An Economic Analysis of the Great Depression: Implications for 2009 National Council for the Social Studies November 13, 2009 Mark C. Schug, Ph.D. University.

An Economic Analysis of the Great Depression: Implications for 2009

National Council for the Social StudiesNovember 13, 2009Mark C. Schug, Ph.D.University of Wisconsin-Milwaukee

Overview

Overview of Focus: Understanding Economics in U.S. History

Demonstration of Lesson 30: Causes of the Great Depression

Implications for today

Table of Contents

Unit 1 Three World Meet

Unit 2: Colonization and Settlement

Unit 3: Revolution and the New Nation

Unit 4: Expansion and Reform

Unit 5: Civil War and Reconstruction

Table of Contents

Unit 6: The Development of the Industrial United States

Unit 7: The Emergence of Modern America

Unit 8: The Great Depression and World War II

Unit 9: Postwar United States

Unit 10: Contemporary United States

Whatdunnit? The Great Depression Mystery

Focus: Understanding Economics in U.S. HistoryLesson 30

Whatdunnit?

In the 1920s, jobs were plentiful and the economy was growing and the standard of living was rising.

Between 1920 and 1929 homeownership doubled.

Most home-owning families enjoyed amenities such as electric lights and flush toilets.

60% of all households had cars, up from 26%.

More teenagers were attending high school.

Whatdunnit?

By 1933… One fourth of the labor

forces was unemployed. Families were losing

their homes and many were going hungry.

Adolescents who should be in school were riding around the country in freight cars, looking for jobs.

Whatdunit?

What happened?• The United states possessed the same

productive resources in the 1930s as it had in the 1920s.

• Great factories and productive machinery were still present.

• Workers had the same skills and were willing to work just as hard.

• How could life have become so miserable for so many in such a short period of time?

1920s

Prosperity of the 1920s was based largely on purchases of homes and cars.

Toward the end of the decade sales began to decline.

End of the 1920s

Machinery workers stand. Car sales people stand. Auto workers stand. Steel workers stand. Construction workers stand. Furniture sellers stand. Furniture workers stand. Clothing sellers stand. Restaurant workers stand. Grocery workers stand.

1929

Normally, people start buying again as automobiles wear out and incomes improve.

Expansion Begins Again

Machinery workers sit. Car sales people sit. Auto workers sit. Steel workers sit. Construction workers sit. Furniture sellers sit. Furniture workers sit. Clothing sellers sit. Restaurant and grocery

workers sit. Grocery workers sit.

What Are the Alleged Causes of the Great Depression?

The Stock Market Crash of October 29, 1929. Excessive borrowing to purchase stocks and

consumer goods. Overproduction of goods and services High tariffs which prevented imports and hurt

exports. Low farm prices and low wages, leading to an

uneven distribution of income.

Why did a mild recession in 1929 become the Great Depression of the 1930s? A Hint

Its mainly about money, banks, and the Federal Reserve System

How is Money Created?

Banks are not just businesses.

Hint: Banks Create Money100% Reserves

Assets Liabilities

Reserves $1000.00 Deposits $1000.00

Loans

Hint: Banks Create MoneyBank 1: 10% Reserves

Assets Liabilities

Reserves $100.00 Deposits $1000.00

Loans $900.00

Hint: Banks Create MoneyBank 2: 10% Reserves

Assets Liabilities

Reserves $90.00 Deposits $900.00

Loans $810.00

$900 + $810 = $1,710 and still moving…

The Fed

The Federal Reserve System was created in 1913.

The Fed has 4 partsBoard of Governors (Washington D.C.)Federal Open Market Committee (FOMC)Reserve Banks (12 members)Member Banks

Conducting Monetary Policy

Inflation: Enemy Number 1

The Federal Reserve System has 3 tools to control inflation:

1. Sets reserve requirements for banks. Raise reserve requirement = reduce

money supply Lower reserve requirement = increase

money supply

Conducting Monetary Policy

2. Manages the Federal Open Market Committee (FOMC).

The FOMC sets a target rate for the Federal Funds rate. This is the rate for loans made from bank to bank.

This is almost always what the media is referring to when it says the Federal Reserve "changing interest rates".

To increase the money supply, the Fed instructs the Open Market Desk at the New York Fed to buy bonds to try and hit the target rate.

To decrease the money supply, the Fed instructs the Open Market Desk at the New York Fed to sell bonds.

Conducting Monetary Policy

3. Sets the discount rate for members who borrow money from the Fed.

Banks can borrow funds to keep up their required reserves is by taking a loan from the Fed Reserve at the discount window.

The discount rate is usually higher than the federal funds rate.

Raise discount rate = reduce money supply Lower discount rate = increase money supply

Visual 30.2 Number of U.S. Banks Closing Temporarily or Permanently, 1920-1933

Year Number of Bank Closings

1920 168

1921 505

1922 367

1923 646

1924 775

1925 618

1926 976

1927 669

1928 499

1929 659

1930 1352

1931 2294

1932 1456

1933 4004

Visual 30.3 Money in Circulation

Year

Money in Circulation*

1929 $26.2

1930 $25.1

1931 $23.5

1932 $20.2

1933 $19.2

*Currency plus bank deposits, in billions of dollars.

Why Did the Fed Fail to Act?

1. The Board of Governors believed that many banks were unsound.

2. They wished to protect the value of the dollar by keeping interest rates high.

3. They wished to protect the nation against inflation which they thought was the main problem.

Why Did the Fed Fail to Act?

1. The Board of Governors believed that many banks were unsound.

2. They wished to protect the value of the dollar by keeping interest rates high.

3. They wished to protect the nation against inflation which they thought was the main problem.

“We Did It.”

In 2002, at Milton Friedman’s 90th birthday Ben Bernanke, then Federal Reserve Board Governor, said:

“ I would like to say to Milton and Anna: Regarding the Great Depression, you were right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

The Current Crisis: Four Possible Factors

1. Erosion of conventional lending standards

2. Low interest rate polices of the Federal

Reserve System during 2002-2006

3. Increased leverage lending of Government

Sponsored Enterprises (GSEs) and

investment banks

4. Increased household debt to income ratio

What Caused the Crisis of 2008?

FACTOR 1: Beginning in the mid-1990s, government regulations change the conventional lending standards.

Fannie Mae/Freddie Mac MarketShare Increases

Freddie Mac/Fannie Mae Share of Outstanding Mortgages

Source: Office federal Housing Enterprise Oversight, www.ofheo.gov.

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

20%

25%

30%

35%

40%

45%

50%

What Caused the Crisis of 2008?

FACTOR 2: The Fed under Greenspan’s chairmanship follows a low interest rate policy during 2002-2006.

Short-Term Interest Rates

Federal Funds Rate and 1-Year T-Bill Rate

Source: www.federalreserve.gov and www.economagic.com

1995

1995

1996

1996

1997

1997

1998

1999

1999

2000

2000

2001

2002

2002

2003

2003

2004

2004

2005

2006

2006

2007

2007

2008

0%

1%

2%

3%

4%

5%

6%

7%

8%

Federal Funds 1 year T-bill

Subprime, Alt-A, and Home Equity Loans

Subprime, Alt-A, and Home Equity as a Share of Total

Source: Data from 1994-2003 is from the Federal Reserve Board while 2001-2007 is from the Joint Center for Housing Studies at Harvard University

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 20070%

10%

20%

30%

40%

50%

Subprime (FRB) Subprime (JCHS) Subprime + Alt-A Subprime + Alt-A + Home Equity

ARM Loans Outstanding

Source: Office of Federal Housing Enterprise Oversight, www.ofheo.gov.

ARM Loans Outstanding

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

0%

5%

10%

15%

20%

25%

What Caused the Crisis of 2008?

FACTOR 3: A Securities and Exchange Commission (SEC) Rule change adopted in April 2004 led to highly leverage lending practices by investment banks and their quick demise when default rates increased as housing prices fell.

What Caused the Crisis of 2008?

FACTOR 4: The Debt/Income Ratio of Households since the mid-1980s doubles. America falls in love with debt!

Household Debt to Disposable Personal Income Ratio

Source: www.economagic.com

1953

1955

1958

1960

1963

1965

1968

1970

1973

1975

1978

1980

1983

1985

1988

1990

1993

1995

1998

2000

2003

2005

2008

20%

40%

60%

80%

100%

120%

140%

The FED Acted Differently

The Fed acted differently in 2008 than it did in 1929.

U.S Monetary Base Expands toGrease the Wheels of Exchange

Monetary Base in Billions of Dollars, 2000-present

Source: The Federal Reserve Bank of St. Louis, www.stlouisfed.org

2000

2000

2001

2001

2002

2002

2003

2003

2004

2004

2005

2005

2006

2006

2007

2007

2008

2008

2009

$500

$600

$700

$800

$900

$1,000

$1,100

$1,200

$1,300

$1,400

$1,500

$1,600

$1,700

$1,800

And U.S. Excess Reserves Increase to Make Lending Possible

Excess Reserves in Billions of Dollars, 2000-present

Source: The Federal Reserve Bank of St. Louis, www.stlouisfed.org

$0

$100

$200

$300

$400

$500

$600

$700

$800

And We Have the Lessons Learned From the Great Depression

Carefully consider those governmental policies which distort incentives and create unintended consequences with negative results:

Monetary contraction of the Great Depression Era

Trade restrictions (Smoot-Hawley Tariff Act of 1930)

Tax increases (Revenue Tax Act of 1932)

Constant changes in monetary and fiscal policy

generates uncertainty and delays private sector

recovery.

Conclusions?

Could the crisis have been avoided if regulators had done more? Less?

Is this a crisis of capitalism or a crisis of businesses and households responding to distorted incentives created by government?

Is this crisis a result of the unintended consequences of well-intended monetary and fiscal officials?