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Special Topic 6
Lessons from the Great Depression
OUTLINE
I. The Economic Record of the Great Depression
A. Large reductions in output
1. Real GDP plunged during 1929-1933
2. After a modest recovery during 1934-1936, real GDP fell again in 1938
B. Soaring unemployment
C. Farm and home foreclosures
D. Bank Failures
E. Human suffering
II. Was the Great Depression Caused by the 1929 Stock Market Crash?
A. The 1929 decline in stock prices reduced wealth, aggregate demand, and real output.
B. Stock prices have fallen by 50% or more during other recessions, but the economy still
moved toward a recovery within a year or two.
C. While the decline in stock prices may have triggered the initial economic decline, the
length and severity of the Great Depression were the result of other factors.
III. Why Was the Great Depression So Lengthy and Severe?
A. Contraction of the Money Supply
1. The supply of money expanded slowly but steadily throughout the 1920s.
2. Even though prices were relatively stable in the 1920s, the Fed increased the
discount rate, four times between January 1928 and August 1929, pushing it from
3.5% to 6%.
B. Smoot-Hawley Tariff Increases of 1930
1. Legislation passed in June 1930, increased tariffs by more than 50% on
approximately 3,200 imported products.
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2. Like proponents of trade restrictions today, the Smoot-Hawley supporters argued
the bill .
3. 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.
4. Sound monetary policy is about monetary and price stability
5. The stock market, which had rebounded to levels prior to the October 1929 crash,
C. Tax Increases in the Midst of a Severe Downturn
1. As the Federal budget fell into deficit in 1931, Congress and the Hoover
Administration instituted a huge tax increase in order to balance the budget.
2. This tax increase reduced aggregate demand and the incentive to earn and invest,
plunging the economy still deeper into recession.
3. 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.
D. Price Controls, Regulations, and Constant Policy Changes
1. Many history books credit New Deal policies with the eventual end of the Great
Depression.
2. Some New Deal policies were helpful:
a. The Federal Deposit Insurance program
b. Re-evaluation of gold and the expansion in the money supply during 1934–
1936.
3. But other policies were harmful, and increased the length and severity of the Great
Depression.
a. The Agricultural Adjustment Act (AAA)
(1) Under the AAA, adopted in 1933, the Roosevelt Administration tried to
push prices up by restricting supply.
b. The National Industrial Recovery Act (NIRA)
(1) More than 500 industries ranging from automobiles and steel to dog
food and dry cleaners were organized into cartels.
(2) Government and business leaders set production quotas, prices, wages,
working hours, and distribution methods for each industry.
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IV. Fiscal Policy During the Great Depression
A. Prior to the Keynesian Revolution, the view that the Federal Budget should be balanced
was widely accepted.
B. Both the Hoover and Roosevelt Administrations raised taxes in an effort to reduce the
V. Lessons from the Great Depression
A. Monetary contraction will undermine economic activity such as investment and thereby
retard output and employment.
B. Trade restrictions will reduce the gains from specialization and exchange.
1. They will not save domestic jobs
OBJECTIVES
This special topic is designed to give students an overview of the Great Depression. The first section
describes the economic conditions in the Great Depression. The second section points out that while
the Great Depression may have been started by the Stock Market Crash of 1929, it was not the cause
of it being so lengthy and severe. The third section discusses the major reasons for the Great
Depression being so long and deep. The fourth section notes that the budget deficits and increases
in government spending were too small to exert much impact on total demand and the level of
economic activity during the 1930s. The last section highlights the lessons to be learned from the
Great Depression.
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IMPORTANT POINTS AND TEACHING SUGGESTIONS
1. Review Exhibit 1. It shows the Great Depression was a severe economic plunge that resulted
in unemployment rates of nearly 25 percent during 1932 1933 and rates of more than 14
percent for an entire decade. It was the longest, most severe period of depressed economic
conditions in American history.
2. Point out that Contrary to a popular view, the Great Depression was not caused by the 1929
stock market crash. We have had similar reductions in stock prices to those of 1929, both before
and after the Great Depression, without experiencing prolonged depressed conditions like those
of the 1930s.
HINTS FOR ANSWERING CRITICAL ANALYSIS QUESTIONS
6. The Great Depression highlights the importance of monetary stability; free trade; avoidance of