Download Section 2A – The Great Depression

Section 2A – The Great Depression
Slide 1-2: Title and Overview
Please understand that the economy always has and likely always will move in cycles.
Picture:
Also, as you move through this section, please keep in mind all of the sources of
economic progress that we just talked about:
1. A stable legal system with strong private property rights.
2. Competitive Markets
3. Limits on Government Regulation
4. An efficient capital market
5. Monetary Stability
6. Low Taxes
7. Free Trade
Slide 3: Key Aspects of the Great Depression
During the Great Depression we had:
 Extremely large reductions in output and relatively low productivity,
 Soaring unemployment that reached all-time highs as high as 25% (compared to the
9.7% that exists right now in the U.S.),
 Farm and home foreclosures: many people lost their homes and their land
 Bank failures: Banks started to go under and people began losing their money so
everyone went to the banks to get their money back and this caused more banks to
fail as the banks never keep all of everyone’s money on hand at the same time.
 Extensive human suffering: People had to spend all day standing in work lines and
soup lines just for the chance of getting work or food.
Slide 4: The Great Depression Clip
Watch Seabiscuit Great Depression Clip – (1:32)
Slide 5: Declines in Real GDP
 Real GDP is the statistical measure of productivity for an entire economy.
 Real GDP plunged during 1929-1933. After a modest recovery during 1934-1936,
real GDP fell again in 1938.
1
Slide 6: High Rates of Unemployment
 The rate of unemployment rose from 3.2% in 1929 to 8.7% in 1930 and 15.9% in
1931. In 1932-1933, the unemployment rate soared to nearly one-quarter of the labor
force.
Slide 7: Foreclosures, Bank Failures and General Human Suffering
Many people went to the banks only to find that the banks had closed down so they
suddenly had no money. They also spent a long time waiting in soup lines and often the
soup would run out so many people would get nothing.
Slide 8: Was the Great Depression caused by the Stock Market Crash of 1929?
 The economy was thriving and moving at a break neck pace in the 1920’s (The
roaring twenties). The DOW Jones Industrial Average as at an all time high on
September 3rd, 1929 at 381.
 Stock prices plunged in September-October 1929. In particular, on October 29th,
1929 (now known as Black Tuesday), The DOW Jones Industrial Average dropped to
230 (it was at 327 just a week before). It continued to fall, closing in at 199 by
November 13th.
 However. But they recovered during the five months from mid-November 1929
through mid-April of 1930. Again, the economy tends to move in cycles. It has
dropped before and always picked back up in 1 to at most 3 years.
 However, stock prices continued on a downward path during May and for the rest of
1930. Why did this recession end up being so long and so severe (remember that the
twenties was a particularly thriving period and so many people had never experienced
really hard times before).
Slide 9: Why was the Great Depression so long and severe?
 While the stock market crash of 1929 triggered a recession, the length and severity of
what we have come to call the Great Depression was the result of misguided
government policies (you probably don’t immediately believe this because this is not
what they teach you in high school, but lets see if you think its true after this section).
 Four things the government did during the Great Depression:
1. Contraction of the Money Supply
2. The Smoot-Hawley Tariff
3. Huge Tax Increases
4. Price Controls, Regulations, and Constant Policy Changes
 I hope you immediately bulk at these as we are going to see how many of those
sources of economic progress the government actually eliminates in the course of this
economic downturn.
Slide 10: Contraction of the Money Supply (1)
 Remember that the Federal Reserve’s (The Fed) job is to keep inflation at a low and
steady level. In the 1920’s, money supply and prices were increasing at a slow and
steady rate.
2


The Fed then increases the Discount Rate (the interest rate the Fed charges the banks
for borrowing money) four times between January 1928 and August 1929. This
caused banks to lend out less money and reduced the money supply.
After the October Stock Market Crash, the Fed aggressively sold government bonds
which also reduces the money supply (Do bond selling experiment in class).
Slide 11: Contraction of the Money Supply (2)
 The money supply fell by 3.9% during 1930, by 15.3% in 1931, and by 8.9% in 1932.
The quantity of money at year-end 1933 was 33% less than in 1929. The money
supply increased during 1934-1937, but dipped again in 1938
 The Price level tends to correlate with the money supply, so there was a significant
drop in prices as well (deflation)
Slide 12: Contraction of the Money Supply (3)
 Remember that allowing interest rates to fluctuate naturally and low and stable price
changes are two of the sources of economic progress.
 As we can see in this graph, through the manipulation of interest rates and the money
supply, prices have began to fluctuate wildly which lead to a significant amount of
business failure and uncertainty
Slide 13: Smoot-Hawley Tariff of 1930
 This tariff increased the taxes on 3,200 imported goods making them significantly
more expensive at a time when people already had very little money. (Hawley is on
the left, Smoot is on the Right). This was the biggest tariff in U.S. history.
 The idea behind this tariff (like with any other tariff) was to help domestic industries
in this hard time.
 Recognizing the restrictions would reduce both trade and output, more than 1,000
economists pleaded with President Hoover to veto the bill; he rejected their advice.
(a similar number of economists pleaded with Obama to not go through with his
stimulus packages, but they were also ignored).
 60 countries responded with retaliatory tariffs, and trade fell by more than 50%. The
unemployment rate was 7.8% when Smoot-Hawley was passed, but it ballooned to
23.6% within two years of its passing (as we will see this is also because of the huge
tax increases). Did it increase domestic employment like they had hoped?
Slide 14: Huge Tax Increases (1)
 The government started trying to incorporate some more social policies to help people
during these hard times and was not collecting a lot of tax revenue so they were
beginning to run a deficit, and at the beginning of the Great Depression this was still
not acceptable so they drove up taxes to new highs in 1931.
 The combination of the Smoot-Hawley Tariff along with record high taxes drove Real
GDP down by 13.3% and drove unemployment up to nearly 25%.
Slide 15: Huge Tax Increases (2)
 The top marginal income tax rate was increased from 25% in 1931 to 63% in 1932 –
other rates were increased by a similar amount.
3

The top marginal rate was pushed still higher to 79% in 1936, and the tax on the
retained earnings of business was also sharply increased. These tax hikes contributed
to the recession of 1937-1938.
Slide 16: Price Controls, Regulations, and Constant Policy Changes (1)
1. Many history books credit New Deal policies with the eventual end of the Great
Depression
2. Some New Deal policies were helpful:
 The Federal Deposit Insurance program: The government now insures your
deposits at the bank up to $100,000. This made people feel more secure about
leaving their money in the banks and reduced bank runs and bank failures.
 Re-evaluation of gold and the expansion in the money supply during 1934-1936.
Roosevelt re-valued the price of gold from $20 an ounce to $35 an ounce which
allowed the government to expand the money supply at a time when it was most
appropriate.
3. But other policies were harmful, and increased the length and severity of the Great
Depression.
Slide 17: Price Controls, Regulations, and Constant Policy Changes (2)
 Under the AAA, adopted in 1933, the Roosevelt Administration tried to push prices
up by restricting supply
1. Farmers were paid to plow under portions of cotton, corn, wheat, and other crops
2. Potato Farmers were paid to spray their potatoes with dye so they would be unfit
for human consumption
3. Cattle, sheep, and pigs were slaughtered. In an effort to push farm prices up, 6
million pigs were slaughtered under the AAA in 1933 alone.
 This policy was extremely economically inefficient (the government took all of their
increased tax dollars to pay people to destroy food at a time when people were
desperately hungry. Productivity was literally destroyed, and remember, that it is
productivity that drives growth and wages). On a personal note, I also find this policy
to be morally bankrupt.
 AAA was declared unconstitutional in 1936.
Slide 18: Price Controls, Regulations, and Constant Policy Changes (3)
The government passed the National Industrial Recovery Act (NIRA) in 1933. Under this
legislation:
 More than 500 industries ranging from automobiles and steel to dog food and dry
cleaners were organized into cartels (grouped together to act as a single firms so they
could raise prices and not have to compete with each other)
 Government and business leaders set production quotas, prices, wages, working
hours, and distribution methods for each industry. They basically said what to make,
how to make it, and what price to sell it for. (If it sounds familiar, the Soviet Union
tried it with a thing called communism – did not work out to well for them).
 Once approved by a majority of the firms, the regulations were legally binding on all
of the firms in the industry. Businesses that did not comply were fined and subject to
jail sentences. Interestingly, prior to this legislation, price fixing of this type would
4
have been a violation of anti-trust legislation (think of how this erodes private
property rights and competition).
Slide 19: Price Controls, Regulations, and Constant Policy Changes (3)
 Industrial output increased sharply during April-July 1933 (again, it looks like the
road to recovery)
 When the NIRA was implemented in July, industrial output fell by more than 25%
over the next 6 months. Output never reached the June 1933 level again until after
the NIRA was declared unconstitutional in May of 1935.
Slide 20: Fiscal Policy During the Great Depression (1)
 Before the Great Depression, the government should have a balanced budget. They
should only spend what they take in and should never run large budget deficits or
surpluses.
 John Maynard Keynes came up with the theory that in order to make these economic
fluctuations easier on people, the government should tax more and spend less (run a
budget surplus) during expansions and should tax people less and spend more money
(or run budget deficits) during the bad times to help alleviate these bad times.
 The idea sounds good and makes sense theoretically, but empirically it does not work
out so well because the economy tends to self-correct and these fiscal policies are
subject to timing problems (recognition lag, administration lag, and impact lag).
Slide 21: Fiscal Policy During the Great Depression (2)
The government did run significant budget deficits throughout the Great Depression and
it did not turn things around (for the variety of reasons that we just talked about).
 The Federal budget was in surplus in 1929 and 1930
 Except for 1934 and 1936, Federal deficits in the 1930s fluctuated around 2% of GDP
Slide 22: Keynesian Vs. Classical Economics
Watch Fear the Boom and the Bust music video (7:32)
Tell them about the sequel Fight of the Century (10:09)
Slide 23: Lessons from the Great Depression
1. Monetary contractions tend to undermine economic activity.
2. Trade restrictions reduce wealth.
3. Raising taxes during a recession makes matters worse.
4. Constant policy changes make for an unstable economic climate: remember the
monopoly example, if the rules keep changing you are not going to know how to
play.
5. Good intentions do not guarantee good outcomes!
Slide 24: Review
1. Know the key characteristics of the Great Depression
A. Large reductions in output
B. Soaring unemployment
C. Farm and home foreclosures
5
D. Bank failures
E. Extensive human suffering
2. Know the four main reasons why the Great Depression was so lengthy and severe.
A. Contraction of the Money Supply
B. The Smoot-Hawley Tariff
C. Huge Tax Increases
D. Price Controls, Regulations, and Constant Policy Changes
3. Understand the lessons that should be learned from the Great Depression.
A. Monetary contractions tend to undermine economic activity.
B. Trade restrictions reduce wealth.
C. Raising taxes during a recession makes matters worse.
D. Constant policy changes make for an unstable economic climate: remember the
monopoly example, if the rules keep changing you are not going to know how to
play.
E. Good intentions do not guarantee good outcomes!
6