The Great Depression

The Great Depression was the longest and most severe economic downturn ever experienced by the Western world.   Although it originated in the United States, it caused sharp declines in output, unemployment and severe deflation in almost everywhere else in the world.   The timing and severity of it varied by country with the hardest hits being the U.S. and Europe and was milder in Japan and Latin America. Began in 1929 and lasted until 1939, this Great Depression represented the harshest misfortune faced by Americans since the Civil Wars and as a result it later sparked fundamental changes in financial institutions, macroeconomic policy, and economic theory.  

It is widely believed that the drop in U.S. output in 1929 was a result of a contractionary monetary policy aiming at reducing stock market speculation.   The Roaring 20’s was a prosperous decade and the excess wealth was in the stock market.   Stock prices had more than quadrupled from their low in 1921 to their peak in 1929.   In 1928 and 1929, the Federal Reserve raised interest rates hoping to slow down the rapid increases in stock prices. These higher interest rates depressed investments in and high ticket purchases such as construction and automobile, respectively, which resulted in production reduction.   By the fall of 1929, Wall Street stocks had reached price levels that could not be justified by realistic anticipations of earnings. Then, investors’ loss of confidence led to panic selloffs that began on “Black Thursday” October 24, 1929 and the stock market bubble burst.   Many stocks had been purchased on margin--the sharp drop in prices ignited fear and forced some investors to liquidate their holdings, thus aggravating the fall in prices. Between their peak in September and their low in November, U.S. stock prices declined 33%.   Wall Street had dropped to about 20% of its previous value by late 1932.   The crash reduced aggregate demand substantially.   Consumer purchases and business investment also...