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.
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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 fell sharply after the crash.
The next blow to the economy occurred in the fall of 1930, when many depositors lost confidence in the solvency of banks and demand that their deposits paid in cash. Banks normally hold only a fraction of deposits as cash reserves and had to liquidate loans in order to raise cash. This hasty liquidation caused many previously solvent banks to fail. The U.S. experienced widespread banking panics in the fall of 1930, spring of 1931, fall of 1931, and the fall of 1932. Finally, on March 6, 1933, President Franklin Roosevelt declared bank holiday. All banks were closed and were allowed to reopen only after being deemed solvent by government inspectors. The panics were brutal attacks to the banking system. By 1933, 11, 000 of 25,000 U.S. banks had failed.
The most destructive impact of the Great Depression was human suffering. In a short period of time, the standards of living and world output dropped steeply. Nearly one-fourth of the labor force could not find employment in the early 1930s and total recovery was not accomplished until the end of the decade. However, as a result of The Great Depression, labor unions and welfare state expanded substantially during the 1930s. Union membership more than doubled between 1930 and 1940. The U.S. government also increased regulation of the economy substantially in the 1930s, especially the financial markets. They established the Securities and Exchange Commission in the 1934 to regulate new stock issues and stock market trading practices, the Banking Act of 1933, also called the Glass-Steagall Act, established and prohibited banks from underwriting or dealing securities. Deposit insurance introduced by the government effectively eliminated banking panics in the U.S. after 1933.
The Great Depression also played a vital role in the development of macroeconomic policies intended to weather sharp economic contractions and expansions. The impact of reduced spending and monetary contraction in the Depression led economist John Maynard Keynes to suggest that increases in fiscal policy, tax cuts, and monetary expansion could be utilized to counteract depressions. This approach, combined with a mounting consensus that government should try to stabilize employment, has led to much more government interventions since the 1930s. Governments and central banks around the world now automatically attempt to prevent or moderate recessions.