Great Depression Warning: You are not logged in. Your IP address will be publicly visible if you make any edits. If you log in or create an account, your edits will be attributed to your username, along with other benefits.Anti-spam check. Do not fill this in! =====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 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> Summary: Please note that all contributions to Christianpedia may be edited, altered, or removed by other contributors. If you do not want your writing to be edited mercilessly, then do not submit it here. You are also promising us that you wrote this yourself, or copied it from a public domain or similar free resource (see Christianpedia:Copyrights for details). Do not submit copyrighted work without permission! Cancel Editing help (opens in new window) Discuss this page