Economic Discussion of the “Great Depression’ 1929 – 1941

Dennis Rees

July 29, 2021

According to Ben Bernanke in his article “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression.” The American Economic Review in 1995, the crisis was propagated by monetary contraction. He states, “In particular, the evidence for monetary contraction as an important cause of the Depression, and for monetary inflation as a leading component of recovery, has been greatly strengthened.”[1] Bernanke was referencing the recent spate of research expanding the sample to many countries, other than the U.S., experiencing similar economic conditions at the time. Although there are clearly many other causal factors in the period 1929 – 1933 that played a role in the devastation of the American economy, we believe, with Bernanke, the primary cause was the abrupt and deep reduction in the money supply precipitating a downward spiral in terms of almost every macroeconomic measure.

This period saw an unprecedented downturn in unemployment moving from 3% to 25%, a reduction in overall income of 40%, deflation of 10% per year, over 1 million family farms lost, over ¼ Million families evicted from their homes, home construction reduced by 80%, over 4000 banks closed, GDP reduced by 33%, stock market crashed over 90%, all in just three years between late 1929 and 1933.[2] By all accounts, this event amounted to the deepest and longest Depression in the historical record before or since. It is stark when you read the immediately above recited statistics, but the human tragedy was by far more apocalyptic when viewed from the perspective of hungry children to demoralized, out of work adults charged with feeding them. The crisis of families cannot be brought into focus utilizing the statistics of the economist alone.

When looking at the causes of this world-wide disaster one must necessarily analyze the acts and omissions of those in charge at the time. Hoover, Roosevelt, the Board of Governors at the Federal Reserve Bank, their respective advisors, and certainly, last but not least, the Congress of the U.S. through the several administrations. The thing that stands out is the unprecedented run up in the money supply in the 1920’s, creating an atmosphere of ‘easy money’ with low interest rates, easy credit, and an oversupply of money measured by M1 and M2[3] that overheated the economy in the “Roaring Twenties” as they were called. This situation decoupled the interest rates from the normal risk evaluation typically imposed by banks. Projects that would normally have been priced at a higher rate due to the risk of the project or principals were funded at artificially low rates because of the low discount rates set by the central bankers. This decoupling of risk from the interest rate allowed thousands of projects to be funded at low rates that would otherwise have been prohibitively expensive, in terms of rate, to fund. The banks exposure to these risky loans certainly had disastrous consequences when the money supply was suddenly and precipitously cut back to the tune of 30% in just 3 years. The economic chaos that resulted forced many of these projects and individual home loans that were granted without regard to risk to default. This pressured over 4000 banks with insufficient liquidity to close their doors to untold loss for their depositors and investors.[4]  

Toward the end of the roaring economy of the 20’s, the Fed began to fear the price levels of the stock market. Fearing this bubble, the Fed sought to burst it, but applied much more than the required ‘pin prick’ in terms of heavy-handed policy adjustments. The Fed, encouraged by Hoover, embarked on a great string of contractionary policies and economic adjustments in 1928, exemplified by actions like extreme open market operations designed to reduce the money supply. In addition, they raised the discount rate to 5%, a level not seen for a decade or more. According to James Hamilton in 1987, “In short, in terms of the magnitudes consciously controlled by the Fed, it would be difficult to design a more contractionary policy than that initiated in January 1928.”[5] As all economists would aver, there is a lag of months or even years from action to effect, felt by the public generally, with respect to actions by the Fed. In addition, the Fed’s actions are interdependent with almost all other economic factors in evidence at the same time and these interdependencies can, and many times do, cause the results to be unpredictable.

All the authors cited in the bibliography to this monograph agree that there are many economic factors to consider when discussing the topic of the Great Depression of 1929 – 1941. They cite Hoover’s encouragement of interventionist policies by the Fed and others to ‘burst’ the Market bubble of the late 20’s, Roosevelt’s continuation and expansion of Hoover’s interventions with the New Deal and Second New Deal programs, and Congressional enactment of new and in many cases disastrous laws like the Wagoner Act that killed off what was left of the labor market. Many and varied were the implemented “remedies” for the Depression. Most of these had long lasting and detrimental effects to society and the economy, still affecting them today. In the final analysis it can be shown that the dramatic expansion of the money supply from 1938 – 1941 along with increased demand due to the anticipated War pulled the U.S. out of the Great Depression. This, despite the many false and otherwise counterproductive remedies applied by Government.

Bernanke, Ben S. “The Macroeconomics of the Great Depression: A Comparative Approach.” Journal of Money, Credit and Banking 27, no. 1 (1995): 1-28. Accessed July 28, 2021. doi:10.2307/2077848.

Bernanke, Ben S. “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression.” The American Economic Review 73, no. 3 (1983): 257-76. Accessed July 28, 2021. http://www.jstor.org/stable/1808111.

Hamilton, James D. “Monetary Factors in the Great Depression.” Journal of Monetary Economics 13 (1987): 1-25.

Middleton, Roger. Review of Reflections on the Great Depression. History of Political Economy 35, no. 4 (2003): 789-791. muse.jhu.edu/article/50844.

Parker, Randall. “An Overview of the Great Depression”. EH.Net Encyclopedia, edited by Robert Whaples. March 16, 2008. URL http://eh.net/encyclopedia/an-overview-of-the-great-depression/

Purcell, Aaron D. Interpreting American History: The New Deal and the Great Depression. Kent: The Kent State University Press, 2014. muse.jhu.edu/book/33650.

Romer, Christina D. “What Ended the Great Depression?” The Journal of Economic History 52, no. 4 (1992): 757-84. Accessed July 28, 2021. http://www.jstor.org/stable/2123226.

[1] Ben S. Bernanke, “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression.” The American Economic Review 73, no. 3 (1983): 25

[2] Roger Middleton, “Review of Reflections on the Great Depression.” History of Political Economy 35, no. 4 (2003): 789-791

[3] The monetary supply is measured as the sum of currency in the hands of the public plus reserves in the banking system.

[4] Randall Parker, “An Overview of the Great Depression (eh.net)” East Carolina University, EH.net online article.

[5] James D. Hamilton, “Monetary Factors in the Great Depression.” Journal of Monetary Economics 13 (1987): 1-25.