The Great Depression of 1930 is the worst economic crisis in the history of the world, so much so that it has become the benchmark against which all recessions are compared.
[You may also read- The Financial Crisis 2008 Explained]
It originated in the US in 1929 and lasted until the late 1930s. It affected most countries in the world.
Effects of the Great Depression:
In the US, by the peak of the crisis in 1932-
- GDP decreased by 33 %
- Industrial production fell by 47 %.
- 1/5th of banks failed
- Unemployment increased to 25 %
- Wages fell by 42 %
- Consumer Price Inflation (CPI) fell by 27 %
The crisis spread on to the rest of the world and the GDP of the world fell by 15 %. The depression also led to the abandonment of the gold standard by most countries.
First things first, what is Depression?
Depression is a sustained downturn in economic activity and is worse than a recession. It is usually characterised by:
- a decline in real GDP exceeding 10%, or
- a recession lasting 2 or more years.
[Recession is a decline in GDP for two consecutive quarters.]
What were the causes of the Great Depression of 1930?
As with most crisis, it was a culmination of many causes:
- The stock market crash of 1929: The stock market crash of 1929 signaled the beginning of the crisis. The stock markets in the US had increased more than 4 times from the low in 1921 to the peak in 1929. The equity prices had risen to more than 30 times earnings (it means that the price rise was not justified as earnings were lower). This was clearly unsustainable and the stock markets suddenly collapsed on October 24, 1929 (came to be known as ‘Black Thursday’). The stock markets in the US declined by 33 % by November 1929.
- Decline in expenditure: The stock market crash shattered the confidence of the investors in the American economy. Many people lost their savings. This led to a decline in consumer sentiments. People cut back on their expenditure. This reduced aggregate demand, which in turn, caused a decline in output.
- Monetary Policy by the Fed: The Federal reserve followed monetary expansion in the 1920s. The total money supply grew by $28 billion, a 61.8% increase between 1921 and 1928. High economic growth in the 1920s and expansion of the money supply led to an increase in stock prices. This is because people invested the surplus money in the stock market. After the stock market crash in 1929, the Federal reserve should have continued with monetary expansion, but it went with monetary tightening by increasing interest rates and did not bail out banks. It reduced the money supply in the economy.
- Bank failure: As mentioned, the Fed did not support the banks during bank runs which were largely caused due to the inability of the farmers to repay their debt (due to collapse in farm prices). One-fifth of banks failed by 1933. It led to a further decrease in the money supply. [Bank run is when people lose confidence in the banking system and want to withdraw their deposits]
- Smoot-Hawley Act: The US enacted a law in 1930 to impose tariffs on imports to protect certain sectors in the country. Many countries retaliated. The world trade declined and exacerbated the crisis further.
- Severe drought in some parts of the US in 1931: This worsened the crisis in the agricultural sector.
- Gold standard: This was one of the factors which led to the spread of the crisis to the other countries. The crisis in the US caused deflation. American goods became cheaper. To prevent trade deficit with the US and the consequent transfer of Gold to the country, central banks across the world raised interest rates. It caused massive monetary contraction.
[Read this article to learn about Gold Standard: International Monetary System]
What ended the Great Depression of 1930?
- Abandonment of Gold Standard by most countries – It enabled them to increase the money supply. (As mentioned, gold standard led countries to pursue monetary contraction)
- Expansionary Fiscal Policy– US President Herbert Hoover attempted to mitigate the impact of the Great Depression through the Reconstruction Finance Corporation in 1932. It authorized the lending of $2 billion to banks, railroads, and other privately held companies. The Government also appropriated $300 million for the nation’s first relief and public works projects. Hoover lost elections in 1933. In March 1933, the newly elected President Franklin Roosevelt passed a series of legislation (known as New Deal), to expand the role of Government in combating the depression. But, it is debatable whether fiscal expansion actually helped to end the great depression.
- World War– Massive military expenditure during the world war-II provided a fiscal stimulus and helped the economy out of depression.