The Great Depression was a worldwide phenomenon, affecting large volumes of the global population. The economy at this time was characterised as being inherently unstable and “fundamentally unsound” (Galbraith, 1954, p.194). The impact of the stock market crash was influential in the Great Depression, economists argue, however, that there were different degrees to which the stock market crash influenced the Depression and that there were other factors which lead to the scale of the Depression. This essay will explore and analyse the contributing factors to the Great Depression, starting with Galbraith who believed the stock market was to blame. The viewpoints held by Hayek, Keynes, Friedman and Schwartz into the causes of the Great Depression will also be analysed, as well as the impact of the gold standard.
Galbraith’s account of the Great Depression contests the conventional view that the stock market crash was a secondary event but instead argues that the “bullish stock market” (Galbraith, 1954, p. ) was to blame for the impending recession. He argues that the mood of the time, one of “confidence and optimism and conviction for ordinary people to become rich” was a pivotal factor in the preceding collapse. At the time, there was a common conception that people would be able to become rich whilst putting in minimal effort, which appealed desirable to many. Due to this desire, “speculative orgies” (Galbraith, 1954, p. ) became common practice amongst different markets in the United States. Recurrent “speculative orgies” are damaging to the economy, but this was not an established idea at the time, meaning little was done to prevent them. The Florida real estate boom is a prime example of the ignorance of the people to unreasonable speculation. In Galbraith’s book, the Great Crash, he identifies that people believed “God intended the middle classes to be rich”. This sentiment enabled the housing boom in Florida to survive the crash that pursued in house prices, displaying how the mood of the time played a vital role in speculation as a fall in the house prices would have previously lead to lower prices for a sustained period.
Galbraith believed that there were five weaknesses in the economy which seemed to have “an especially intimate bearing on the ensuing disaster” (Galbraith, 1954, p.194). The first of these was the bad distribution of income, where “five percent of the population with the highest incomes in that year received approximately one-third of all personal income”. This created problems in the economy, as there was a disproportionate dependency on high levels of investment and consumer spending on luxury goods by the wealthier Americans. Following the crash, there was a reluctance of the top five percent to spend money on investment and luxury items, which created a sharp contraction in the economy. This reduction in spending on luxury goods and investment would have acted as a signal to the rest of the economy to reduce unnecessary spending, reducing confidence, which never recovered before the Great Depression. It is from this idea that it can be argued that because of the scale of speculation and the shock to confidence that the Great Depression was profound.
The bad corporate structure was another one of Galbraith’s weaknesses, with large amounts of “corporate larceny” (Galbraith, 1954, p.195). Holding companies and investment trusts were among the most poorly structured, due to the leverage they had on the operations of utilities such as railroads. As well as being poorly structured, the industry was poorly regulated. Galbraith’s third weakness was the poor banking structure which was “inherently weak” (Galbraith, 1954, p.196). The weakness was largely due to the number of independent units. The separation of the system placed pressure on other banks, meaning if one failed, a “domino effect” was created in the banking industry (Galbraith, 1954, p.197). People rushed to take money out of banks in the fear that they might collapse, which caused other banks to collapse. Another weakness outlined by Galbraith was imbalances within the foreign trade. Galbraith’s argument was that thee
Galbraith believed that it was these five factors that underpinned the stock market crash, and heightened the impact of the Great Depression, as there were weaknesses throughout the fundamental parts of the economy. It was these weaknesses that lead to the enormity of the crash, as the five factors all hampered confidence in the economy, reducing aggregate demand, and causing the stock market crash.
Throughout Galbraith’s book, he argues how the mood of the time was the main factor in influencing the speculation, but the main weakness with the theory was that the mood of the time alone wouldn’t have created speculation on the scale it was seen throughout the 1920s. In fact, the ability to buy stock on margin had an ultimate bearing on the increase in speculation. By only having to assume ten percent of the cost of the stock, people were encouraged to buy more than they would have previously. The mood of the time, should it have been as strong as mentioned by Galbraith could have reduced the severity of the stock market crash, and therefore reduce the severity of the Depression, following Galbraith’s argument that the stock market crash was the cause of the Depression.
Unlike Galbraith, Hayek argued that the stock market crash was caused by the ease of accessing money and credit. This money was used to finance the speculation of the time. As stated in the Hayekian explanation, it was, in fact, the oversupply of credit which should have created high levels of inflation, but this did not happen. In fact, according to Hayek (1931), the price level remained almost constant between June 1924 and June 1929. There was evidence of increased productivity, which should have created a reduction in price levels, however, the availability of cheap credit counter-acted this. The key problem with this theory is that
The stability of the price level disguised what was going on. Much of the instability in the slump stems from the oversupply of credit which was seen in the boom. It can be argued that “the boom was the illusion; the slump the reality” (BBC, 2011). This lead to Hayek’s idea that the slump of the 1930s was caused by the inflation of the 1920s.
According to Hayek, the rate of interest of the US was kept too low and out of sync with the market rate. The Fed distorted interest rates, as they injected money into the economy in order to maintain the price level. The oblivious nature of the economy to the distortions in the price level promoted unsustainable investments, many of which were abandoned when the Great Depression occurred. Hayek holds the view that the central bank had an artificially low interest rate, putting them at fault for flooding the market with credit, leading to a period of speculation. As credit was cheap and readily available, excessive investment was created, fuelling the present boom. The interest rate in 1927 was lowered by the Fed, fuelling further speculation. By manipulating the interest rate, the period of production was artificially extended and lead to further speculative bubbles. This argument from Hayek (1931) was mirrored by Robbins, who argued that the actions made by the Federal Reserve System, the expansion of credit, was “the direct outcome of misdirected management on the part of the Federal Reserve authorities” (Robbins, 1934, p.52).
Hayek argued that in order to get out of a slump, there was a need for not only adequate spending but also to reach the pre-boom level of sustainable production (BBC, 2011). He argued that the slump of the 1930s is the readjustment process following the boom, and should be left to adjust without intervention.
Hayek argues that should the Federal Reserve Authorities have not adopted an easy-money policy, there would have only been a mild slump in 1927. This, however, was not the case, with the easy-money policy being put into place once symptoms of a depression were noticed, leading to the boom being prolonged and the impacts of the impending recession heightened (Hayek, 1931, p.329).
Keynes believed that the Depression was caused by failed attempts to boost unemployment, which came about as a result of “sticky wages” which is outlined in Econstories’s video “Fear the Boom and Bust”. Keynes rejected the views held by Hayek and argued against the idea that the government’s strategy towards monetary policy was responsible for the boom and bust cycle and the persistence of the Depression was due to government interference within the market (Pongracic, 2007, p.22). Instead, Keynes’s theory involved steering the markets through influencing aggregate demand, particularly investment. Due to the investment boom in the 1920s, many firms reduced investment by the late 1920s. This was further reduced by the stock market crash of 1929.
Whilst Hayek argued that the low interest rates were the reason for the investment at the time, Keynes argued that the animal spirits present in the economy had a large influence – “a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities” (Keynes, 1964, p.144-145). He argues that slumps and depressions are exaggerated as a result of animal spirits, which is his explanation for the enormity of the Great Depression. Whilst this
Friedman and Schwartz provided an alternative notion in their book: Monetary History of the United States (1963) – the idea that monetary contraction and errors made by the Federal Reserve were the cause of the Depression (Romer & Romer, 2012, p.1). The argument held by Friedman and Schwartz was in opposition to the argument held by Keynes, as they argued that should the Federal Reserve have left the market to self-correct, recovery from the stock market crash could have been rapid. They attribute the cause of the stock market crash to a speculative bubble. Throughout Friedman and Schwartz’s book (1963), there is a strong focus that output and prices fell as a result of monetary shocks, however, they provide little evidence of the impact monetary shocks would have on spending and output (Romer & Romer, 2012, p.2). Following the research of Friedman and Schwartz, other economists looked into government policy failures,
There are other views for the reasons behind the Great Depression. In the 1960s, it was noted that the gold standard had a particular influence on the scale of the Depression. The gold standard was meant to provide stable prices following World War 1, however, due to mismanagement by the Federal Reserve, the recession was made into a global crisis. The fundamental error with the gold standard was that the UK returned at a rate that was overvalued compared to gold, reducing the competitiveness of the UK. The lack of competitiveness in the UK
As the US was the hegemony, it was required to redistribute gold around the world to provide economic stability for the rest of the countries, but its failure to do this meant the gold standard failed. In an article by Lewis, the Federal Reserve “did its job of serving as a lender of last resort” (2012), as the lending rates between the banks were kept low and stable which was what the Federal Reserve was created to do. Friedman and Schwartz’s account contests the view that the Federal Reserve carried out its job as the lender of last resort, arguing that there was more that could have been done to offset the decrease in liquidity (Pongracic, 2007, p.24).
Whilst it seems that the stock market crash had a detrimental impact on uncertainty, and can be used to explain the fall in output immediately following the crash, there is still uncertainty as to why the economy remained in a depressed state for the rest of 1930 (Romer, 1990, p. 614). Actions made by the Federal Reserve in terms of monetary policy and gold distribution, as outlined by Friedman and Schwartz, lengthened the crisis. Should the stock market crash have been managed effectively, the ensuing disaster would have been better managed and less intense.