America's Great Depression

America's Great Depression

The Great Depression is probably one of the most misunderstood events in American history. It is routinely cited, as proof that unregulated capitalism is not the best in the world, and that only a massive welfare state, huge amounts of economic regulation, and other Interventions can save capitalism from itself. Among the many myths surrounding the Great Depression are that Herbert Hoover was a laissez faire president and that FDR brought us out of the depression. What caused the Great Depression? To get a handle on that, it's necessary to look at previous depressions and compare. The Great Depression was by no means the first depression this country ever had, but it was clearly the worst. What made it different than the rest? At the time of the Great Depression, government intervention in the economy was higher than it had ever been and a special government agency had been set up specifically to prevent depressions and their associated problems, such as bank panics. This agency was the Federal Reserve Board and it was to have been the loaner of last resorts for banks in order to prevent collapses as had happened during earlier depressions. But as America sees, there is good reason to believe that the Federal actions explain many of the problems that lead up to the stock market crash and the subsequent depression. Although there are many macroeconomics schools of thought, this paper will be concentrating on two initially, Keynesian economics and Austrian School economics. Keynesian economics got its start during the Great Depression with the publication in 1936 of The General Theory of Employment, Interest, and Money, by John Maynard Keynes. Austrian School economics began much Earlier, most notably with the publication in 1871 of Carl Menger's Principles of Economics. While the Austrian theory has Never been mainstream (economist Paul Krugman refers to it as the economic equivalent of the phlogiston theory), its adherents are some of the harshest critics of Keynesian interventions. The greater of the two economic systems used has got to be Keynesian.

The exact cause of business cycles is one of the biggest problems in economics. There are several explanations. The current Keynesian models rely on what is referred to as "sticky wages" (or "sticky prices") to explain why the cycles occurs. Under these models, wages or prices fail to reach their market clearing level. The Austrian School explanation is that all business cycles are due to government intervention in the economy. In particular, government efforts to manipulate the interest rate causes a boom and bust cycle because people over-invest ("mailnvestment") when interest rates are low and when interest rates are Raised to stave off the inevitable inflation, a bust is caused due to the mismatching of consumer and business goods. There are six depressions in American history that is thought to be the worst since detailed records of economic data started To be kept (around 1867), 1873-79, 1893-97 (actually two contractions separated by an incomplete expansion), 1907-08, 1920-21, 1929-33, and 1937-38. Although depressions vary on length and severity, the similarities are so profound that Nobel Laureate Robert Lucas has stated; "business cycles are all alike." Since it's been about 60 years since we've had a depression, One might think that the economy is being managed better than it used to be. It's not clear why the economy is being managed better. The Federal Reserve Board was created in 1913 and yet half of the worst depressions happened after its creation. A Better candidate might be the adoption of Keynesian management techniques, which were not fully implemented until after the Last severe contraction in 1937. But there are some indicators that that is not responsible either. Detailed studies have been done to compare post-war business cycles with prior ones. At least one indicates that there was no improvement. Obvert Lucas made a key insight into the difficulties of managing the economy. Looking at post-World War II business Cycles, he argued that if one could choose between smoothing out the cycles completely and increasing the annual economic Growth by 0.1%, the latter would make people better off overall. As we consider the different policy options, it is important to keep this insight in mind as one more trade off that has to be considered.

The Federal Reserve Board was created in 1913. Ostensibly, it was to act as the lender of last resort to prevent bank panics like the one that had occurred in 1907. Although some conspiracy minded folks might weave elaborate tales regarding its Creation, the reason is rather straightforward. The big banks simply wanted government protection and bailouts and were more than willing to endure a little government regulation in return. Like the Interstate Commerce Commission before it, the Federal Government would be staffed with people from the industry that it was supposedly a watchdog over and who would most likely feel that what's good for banks are good for America? Throughout the years preceding the Stock Market crash, the Federal Government did just that. The Federal Government set below market interest rates and low reserve requirements that all favored the big banks. The money supply actual Increased by about 60% during this time. The phrase "buying on margin" entered the American vocabulary at this time as more And more Americans over-extended themselves to take advantage of the soaring stock market. So what went wrong? It was in 1929 that the Federal Government realized that it could not sustain its current policy. When it started to rise Interest rates, the whole house of cards collapsed. The Stock Market crashed and the bank panics began. But what would make this depression worse than all the rest? There was a depression in 1921, but no one remembers that one. What was Different? As we'll see,