Great Depression

====Keynesian view====
British economist [[John Maynard Keynes]] argued in ''[[The General Theory of Employment, Interest and Money]]'' that lower [[aggregate expenditure]]s in the economy contributed to a massive decline in income and to employment that was well below the average. In such a situation, the economy reached equilibrium at low levels of economic activity and high unemployment.

Keynes's basic idea was simple: to keep people fully employed, governments have to run deficits when the economy is slowing, as the private sector would not invest enough to keep production at the normal level and bring the economy out of recession. Keynesian economists called on governments during times of [[Crisis (economic)|economic crisis]] to pick up the slack by increasing [[government spending]] or cutting taxes.

As the Depression wore on, [[Franklin D. Roosevelt]] tried [[public works]], [[Agricultural subsidy|farm subsidies]], and other devices to restart the U.S. economy, but never completely gave up trying to balance the budget. According to the Keynesians, this improved the economy, but Roosevelt never spent enough to bring the economy out of recession until the start of [[World War II]].<ref>{{Cite journal| author-link=Lawrence Klein|first=Lawrence R.|last=Klein|title=The Keynesian Revolution|year=1947| pages=56–58, 169, 177–179|location=New York|publisher=Macmillan}}; {{Cite book|first=Theodore|last=Rosenof|title=Economics in the Long Run: New Deal Theorists and Their Legacies, 1933–1993|year=1997|location=Chapel Hill|publisher=University of North Carolina Press|isbn=0-8078-2315-5}}</ref>

=====Debt deflation=====
[[File:U.S. Public and Private Debt as a % of GDP.jpg|thumb]]
[[Irving Fisher]] argued that the predominant factor leading to the Great Depression was a vicious circle of deflation and growing over-indebtedness.<ref name="Fisher33">{{cite journal|last=Fisher|first=Irving|s2cid=35564016|date= October 1933|title=The Debt-Deflation Theory of Great Depressions|journal=Econometrica|volume=1| pages=337–57|doi=10.2307/1907327|issue=4|publisher=The Econometric Society|jstor=1907327}}</ref> He outlined nine factors interacting with one another under conditions of debt and deflation to create the mechanics of boom to bust. The chain of events proceeded as follows:
# Debt liquidation and distress selling
# Contraction of the money supply as bank loans are paid off
# A fall in the level of asset prices
# A still greater fall in the net worth of businesses, precipitating bankruptcies
# A fall in profits
# A reduction in output, in trade and in employment
# [[Pessimism]] and loss of confidence
# Hoarding of money
# A fall in nominal interest rates and a rise in deflation adjusted interest rates<ref name="Fisher33"/>

During the Crash of 1929 preceding the Great Depression, margin requirements were only 10%.<ref name="Margin Requirements">{{cite journal|last=Fortune|first=Peter|date=September–October 2000|title=Margin Requirements, Margin Loans, and Margin Rates: Practice and Principles – analysis of history of margin credit regulations – Statistical Data Included|journal=New England Economic Review|url=https://findarticles.com/p/articles/mi_m3937/is_2000_Sept-Oct/ai_80855422/pg_5|archive-url=https://web.archive.org/web/20150811102239/http://findarticles.com/p/articles/mi_m3937/is_2000_Sept-Oct/ai_80855422/pg_5|url-status=dead|archive-date=August 11, 2015|access-date=February 18, 2022}}</ref> Brokerage firms, in other words, would lend $9 for every $1 an investor had deposited. When the market fell, brokers [[Margin call|called in these loans]], which could not be paid back.<ref name="lhf-30s">{{cite web|access-date=May 22, 2008|url=https://www.livinghistoryfarm.org/farminginthe30s/money_08.html|title=Bank Failures|publisher=Living History Farm|archive-url=http://webarchive.loc.gov/all/20090219185825/https://livinghistoryfarm.org/farminginthe30s/money_08.html|archive-date=February 19, 2009|url-status=dead}}</ref> Banks began to fail as debtors defaulted on debt and depositors attempted to withdraw their deposits {{Lang|fr|en masse}}, triggering multiple [[bank run]]s. Government guarantees and Federal Reserve banking regulations to prevent such panics were ineffective or not used. Bank failures led to the loss of billions of dollars in assets.<ref name="lhf-30s"/>

Outstanding debts became heavier, because prices and incomes fell by 20–50% but the debts remained at the same dollar amount. After the panic of 1929 and during the first 10 months of 1930, 744 U.S. banks failed. (In all, 9,000 banks failed during the 1930s.) By April 1933, around $7&nbsp;billion in deposits had been frozen in failed banks or those left unlicensed after the [[Emergency Banking Act|March Bank Holiday]].<ref>"Friedman and Schwartz, Monetary History of the United States", 352</ref> Bank failures snowballed as desperate bankers called in loans that borrowers did not have time or money to repay. With future profits looking poor, [[Investment|capital investment]] and construction slowed or completely ceased. In the face of bad loans and worsening future prospects, the surviving banks became even more conservative in their lending.<ref name="lhf-30s"/> Banks built up their capital reserves and made fewer loans, which intensified deflationary pressures. A [[Virtuous circle and vicious circle|vicious cycle]] developed and the downward spiral accelerated.

The liquidation of debt could not keep up with the fall of prices that it caused. The mass effect of the stampede to liquidate increased the value of each dollar owed, relative to the value of declining asset holdings. The very effort of individuals to lessen their burden of debt effectively increased it. Paradoxically, the more the debtors paid, the more they owed.<ref name="Fisher33"/> This self-aggravating process turned a 1930 recession into a 1933 great depression.

Fisher's debt-deflation theory initially lacked mainstream influence because of the counter-argument that debt-deflation represented no more than a redistribution from one group (debtors) to another (creditors). Pure re-distributions should have no significant macroeconomic effects.

Building on both the monetary hypothesis of Milton Friedman and Anna Schwartz and the debt deflation hypothesis of Irving Fisher, [[Ben Bernanke]] developed an alternative way in which the financial crisis affected output. He builds on Fisher's argument that dramatic declines in the price level and nominal incomes lead to increasing real debt burdens, which in turn leads to debtor insolvency and consequently lowers [[aggregate demand]]; a further price level decline would then result in a debt deflationary spiral. According to Bernanke, a small decline in the price level simply reallocates wealth from debtors to creditors without doing damage to the economy. But when the deflation is severe, falling asset prices along with debtor bankruptcies lead to a decline in the nominal value of assets on bank balance sheets. Banks will react by tightening their credit conditions, which in turn leads to a [[credit crunch]] that seriously harms the economy. A credit crunch lowers investment and consumption, which results in declining aggregate demand and additionally contributes to the deflationary spiral.<ref>Randall E. Parker, ''Reflections on the Great Depression'', Edward Elgar Publishing, 2003, {{ISBN|978-1-84376-550-9}}, pp. 14–15</ref><ref name="Bernanke83">{{cite journal|last=Bernanke|first=Ben S|date=June 1983|title=Non-Monetary Effects of the Financial Crisis in the Propagation of the Great Depression|journal=The American Economic Review|publisher=The American Economic Association|volume=73|issue=3|pages=257–276|jstor=1808111|url=https://faculty.arts.ubc.ca/dpaterson/econ532/10twenties/bernanke.pdf|access-date=February 22, 2021|archive-date=November 18, 2017|archive-url=https://web.archive.org/web/20171118070151/https://faculty.arts.ubc.ca/dpaterson/econ532/10twenties/bernanke.pdf|url-status=dead}}</ref><ref name="Mishkin78">{{cite journal|doi=10.1017/S0022050700087167|last=Mishkin|first= Fredric|date=December 1978|title=The Household Balance and the Great Depression|journal=Journal of Economic History|volume=38|issue=4|pages=918–937|s2cid=155049545 }}</ref>

=====Expectations hypothesis=====

Since economic mainstream turned to the [[new neoclassical synthesis]], expectations are a central element of macroeconomic models. According to [[Peter Temin]], Barry Wigmore, Gauti B. Eggertsson and [[Christina Romer]], the key to recovery and to ending the Great Depression was brought about by a successful management of public expectations. The thesis is based on the observation that after years of deflation and a very severe recession important economic indicators turned positive in March 1933 when [[Franklin D. Roosevelt]] took office. Consumer prices turned from deflation to a mild inflation, industrial production bottomed out in March 1933, and investment doubled in 1933 with a turnaround in March 1933. There were no monetary forces to explain that turnaround. Money supply was still falling and short-term interest rates remained close to zero. Before March 1933, people expected further deflation and a recession so that even interest rates at zero did not stimulate investment. But when Roosevelt announced major regime changes, people began to expect inflation and an economic expansion. With these positive expectations, interest rates at zero began to stimulate investment just as they were expected to do. Roosevelt's fiscal and monetary policy regime change helped make his policy objectives credible. The expectation of higher future income and higher future inflation stimulated demand and investment. The analysis suggests that the elimination of the policy dogmas of the gold standard, a balanced budget in times of crisis and small government led endogenously to a large shift in expectation that accounts for about 70–80% of the recovery of output and prices from 1933 to 1937. If the regime change had not happened and the Hoover policy had continued, the economy would have continued its free fall in 1933, and output would have been 30% lower in 1937 than in 1933.<ref>Gauti B. Eggertsson, [https://www.aeaweb.org/articles.php?doi=10.1257/aer.98.4.1476 ''Great Expectations and the End of the Depression''] {{Webarchive|url=https://web.archive.org/web/20160125070317/https://www.aeaweb.org/articles.php?doi=10.1257%2Faer.98.4.1476 |date=January 25, 2016 }}, American Economic Review 2008, 98:4, 1476–1516</ref><ref>Christina Romer, [https://www.nytimes.com/2012/10/21/business/how-the-fiscal-stimulus-helped-and-could-have-done-more.html "The Fiscal Stimulus, Flawed but Valuable"] {{Webarchive|url=https://web.archive.org/web/20211129132620/https://www.nytimes.com/2012/10/21/business/how-the-fiscal-stimulus-helped-and-could-have-done-more.html |date=November 29, 2021 }}, ''The New York Times'', October 20, 2012.</ref><ref>Peter Temin, ''Lessons from the Great Depression'', MIT Press, 1992, {{ISBN|978-0-262-26119-7}}, pp. 87–101.</ref>

The [[recession of 1937–1938]], which slowed down economic recovery from the Great Depression, is explained by fears of the population that the moderate tightening of the monetary and fiscal policy in 1937 were first steps to a restoration of the pre-1933 policy regime.<ref>{{cite journal|jstor=29730131|at=p. 1480|title=Great Expectations and the End of the Depression|journal=The American Economic Review|volume=98|issue=4|last1=Eggertsson|first1=Gauti B.|year=2008|doi=10.1257/aer.98.4.1476|hdl=10419/60661|hdl-access=free}}</ref>
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