THE GREAT DEPRESSION

Section 2-Group 6 Members: Ishan Ghai DM15224 Lakshmi R S Niranjani Mohan DM15231 DM15234 Nishanth M V Phani Kiran DM15235 DM15238

Koushik Sekar DM15229

The Great Depression was a period of severe worldwide economic depression in the decade preceding World War II. It started in 1930 and lasted until the late 1930s or middle 1940s and was the longest, most widespread, and deepest depression of the 20th century. The American economy in the 1920s was booming due to the growth in construction and automobile sectors which was accompanied by a phenomenal growth in the stock markets. By the end of 1920s the construction industry was on a decline and in the automobile industry the rate of production was greater than the rate of sale. However, these warning signals were overlooked because of the artificial success of the stock market.

Reasons for Great Depression

Income disparity. Bad monetary policies. Lax regulation. Barriers to foreign trades. Heavy borrowings due to low interest rates making the financial sector more vulnerable to shocks. Speculative stock market.

Macroeconomic models and the Great Depression:

Classical economic model believes that the output can be increased only from the supply side and it assumes that the AS curve is similar to simple supply curve. However, this assumption may not be true to all industries. Though Herbert Hoover explicitly said that he is not an advocate of Laissez-Faire and that the government ought to play a significant role in stabilizing the economy we can see that in his actions this model was not reflected and only the classical model was reflected. This can be seen through points where 1) Hoover was committed more to individual initiative and responsibility.

2) He followed policy of fiscal conservatism. 3) There was limited view of the role of Government. 4) He opposed to direct federal relief for the unemployed. By the end of 1931, Hoover was willing to take unprecedented to curb the depression and for this he advocated two programs in which the government intervened to help the individual.

1. Relief and construction act 2. Federal home loan bank act. This was basically a shift from classical model to Keynesian model. Though he started this model it failed miserably. This led to loss of faith of people in republics. Roosevelt came into power and decided to adopt the Keynesian theory.

Keynesian model:
This model has given a new perspective to increase output, by looking at the demand side. The demand can be increased by government intervention by increasing expenditure and create employment opportunities. As the result, the income increase and demand for products rises contributing to growth.

Performance: Nom. Int. Rate 5.9 3.6 2.6 2.7 1.7 1 0.8 0.8 0.9 0.8 0.6 0.6 Money Supply 26.6 25.8 24.1 21.1 19.9 21.9 25.9 29.6 30.9 30.5 34.2 39.7 Price Level 50.6 49.3 44.8 40.2 39.3 42.2 42.6 42.7 44.5 43.9 43.2 43.9

Year 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940

Inflation -2.6 -10.1 -9.3 -2.2 7.4 0.9 0.2 4.2 -1.3 -1.6 1.6

The reduced interest rates and the collapse of the banking system made the people withdraw money from the banks. This has resulted in less money supply in the economy. This could have been countered by the government by open market operations. The increase in domestic savings rate has caused reduction in the consumption and investment even in a low interest rate period. This has resulted in low growth.

Some Key Learnings

The Changes in the classical school of thought towards a more comprehensive model taking into consideration the real world scenarios, especially, depression and recession, which could not be properly explained by the classical model. The Evolution of the Keynesian model and the neo modern model that explained the possible scenarios and a more holistic understanding of the macroeconomic variables such as interest rates, real wages and aggregate demand and supply, explained along the lines of practical scenarios The change in the capitalist model as such. The capitalist model of completely free economy and regulation-less business scenarios was forced to be changed. Government intervention in economy, especially in monetary and fiscal policies and regulation of industries on some aspects were some major changes capitalism had to incorporate, borrowing from socialist aspects.