmelech et al., 2017).

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The factor that hit the aggregate demand of the United States in the year 1930 was the
first four waves of panic in the banking sector. In this context it is relevant to mention that a
banking panic may occur when the depositors lose confidence about the solvency of the banking
system and demand their deposits to be returned to them in cash. Banks generally hold a fraction
of deposits in hand and liquidate loans to raise the cash required. This liquidation process causes
failure in the banking system (Babina et al., 2017). During the period of 1930 to 1933 the
economy of United States faced four consecutive banking panics which lead to the closure of
banks and it had been declared that the banks will reopen only after they were declared to be
solvent by the government inspectors. This banking panic affected the US banking system
significantly as by the end of 1933 almost one fifth of the banks which were operating even in
1930 were closed (Stuckler et al., 2012).
Naturally the banking panics are inexplicable and irrational events, however, there were
some factors that contributed to this event. Some of the economists believe that a significant
increase in the debt of farm along with the policies of U.S. government that encouraged the small
banks had given rise to an environment where panic and skepticism could easily spread.
Coupled with the aforesaid factors the Federal Reserves also contracted the money supply
in the U.S economy which posed a contractionary impact over the output of the economy. The
picture below explains the role monetary collapse played during the great depression of United
States. The figure clearly depicts that the supply of money and output together during the period
of 1900 through 1940. It can be observed that during 1920 both money supply and GDP grew
steadily but in 1930 both depicted a steep fall (Saint-Etienne, 2013). The fall in the supply of
money affected the spending in numerous ways. While actual prices declined coupled with a

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rapid decline in the money supply the consumers and the businesses assumed that in future there
would be a deflation and expected that wages and prices will also be very low in future.
Figure 1: The GDP and Monetary Policy of United States
(Source: Romer and Romer, 2013)
A group of economists stresses in the fact that the Federal Reserve allowed a huge
decline in the money supply in order to support the gold standard. Under the genre of gold
standard each of the countries determines the value of its currency in terms of gold and enacts
remedial monetary measures to preserve that fixed price (Romer and Romer, 2013). It is also a
matter of fact that if the Federal Reserve implements an expansionary policy the people would
think that the country has lost its faith on the gold standard. This could certainly lead to a
significant gold outflow due to which the country would be forced to devalue its own currency.

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However be there are debates regarding the role played by the Gold Standard in limiting
the monetary policy of the country but it can undoubtedly be regarded as the key factor that gave
rise to the transmission of this American decline to the other countries as well. Under the system
of gold standard an imbalance in the trade or flows of assets resulted in an international gold
flows (Irwin, 2017).
As the economy of United States started to contract significantly there was a tendency of
gold flow out of the other countries towards the United States. This happened because the major
deflation in the United States in turn made the American products relatively attractive to the
foreigners while the reduced income decreased the demand of America for the foreign products.
In order to deal with the tendency towards the American trade surplus and outflows of foreign
gold, the central banks raised the interest rates throughout the world (Nanda and Nicholas, 2014).
In order to maintain this international gold standard it required a huge contractionary monetary
policy throughout the world so as to match the happenings in the United States. The result of this
was a drastic decline in the general price level and output throughout the world that in turn
matched with the downturn in the United States.
Financial crisis coupled with banking panics took place in various countries along with
United States. In the year 1931, difficulties regarding payment in Creditanstalt, the largest
Australian bank emerged. This gave rise to a financial difficulty and affected a major portion of
the Europe. This also acted as a key reason for Britain to abandon the gold standard. Similarly
there were other countries as well like Austria, Hungary and Germany that suffered terrible
banking panic (Coen-Pirani and Wooley., 2017). This banking panic as an overall outcome
reduced the level of output and prices in numerous countries.

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Conclusion
There are numerous reasons which have been pointed out by the economists behind the
Great Depression. However, it is also a matter of fact that the banking panic and the stock market
crash have always been identified as the common and most impactful factors that accumulated
the depression. There are some economists who have argued that the protectionist policies of
trade and the collapse of international trade are the major reasons behind the great depression.
They have pointed that the Smoot-Hawley tariff, enacted in the 1930 increased the cost
associated with imported goods. In response to that the trade partners of United States
implemented retaliatory actions. Nevertheless, some of the theorists stated that this fact is
already contained in the banking panic where the contractionary monetary policy was
implemented by the Federal Bank.

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Reference List
Babina, T., Garcia, D. and Tate, G.A., 2017. Friends during Hard Times: Evidence from the
Great Depression.
Benmelech, E., Frydman, C. and Papanikolaou, D., 2017. Financial frictions and employment
during the great depression (No. w23216). National Bureau of Economic Research.
Coen-Pirani, D. and Wooley, M., 2017. Fiscal Centralization: Theory and Evidence from the
Great Depression. American Economic Journal: Economic Policy.
Irwin, D.A., 2017. Peddling protectionism: Smoot-Hawley and the great depression. Princeton
University Press.
Moser, J.E., 2013. The great depression. A Companion to World War II, Volume I & II, pp.47-62.
Nanda, R. and Nicholas, T., 2014. Did bank distress stifle innovation during the Great
Depression?. Journal of Financial Economics, 114(2), pp.273-292.
Ohanian, L.E., 2017. The Great Recession in the Shadow of the Great Depression: A Review
Essay on Hall of Mirrors: The Great Depression, the Great Recession, and the Uses and Misuses
of History, by Barry Eichengreen. Journal of Economic Literature, 55(4), pp.1583-1601.
Romer, C.D. and Romer, D.H., 2013. The missing transmission mechanism in the monetary
explanation of the Great Depression. American Economic Review, 103(3), pp.66-72.
Saint-Etienne, C., 2013. The Great Depression, 1929-1938: Lessons for the 1980's. Hoover
Press.

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Stuckler, D., Meissner, C., Fishback, P., Basu, S. and McKee, M., 2012. Banking crises and
mortality during the Great Depression: evidence from US urban populations, 1929–1937. J
Epidemiol Community Health, 66(5), pp.410-419.
Temin, P., 2014. From Great Depression to Great Recession.
Tindall, G.B. and Shi, D.E., 2016. America: A narrative history. WW Norton & Company.