Macroeconomics Project, Essay Example

The Great Depression was a worldwide economic crisis and was the largest economic downturn in American history. Beginning in 1929 with Black Tuesday, it ran until 1941, with America’s entrance to World War Two usually considered the end date. Black Tuesday was the collapse of the American stock market in October of 2009, an event that occurred for numerous reasons. The crisis lead to high unemployment and deflation, with many government programs put forth in an attempt to counter it, collectively entitled The New Deal. As the greatest modern economic crash, it is often studied by economists, who hope to learn lessons from the exceptional downturn.

The basic reason for the collapse of the American stock market was a speculative bubble. Investors had poured money into the market during the economic boom of the 1920s, and were expecting the value to keep paying off. Often times, stocks were bought with loans, with the stocks themselves standing as the collateral. People believed they were wealthier than they were, as significant amounts of that wealth was the paper value of the stocks. When the stocks sank, investors had lost the value and tried to sell off their holdings en masse, exacerbating the issue. At this point, the stock market collapsed. After the crash, people began defaulting on bank loans and banks suddenly did not have the assets required to ensure their deposits be paid. Account holders panicked, withdrew money, and several banks collapsed. This crisis in the financial industry was enough to sink the entire economy.

With unemployment at nearly 25% during the Depression, the governments of the world began trying to fix their economies. In the United States, Herbert Hoover was president in 1929, and has often been criticized for inaction during his time in charge of the country. Despite this reputation, he oversaw large tax increases, the Smooty-Hawley tariff, and protections for farmers. He lost a reelection bid to Franklin Delano Roosevelt in 1932 and FDR pursued more government efforts to revive the economic situation. The series of laws he passed were termed the New Deal, an attempt at fiscal stimulus, which would spur the economy through increased government spending and some tax cuts.

Agricultural protections, such as the destruction of certain crops to ensure farmers higher prices on goods and Smoot-Hawley tariffs were detrimental to recovery. Both policies raised prices at a time when the objective should have been to get prices down to their market clearing level, where people would buy them again and perhaps stimulate aggregate demand through a lower price level. Smoot-Hawley also made the economy less productive, by not allowing the market to indicate comparative advantages of nations. However, the New Deal was rather effective as stimulus. Aggregate demand was extremely low during the Depression, so putting money into the economy could fix that. On top of that, more monetary stimulus could have been used to accomplish the same thing. Monetary stimulus could have given money to the financial institutions that crashed, helping to avoid the bank runs that plagued the economy. Perhaps the best piece of policy was to insure deposits federally, making sure no one would have to fear a bank run again. Unfortunately, this was too late to solve the Depression itself.

The Great Depression is such an interesting case study for governments during today’s economic recession. Both had speculative bubbles at the root, and both have been fought with attempts at stimulus. It is debatable how effective stimulus was in each case, due to the difficulty in establishing what would have happened without stimulus or with different stimulus. However, according to Keynesianism, these steps should have served to at least prevent a more excessive downturn.