During high school I asked a nave question to my economics teacher which is the best phase for an economy and can we get rid of downturns. Her response was a measured one the best economic phase is when the aggregate demand keeps exceeding aggregate supply slightly with little inflation. And on making depression a word of past she responds, we still have to go a long way. It is not a matter of economic cycle but a matter of human greed. Regulatory bodies can only play a limited role in controlling the economy in capitalism, in the end it all boils down to the people. After burning our fingers in various downturns since The Great Depression, we can safely say that monetary steps contributed more to it than pure collapse in demand of goods. Factors contributing to The Great Depression The Stock Market Crash Decade of strong performance after the first World War, the stock market was euphoric and rose to unprecedented heights. When the economy got overheated and speculation ran rampant, a crash was unavoidable. Under such circumstances the best government could do was to do nothing that might make a bad thing worse. But President Hoover had other ideas, together with Federal Reserve policy board head Miller he decided to clamp down the share prices and bring the market down by keeping away banks to extending loans that would be used buy stocks. The situation was further worsened by firming of money rates to commercial interests. With it the bank is not within its reasonable claim for discount facilities at its federal reserve bank when it borrows either for the purpose of making speculative loans or for the purpose of maintaining speculative loans. It cut the money supply by one-third from 1929 to 1932. There was much less money to go around, businessmen could not get new loans--and could not even get their old loans renewed. They had to stop investing. Not because they did not want to but because banks could not lend them the money they needed. This interpretation blames the government and calls for a much more careful Federal Reserve policy. As the system collapsed it spreads panic. The first banking panic occurred in late 1930; the second in the spring of 1931, and the third in March 1933. When it was over, 10,000 banks had gone out of business, with well over $2 billion in deposits lost. Deflation Effects Misreading of deflation effects is also one of the major reasons, as the depression lasted longer than any before it. It is safely assumed that in deflationary conditions the interest rates will come down drastically and it will encourage people to borrow and invest money again in the economy. But as the market crashed and lots of people loosing the saving, unemployment sets in. The nominal interest rates increased steeply, leaving purchasing power of people drastically reduced. With this a sharp recession became a global depression. In the next article I will discuss why The Great Depression spread across borders and became global phenomena. |
