Economic History of the US

Transcription

1 Economic History of the US Depression and the World Wars, Lecture #3 Peter Allen Econ 120

2 Great Depression, Largest economic contraction in US history Front-loaded collapse that took 3 ½ years Sep Mar 1933 Real GDP, -27% (nominal GDP, -46%) Unemployment, 3.2% to 24.9% CPI, -25% WPI, -33% Stock market crash, 23 Oct.- 15 Nov. 1929, - 50%

3 Collapse Spanned Hoover Administration March 1929 to March 1933 Most impressive presidential resumé Worst enemy everything he thought he knew about economics New elements, inflated demand

4 Great Depression, Largest economic contraction in US history Why didn t the economy correct itself? Did knowledge of economics help? President Hoover Treasury Secretary Andrew Mellon Clue: response to financial crisis?

5 ($ billion) ($ billion) Great Depression Real GDP fell by 27% between 1929 and 1933, and nominal fell By more because of deflation Nominal Real Private investment fell by 88.5%, from $16.2 billion in 1929, to $1.9 billion in

6 Unemployment, %

7

8 Sharp Drop of Spending by Businesses and Households Real goods sectors 1. Drop of residential and non-residential construction 2. Impact of deflation on the farm economy 3. Overexpansion in consumer durable production 4. Simultaneous contraction overseas 5. Began in summer 1929 Catalysts, financial sector 1. Effect of stock market crash on expectations 2. Irrational optimism irrational pessimism 3. Financial crisis, bank runs, halt to lending 4. Wealth effect?

9 Stock Market Crash? Wealth effect? 1.5 million people were in the stock market out of a population of 120 million 600,000 margin accounts Large wealth effect, but on a small segment of population New element of consumer indebtedness But large effect on business psychology and public expectations most striking aspect of the stock market crash was not the participation, but the way it became central to the culture John K. Galbraith, The Great Crash, 1929 i.e. came to dominate expectations of the future

10 Banking System Crisis 2 Waves of Bank Runs , 5,000 banks w/7% of deposits 1933, 4,000 banks w/ 8% of deposits Banks Main Mistakes 1. Broker loans for margin lending 2. Loans to overinvestment in consumer durable companies 3. Direct investment in stocks Subprime of the day Fear of banks insolvency caused depositors to demand gold Banking system stopped functioning

11 FDR, Bank Holiday March 4, 1933, first day 3 things 1. Closes all banks 2. Suspended gold convertibility 3. Fed to offer unlimited currency to depositors once banks reopened Later, Banking Act of FDIC, permanent deposit insurance 2. Separation of Commercial and Investment Banks

12 Effect of Bank Runs The Effect of Bank Runs ($ billion) Currency in Checking Circulation Deposits M % change +31% -35% -25%

13 Role of the Financial Crisis Cause of GD, decline of money supply a) Withdrawal of deposits for currency b) banks decision to stop lending c) Multiple contraction of deposits and credit d) Hoarding/mattress $ Fed should have done two things a) stopped the bank run by acting as lender of last resort b) Increased money supply to offset drop of M1 and M2 with open market operations c) Gold standard precluded unilateral action Net Money National Supply Product ($ bn) ($ bn) Velocity Classical, Laissez-faire??

14 Effect of Contraction of Deposits Value of Money, 1/P MS 2 MS 1 Price Level, P 1 1 ¾ B 1.33 ½ 2 ¼ A MD 1 4 $19.91 $26.64 Quantity of Money

15 Deflation, Consumer price level as a % of Fell by 4.5% in 1930, 12% in 1931 and 11.5% in long enough to create expectations of falling prices Devastating to consumer and investment spending make sure this doesn t happen!!

16 Money and Income,

17 Temin s Critique of the Monetarist Interpretation of the Great Depression

18 Other theories Ben Bernanke asymmetric info. problem Bank failures severed informal credit relationships Between local banks and small businesses Irving Fisher Effect of rising real value of debt, i.e. deflation on spending by businesses and consumers Joseph Schumpeter FDR made the Depression worse by changing regulations continuously and anti-business rhetoric