Download An Overview of the Great Depression

An Overview of the Great Depression
• EQ- How did the decline in the global
economy lead to a rise in totalitarianism?
• GQ- What were the primary causes of the
Great Depression and how do these causes
mirror the recent economic problems?
• SWBAT- compare and contrast the causes
of the GD and housing bubble
• Mission Statement connections: A, C, D
What makes a Depression Great?
• Recession: When your neighbor loses his or her job.
• Depression: When you lose your job.
Why study the Great Depression?
• Worst economic disaster of the 20th century.
• Cause or causes are still debated.
• A defining event, especially for the
government’s involvement in the economy.
• Useful for learning important macroeconomic
concepts.
Some Concepts
• Gross Domestic Product (GDP): Comprehensive
measure of the nation’s output of final goods and
services.
• Real GDP: GDP measured at a fixed price level
(i.e., inflation adjusted).
• Nominal GDP: GDP measured at current prices.
• Inflation: A sustained increase in the general price
level (often calculated in terms of the Consumer
Price Index (CPI)).
More Concepts
• Deflation: A sustained decrease in the general
price level.
• Recession: Sustained decline in real GDP
(approximately two quarters).
• Depression: Very severe recession.
• Money Stock: The stock of assets that serve as
media of exchange (e.g., coin, currency, checking
accounts).
• Real Interest Rate: Measure of the cost of
borrowing adjusted for inflation/deflation.
How Great was the Great Depression?
• Real
output (GDP) fell 29% from
1929 to 1933.
• Unemployment increased to 25%
of labor force.
• Consumer prices fell 25%;
wholesale prices 32%.
• Some 7000 banks failed.
Why Did It Happen? Some Suggested Causes
• The stock market crash – end of the party
Stock Market Boom and Bust
S&P Composite Index
35
Sept. 1929
30
25
20
15
10
5
July 1932
0
Jan-21
Jan-23
Jan-25
Jan-27
Jan-29
Jan-31
Jan-33
Jan-35
Jan-37
Jan-39
The Stock Market Crash
The timing of the crash (Oct. 1929) is suggestive.
Possible channels:
• Destruction of wealth
• Increased uncertainty
• Role of banks
Conclusion: Probably had some effect, but not big
enough by itself.
Why Did It Happen? Some Suggested Causes
• The stock market crash – end of the party
• Collapse of world trade – globalization in reverse
The Collapse of World Trade
$ value imports of 75 countries
Why Did It Happen? Some Suggested Causes
• The stock market crash – end of the party
• Collapse of world trade – globalization in
reverse
• Monetary collapse
Bank Failures
• 7000 banks failed -- many during
“panics”
• Number of banks fell from 25,000 in
1929 to 15,000 by 1934
Possible Channels:
• Loss of deposits  decline in
expenditures
• Customer relationships broken 
harder to borrow
• Money supply contraction
Commercial Bank Failures, 1920-2004
4500
4000
3500
3000
2500
2000
1500
1000
500
19
20
19
25
19
30
19
35
19
40
19
45
19
50
19
55
19
60
19
65
19
70
19
75
19
80
19
85
19
90
19
95
20
00
0
Banking Panics
• Bank depositors lost confidence  bank runs
• Banks lost gold, currency and other reserve assets
• Loss of reserves caused banks to reduce loans and
deposits (causing money stock to fall)
• Contracting money stock reduced spending
• Reduced spending led to lay-offs (increased
unemployment), falling prices (deflation) and lower
output.
The Fed’s Monetary Policy
• Fed officials did not watch (or even
measure) the money supply. But, why didn’t
they respond to bank panics?
• Most failed banks were small,
nonmember banks.
• Interest rates were falling
Recovery
• Rapid money supply growth (end of banking
panic, gold inflows)
 rising price level
 falling real interest rate
 and increased spending.
Recovery
• Rapid money supply growth (end of banking
panics, gold inflows)  rising price level, falling
real interest rate and increased spending.
• FDR and the New Deal?
– Restored confidence in banking system (FDIC)
– Early years marked by regulation/reform, little
new spending (alphabet programs, e.g., NRA,
WPA, PWA, CCC, etc.)
– Later years saw increased spending
Recovery
• Rapid money supply growth (end of banking
panics, gold inflows)  rising price level, falling
real interest rate and increased spending.
• FDR and the New Deal?
– Restored confidence in banking system (FDIC)
– Early years marked by regulation/reform, little
new spending (alphabet programs, e.g., NRA,
WPA, PWA, CCC, etc.)
– Later years saw increased spending
• World War II (when unemployment finally fell
below 10%)
Could It Happen Again?
• The Depression was not a failure of capitalism or
markets, but rather a failure of the Federal
Reserve.
• Monetary policy should maintain price stability –
avoid deflation and inflation.
• The Fed should respond to financial crises that
increase the demand for money or threaten to
disrupt the payments system.
United States 2008
Housing Bubble
What is a housing bubble?
• A run-up in housing prices fueled by
demand, speculation and the belief that
recent history is an infallible forecast of the
future.
The Perfect Storm
• Four Causes of the bursting of the bubble:
–
–
–
–
Low mortgage interest rates
Low short-term interest rates
Relaxed standards for mortgage loans
Irrational exuberance
1) Low mortgage rates
• U.S. mortgage rates peaked at 18% in 1982
• From late 2002 through most of 2005
mortgage rate are below 6%
1) Low mortgage rates
Fannie Mae and
Freddie Mac
• Investors “purchase”
mortgages from Fannie and
Freddie.
• They make money on the
mortgage payments made by
homeowners
Mortgage-backed securities
• Wall Street firms also sell
similar items called
Mortgage
Why would low mortgage rates
contribute to the Great
Depression?
• Low mortgage rates kept monthly payments
affordable for more buyers even as home
prices rose.
2) Low short-term interest rates
• Low short-term interest rates encouraged
the use of adjustable rate mortgages
(ARMs)
• More people were able to afford mortgages
at this rate, further driving up home values
2) Low short-term interest rates
• Low short-term interest rates encourage
leveraging
– Borrowing at short-term rates to invest in longterm, higher profitable investments (mortgage
backed securities)
– Leveraging increased the availability of
mortgages and thus caused home values to
continue to rise
Relaxed standards for
mortgages
• 1995, The Community Reinvestment Act
– Compel banks to increase loans to lowerincome households
• 1996, the Department of Housing and
Urban Development
- increase the % of mortgage loans to lowerincome households that Fannie and Freddie
were required to hold
Relaxed standards for
mortgages
• Increased competition in the mortgage
market due to the internet and other sources
led to lenders lowering their standards.
– Fees and down payments were lowered or
eliminated
Relaxed standards for
mortgages
• “Originate to Sell”
– Mortgages that were intended to be sold as
securities shortly after closing
– Lessens incentive of mortgage companies to
ensure the quality of the loan
– Mortgages grouped together and sold as
mortgage-backed securities
Irrational Exuberance
• “a heightened state of speculative fervor”
• Investors act under the assumption that real
estate prices will continue to rise
– They had not fallen since the Great Depression
Your Assignment
• Compare and contrast the stock market
crash of 1929 to the bursting of the housing
bubble in 2008
– Create an organizer with similarities and
differences of the two economic crises