Decision makers lacked effective mechanisms for determining what went wrong and lacked the authority to take actions sufficient to cure the economy. Some decision makers misinterpreted signals about the state of the economy, such as the nominal interest rate, because of their adherence to the real bills philosophy.
Others deemed defending the gold standard by raising interests and reducing the supply of money and credit to be better for the economy than aiding ailing banks with the opposite actions. On several occasions, the Federal Reserve did implement policies that modern monetary scholars believe could have stemmed the contraction.
In the spring of , the Federal Reserve began to expand the monetary base, but the expansion was insufficient to offset the deflationary effects of the banking crises. In the spring of , after Congress provided the Federal Reserve with the necessary authority, the Federal Reserve expanded the monetary base aggressively. The policy appeared effective initially, but after a few months the Federal Reserve changed course. A series of political and international shocks hit the economy, and the contraction resumed.
Congress responded by reforming the Federal Reserve and the entire financial system. Under the Hoover administration, congressional reforms culminated in the Reconstruction Finance Corporation Act and the Banking Act of These agencies dominated monetary and banking policy until the s.
The creation of the modern intellectual framework underlying economic policy took longer and continues today. Bernanke, Ben. Essays on the Great Depression. Princeton: Princeton University Press, Chandler, Lester V. American Monetary Policy, to New York: Harper and Row, New York: Harper Collins, Eichengreen, Barry. Friedman, Milton and Anna Schwartz. A Monetary History of the United States: Kindleberger, Charles P. Berkeley: University of California Press, Meltzer, Allan. A History of the Federal Reserve: Volume 1, to Chicago: University of Chicago Press, Romer, Christina D.
Temin, Peter. Cambridge: MIT Press, Marriner S. It didn't recover for 25 years. People lost all confidence in Wall Street markets. Businesses, banks, and individual investors were wiped out. Even people who hadn't invested lost money.
Their banks invested the money from their savings accounts. As countries' economies worsened, they erected trade barriers to protect local industries. In , Congress passed the Smoot-Hawley tariffs , hoping to protect U. Other countries retaliated. That created trading blocs based on national alliances and trade currencies. Here's what happened to U. S GDP for the first five years of the Depression:. As a result, many defaulted.
They lost everything and became migrants looking for work wherever they could find it. Here are the price changes during the depression years:. The success of the New Deal made Americans expect that the government would save them from any economic crises. During the Great Depression, people relied on themselves and each other to pull through. The New Deal signaled that they could rely on the federal government instead. FDR modified the gold standard to protect the dollar's value.
That set a precedent for President Richard Nixon to end it completely in University of California, Irvine. University of Washington. Harvard Business School.
Bureau of Economic Analysis. Nominal GDP. Stanford University. American Historama. New York Magazine. The Economist. Wilson Center. Trade Policy in Crisis.
The National Bureau of Economic Research. Actively scan device characteristics for identification. Use precise geolocation data. Select personalised content. Create a personalised content profile.
Measure ad performance. Select basic ads. As a result, the leading nations established a gold exchange system whereby the governments of the United States and Great Britain would be willing, at all times, to redeem the dollar and the pound for gold, and other countries would hold much of their international reserves in British pounds or U.
The demand for gold increased as countries returned to the gold standard. Because the franc was undervalued when France returned to the gold standard in June , France began to receive gold inflows. As French exports rose and French imports fell, their international accounts were balanced by gold shipped to France. In , the Federal Reserve System raised its discount rate—that is, the rate it charged on loans to member banks—in order to raise interest rates in the United States, which would stem the outflow of American gold and dampen the booming stock market.
As a result, the United States began to receive shipments of gold. These deflationary policies were designed to restrict economic activity and reduce price levels, and that is exactly what they did. Thus began the worldwide Great Depression. The onset of the contraction led to the end of the stockmarket boom and the crash in late October However, the stock market collapse did not cause the depression; nor can it explain the extraordinary length and depth of the American contraction.
In most countries, such as Britain, France, Canada, the Netherlands, and the Nordic countries, the depression was less severe and shorter, often ending by Those countries did not have the banking and financial crises that the United States did, and most left the gold standard earlier than the United States did. In the United States, in contrast, the contraction continued for four years from the summer of through the first quarter of During that time real GNP fell In previous depressions, wage rates typically fell percent during a one- to two-year contraction; these falling wages made it possible for more workers than otherwise to keep their jobs.
However, in the Great Depression, manufacturing firms kept wage rates nearly constant into , something commentators considered quite unusual. With falling prices and constant wage rates, real hourly wages rose sharply in and Though some spreading of work did occur, firms primarily laid off workers.
As a result, unemployment began to soar amid plummeting production, particularly in the durable manufacturing sector, where production fell 36 percent between the end of and the end of and then fell another 36 percent between the end of and the end of Why had wages not fallen as they had in previous contractions?
One reason was that President Herbert Hoover prevented them from falling. When President Hoover organized conferences in December to urge business, industrial, and labor leaders to hold the line on wage rates and dividends, he found a willing audience.
The highly protective Smoot-Hawley Tariff, passed in mid, was supposed to provide protection from lower-cost imports for firms that maintained wage rates. Though there was not a general call for tariff increases, Hoover proposed it in as a means of aiding farmers. He quickly lost control of the bill and it ended up protecting American businesses in general with much less real protection for farmers.
Many of the tariff increases in the Smoot-Hawley Tariff were quite large; for example, the tariff on Canadian hard winter wheat rose 40 percent, and that on scientific glass instruments rose from 65 percent to 85 percent.
Overall on dutiable imports the tariff rate rose from These numbers may sound small, but compared with the U. The first major bank runs and failures occurred in the Southeast in November ; these were followed by more runs and failures in December.
There was another flurry of bank runs and bank failures in the late spring and early summer of After Great Britain left the gold standard in September , the Federal Reserve System initiated relatively large increases in the discount rate to stem the gold outflow. Overseas investors in nations still on the gold standard expected the United States to either devalue the dollar or go off the gold standard as Great Britain had done.
The result would be that the dollars they held, or their dollar-denominated securities, would be worth less. To prevent this they sold dollars to obtain gold from the United States. The rise in American interest rates also made it more costly to sell American assets for dollars to redeem in gold.
The resulting rise in interest rates caused not only more business failures, but also a sharp rise in bank failures. In the late spring and early summer of , the Federal Reserve System finally undertook open market purchases, bringing some signs of relief and possible recovery to the beleaguered American economy. By the surplus had turned into a deficit that grew rapidly as the economy contracted. By the end of Hoover had decided to recommend a large tax increase in an attempt to balance the budget; Congress approved the tax increase in Personal exemptions were reduced sharply to increase the number of taxpayers, and rates were sharply increased.
The lowest marginal rate rose from 1. We now understand that such a huge tax increase does not promote recovery during a contraction. Bank runs and bank failures resumed with a vengeance, and American dollars began to be redeemed for gold as the gold outflow resumed. Between and , 10, of the 24, commercial banks in the United States failed. As the public increasingly held more currency and fewer deposits, and as banks built up their excess reserves, the money supply fell Though the Federal Reserve System did increase bank reserves, the increases were far too small to stop the fall in the money supply.
As businesses saw their lines of credit and money reserves fall with bank closings, and consumers saw their bank deposit wealth tied up in drawn-out bankruptcy proceedings, spending fell, worsening the collapse in the Great Depression.
President Roosevelt came into office proposing a New Deal for Americans, but his advisers believed, mistakenly, that excessive competition had led to overproduction, causing the depression. Reduced production, of course, is what happens in depressions, and it never made sense to try to get the country out of depression by reduc ing production further. In its zeal, the administration apparently did not consider the elementary impossibility of raising all real wage rates and all real prices.
The AAA immediately set out to slaughter six million baby pigs and reduce breeding sows to reduce pork production and raise prices. Since cotton plantings were thought to be excessive, cotton farmers were paid to plow under one-quarter of the forty million acres of cotton to reduce marketed production to boost prices. Most of the payments went to the landowners, not the tenants, making conditions desperate for tenant farmers. Though landowners were supposed to share the payments with their tenant farmers, they were not legally obligated to do so and most did not.
As a result, tenant farmers, and especially black tenants, who were more easily discriminated against, received none of the payments and less or no income from cotton production after large portions of the crop were plowed under. Where persuasion was ineffective in inducing the many independent farmers to reduce production, the federal government intended to mandate production cutbacks and purchase the product to take it off the market and raise prices. The NRA was a vast experiment in cartelizing American industry.
Code authorities in each industry were set up to determine production and investment, as well as to standardize firm practices and costs. The entire apparatus was aimed at raising prices and reducing, not increasing, production and investment. As the NRA codes began to take effect in the fall of , they had precisely that effect. The recovery that had seemed so promising in the summer largely stopped, and there was little increase in economic activity from the fall of through midsummer Enforcement of the codes was sporadic, disagreement over the codes increased, and, in smaller, more competitive industries, fewer firms adhered to the codes.
Released from the shackles of the NRA, American industry began to expand production. By the fall of a vigorous recovery was under way.
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