Economic Theories in the Great Depression Blog Post

     There are many competing views regarding the reasons for the Great Depression. Two classical competing economic theories regarding the causes of the Great Depression include the Keynesian and monetarist explanations. Most historians and economists either adhere to one of these two theories when examining the causes of the Great Depression. The Keynesian explanation is a demand driven explanation for the Great Depression and the severe economic recession that occurred in the United States just before World War II. The Keynesian theory of the cause of the Great Depression argues that the wide spread loss of economic and financial confidence led to drastically lower investments by Americans as well as lower consumption. Monetarists, on the other hand, argue that the Great Depression was caused by a simple ordinary recession that was accelerated and made worse significantly by poor economic policy decisions. These poor economic decisions, these monetarists argue, especially were made by the Federal Reserve. The Federal Reserve's monetary policy, under this economic theory, caused a shrinking of the money supply and causing debt inflation which worsened the Great Depression.                                                                                                                                         Therefore, while there are various economic theories regarding  The traditional Keynesian explanation will be discussed for the purposes of this blog post. Under the Keynesian economic theory, over speculation in the stock market and buying on credit caused a stock market crash that was only worsened once panic set in. In other words, the recession became a self-full-filling prophecy and snowballed once the recession began. Once the crash occurred, people ran on the banks and took their money out of the banks, this only worsened the economic situation and left many banks with no money in their vaults or an inability to give money to those who had deposited it. As people attempted to take their money out of the bank, the banks of course called in their loans in order to be able to pay out the money requested by those who had formerly had their money in banks. The people with loans, of course, could not pay these loans back so suddenly and this just worsened the economic depression. People believed also that they could lessen the economic blow by staying away from the stock market and avoiding the stock market so they would not lose any more money. This mindset continued for decades due to the extreme economic devastation that occurred for many during the Great Depression. In his book, The General Theory of Employment, Interests and Money (1936), British economists John Maynard Keynes introduced concepts that he hoped would help explain the causes of the Great Depression. Keynes wrote throughout his book about reasons that natural self-correcting economic mechanisms failed to work and prevent such a horrific economic downturn as seen in the Great Depression. Keynes argues that Hoover did the opposite of what should have been done to lessen the blow of the Great Depression. In other words, he should have cut taxes according to Keynesian theory as well allowed the Federal Reserve to "create new money that it could spend and borrow." The idea being that if taxes were cut, consumers would spend more which would lessen the blow of the depression. President Hoover, instead, did the opposite of Keynesian economic policy and suggestions and instead raised taxes in order to lessen the budget deficit that was created by the Great Depression. Under the Keynesian theory, the United States' government should have just run a budget deficit rather than continued to try to raise taxes to prevent a deficit. Keynes also argued that more workers could be employed by decreasing interest rates and encouraging companies to borrow money in order to make products. Many economists use the length of the Great Depression as evidence that Keynes theories regarding the Great Depression and the causes of its severity were correct. Therefore, under the Keynesian theory employment rates only started to rise due to World War II and therefore allowed for employment rates to rise to a rate that eased unemployment rates overall and allowed the American economy to begin to recover.                                                                                                                             Total debt to GDP levels in the U.S. reached a high of just under three hundred percent right before and during the Great Depression. In other words, people going into the Great Depression were in a large amount of debt and were borrowing on credit at unprecedented levels. So much so that the levels of debt seen before the Great Depression were not seen again until the end of the 19th century nearly a seventy years after the Great Depression. Never before had the country ever had money available at such large volumes at such low interest rates. This allowed more people opportunities to buy homes, cars, and other items on margin or credit but also opened the door to over borrowing and overspeculation when stocks were also allowed to be bought on margin. This over borrowing in many ways draws parallels to the 2008 financial crisis when many people were allowed to take out mortgages that they simply could not afford. This inability to pay the loans back, of course, eventually led to a domino effect in the American economic landscape. The same is true during the Great Depression. People borrowed money at low interest rates at an alarming rate and this eventually led to the boom of the nineteen twenties to burst. Irving Fisher, a famed economists and statistician argued that the predominant reason for the Great Depression was because of large amounts of indebtedness and deflation. Fischer said that loose lending policies led to over indebtedness which caused asset bubbles and speculation. Additionally, asset prices fell and many people liquidated assets in an attempt to pay off their indebtedness. This created a domino effect that led to the worst recession the United States and possibly the world has ever seen. People began to hoard money and once people lost confidence in banks the wheels were set in motion towards a recession that was impossible to stop. A fact that seems to support Keynesian theories and Fischer's claims is that right before the Great Stock Market Crash of 1929 the percentage of margin required to buy a stock was only ten percent. In other words, brokerage firms were lending ninety dollars to every ten dollars that someone deposited. Of course, this was a drastic risk. When the market, inevitably fell, brokers attempted to call in loans that of course most people could not pay back. Banks then began to fail as debtors defaulted on their loans. Bank failures, in turn, led to the loss of millions of dollars of assets. The liquidation of debtors debt could not keep up with the falling prices that it had caused and conditions only worsened. Thus, the Great Depression was caused like many other financial crisis that America has experienced, by overspeculation and over indebtedness that caused a snowball effect ripple within the American economy. A ripple so large that a World War was what eventually was able to slow the impact and effects of such a powerful recession.