World Financial Crisis 1929:

Eighty Five years ago, the New York Stock Exchange experienced the worst financial panic the
country had ever seen. There have been more crashes since with bigger numbers and bigger
losses but nothing quite rivals the terror and devastation of Black Tuesday: October 29, 1929.
When President Calvin Coolidge delivered his 1928 State of the Union address, he noted that
America had never "met with a more pleasing prospect than that which appears at the present
time." Americans had a lot to be proud of back then: World War I was thoroughly behind them,
radio had been invented, and automobiles were growing cheaper and more popular. Sure, the
disparity between the rich and the poor had widened within the past decade, but Americans could
now buy goods on installment plans a relatively new concept and families could afford more
than ever before. Stocks were on a tear: between 1924 and 1929, the Dow Jones Industrial Average
quadrupled. At that time, it was the longest bull market ever recorded; some thought it would last
forever. In the fall of 1929, economist Irving Fisher announced that "stock prices have reached what
looks like a permanent plateau."
As Dow stock average soared throughout the Roaring Twenties, many investors aggressively
purchased shares, comforted by the fact that stocks were thought to be extremely safe by most
economists due to the countrys powerful economic boom. Investors soon purchased stocks on
margin, which is the borrowing of stock for the purpose of gaining financial leverage. For every
dollar invested, a margin user would borrow nine dollars worth of stock. The use of leverage meant
that if a stock went up 1%, the investor would make 10%. Unfortunately, leverage also works the
other way around and amplifies even minor losses. If a stock drops too much, a margin holder could
lose all of their investment and possibly owe money to their broker as well.
From 1921 to 1929, the Dow Jones rocketed from 60 to 400, creating many new millionaires. Very
soon, stock trading became Americas favorite pastime as investors jockeyed to make a quick
killing. Investors mortgaged their homes and foolishly invested their life savings into hot stocks
such as Ford and RCA. To the average investor, stocks were practically a sure thing. Few people
actually studied the finances and underlying businesses of the companies that they invested in.
Thousands of fraudulent companies were formed to hoodwink unsavvy investors. Most investors
never even thought a crash was possible in their minds, the stock market always went up.

The Timeline For Great Depression:

Event Date: Event Title: Event Description:
Oct, 1929 Black
Tuesday
The stock market crashes, marking the end of six years of
unparalleled prosperity for most sectors of the American economy.
The "crash" began on October 24 (Black Thursday). By October 29,
stock prices had plummeted and banks were calling in loans. An
estimated $30 billion in stock values "disappeared" by mid-
November.
June 17,
1930
Smoot-
Hawley
Tariff
Congress passes the Smoot-Hawley Tariff, steeply raising import
duties in an attempt to protect American manufactures from
foreign competition. The tariff increase has little impact on the
American economy, but plunges Europe farther into crisis.
16th May,
1931
Riots Food riots broke out, workers marched on Detroit, and foreign
workers were deported
No major legislation is passed addressing the Depression.
Dec 1931 Major Bank
Collapse

New York's Bank of the United States collapses in the largest bank
failure to date in American history.[M31] $200 million in deposits
disappear, and the bank's customers are left holding the bag.
January
1932
Reconstructi
on
Congress establishes the Reconstruction Finance Corporation. The
R.F.C. is allowed to lend $2 billion to banks, insurance companies,
building and loan associations, agricultural credit organizations
and railroads.
March 1932 Ford Strike Three thousand unemployed workers march on the Ford Motor
Company's plant in River Rouge, Michigan. Dearborn police and
Ford's company guards attack the workers, killing four and injuring
many more.
April 1932 Unemployed
men line up
for work
More than 750,000 New Yorkers are reported to be dependent
upon city relief, with an additional 160,000 on a waiting list.
Expenditures average about $8.20 per month for each person on
relief.
November
1932
Roosevelt
Elected
Franklin Delano Roosevelt is elected president in a landslide over
Herbert Hoover. Roosevelt receives 22.8 million popular votes to
Hoover's 15.75 million.
12th Mar,
1933
Fireside Chat President Roosevelt delivers his first radio "fireside chat,"
explaining to the American people what has happened in the U.S.
banking system.
28th Mar,
1933
New
President
Franklin D. Roosevelt took office. More than 11,000 of the nations
25,000 banks had closed Roosevelt announces a three-day bank
holiday to prevent a third run on banks and to shore up the
banking system. Unemployment reached its highest level, at 25%
April 1933 The Civilian
Conservation
Corps
The first New Deal program, the Civilian Conservation Corps (CCC)
is created. Thousands of young men go to camps to work on
projects such as building parks, building roads, and fighting forest
fires.
May 1933 The
Tennessee
Valley
Authority
The Tennessee Valley Authority, another New Deal program, brings
electricity and jobs to Americans living in the southern part of the
United States.
1934 Congress authorizes creation of the Federal Communications
Commission, the National Mediation Board and the Securities and
Exchange Commission.
The economy turns around: GNP rises 7.7 percent, and
unemployment falls to 21.7 percent. A long road to recovery
begins.
Sweden becomes the first nation to recover fully from the Great
Depression. It has followed a policy of Keynesian deficit spending.




8th Apr,
1935
Emergency
Relief
Appropriatio
n Act
Congress passes the Emergency Relief Appropriation Act creating
the Works Progress Administration (WPA) and providing almost
$5 billion for work relief for the unemployed for such projects as
construction of airports, schools, hospitals, roads, and public
buildings.
14th August
1935
Social
Security Act
the Social Security Act established a system of old-age benefits for
workers, benefits for victims of industrial accidents,
unemployment insurance, aid for dependent mothers and children,
the blind, and the physically handicapped.
Nov 3, 1936 FDR Franklin D. Roosevelt is elected to a second term as president
March 1937 Another
Recession
After showing some improvement, the economy starts to suffer
again when more Americans lose their jobs. Many people begin to
lose hope that things will ever get better.
1938 No major New Deal legislation is passed after this date, due to
Roosevelt's weakened political power.
the GNP falls 4.5 percent, and unemployment rises to 19.0 percent.

December 7,
1941
Japan
attacks Pearl
Harbor
Japan bombs American ships at Pearl Harbor in Hawaii. Thousands
of Americans are killed in the attack.
December
1941
The Great
Depression
Ends
The United States declares war on Japan and joins World War II.
Because the war creates so much money and jobs for the economy,
the Great Depression ends soon after the U.S. goes to war.

Timing and severity
The Great Depression began in the United States as an ordinary recession in the summer of 1929.
The downturn became markedly worse, however, in late 1929 and continued until early 1933. Real
output and prices fell precipitously. Between the peak and the trough of the downturn, industrial
production in the United States declined 47 percent and real gross domestic product (GDP) fell 30
percent. The wholesale price index declined 33 percent (such declines in the price level are referred
to as deflation). Although there is some debate about the reliability of the statistics, it is widely
agreed that the unemployment rate exceeded 20 percent at its highest point. The severity of the
Great Depression in the United States becomes especially clear when it is compared with Americas
next worst recession of the 20th century, that of 198182, when the countrys real GDP declined
just 2 percent and the unemployment rate peaked at less than 10 percent. Moreover, during the
198182 recession prices continued to rise, although the rate of price increase slowed substantially
(a phenomenon known as disinflation).
The Depression affected virtually every country of the world. However, the dates and magnitude of
the downturn varied substantially across countries. Table 1 shows the dates of the downturn and
upturn in economic activity in a number of countries. Table 2 shows the peak-to-trough percentage
decline in annual industrial production for countries for which such data are available. Great Britain
struggled with low growth and recession during most of the second half of the 1920s. Britain did
not slip into severe depression, however, until early 1930, and its peak-to-trough decline in
industrial production was roughly one-third that of the United States. France also experienced a
relatively short downturn in the early 1930s. The French recovery in 1932 and 1933, however, was
short-lived. French industrial production and prices both fell substantially between 1933 and 1936.
Germanys economy slipped into a downturn early in 1928 and then stabilized before turning down
again in the third quarter of 1929. The decline in German industrial production was roughly equal
to that in the United States. A number of countries in Latin America fell into depression in late 1928
and early 1929, slightly before the U.S. decline in output. While some less-developed countries
experienced severe depressions, others, such as Argentina and Brazil, experienced comparatively
mild downturns. Japan also experienced a mild depression, which began relatively late and ended
relatively early.

Dates of the Great Depression in various countries
(in quarters)













Peak-to-trough decline in industrial production in various countries
(annual data)
Country Decline
Country Depression began Recovery began
United States 1929:3 1933:2
United Kingdom 1930:1 1932:4
Germany 1928:1 1932:3
France 1930:2 1932:3
Italy 1929:3 1933:1
Japan 1930:1 1932:3
Canada 1929:2 1933:2
Belgium 1929:3 1932:4
The Netherlands 1929:4 1933:2
Sweden 1930:2 1932:3
Switzerland 1929:4 1933:1
Denmark 1930:4 1933:2
Poland 1929:1 1933:2
Czechoslovakia 1929:4 1933:2
Argentina 1929:2 1932:1
Brazil 1928:3 1931:4
India 1929:4 1931:4
South Africa 1930:1 1933:1
United States 46.8%
United Kingdom 16.2%
Germany 41.8%
France 31.3%
Italy 33.0%
Japan 8.5%
Canada 42.4%
Belgium 30.6%
The Netherlands 37.4%
Sweden 10.3%
Denmark 16.5%
Poland 46.6%
Czechoslovakia 40.4%
Argentina 17.0%
Brazil 7.0%

The general price deflation evident in the United States was also present in other countries.
Virtually every industrialized country endured declines in wholesale prices of 30 percent or more
between 1929 and 1933. Because of the greater flexibility of the Japanese price structure, deflation
in Japan was unusually rapid in 1930 and 1931. This rapid deflation may have helped to keep the
decline in Japanese production relatively mild. The prices of primary commodities traded in world
markets declined even more dramatically during this period. For example, the prices of coffee,
cotton, silk, and rubber were reduced by roughly half just between September 1929 and December
1930. As a result, the terms of trade declined precipitously for producers of primary commodities.
The U.S. recovery began in the spring of 1933. Output grew rapidly in the mid-1930s: real GDP rose
at an average rate of 9 percent per year between 1933 and 1937. Output had fallen so deeply in the
early years of the 1930s, however, that it remained substantially below its long-run trend path
throughout this period. In 193738 the United States suffered another severe downturn, but after
mid-1938 the American economy grew even more rapidly than in the mid-1930s. The countrys
output finally returned to its long-run trend path in 1942.
Recovery in the rest of the world varied greatly. The British economy stopped declining soon after
Great Britain abandoned the gold standard in September 1931, although genuine recovery did not
begin until the end of 1932. The economies of a number of Latin American countries began to
strengthen in late 1931 and early 1932. Germany and Japan both began to recover in the fall of
1932. Canada and many smaller European countries started to revive at about the same time as the
United States, early in 1933. On the other hand, France, which experienced severe depression later
than most countries, did not firmly enter the recovery phase until 1938.

How the Stock Market Crash of 1929 Happened
In 1929, the Federal Reserve raised interest rates several times in an attempt to cool the
overheated economy and stock market. By October, a powerful bear market had commenced. On
Thursday, October 24th 1929, a spate of panic selling occurred as investors began to realize that the
stock boom was actually an over-inflated speculative bubble. Margin investors were being
decimated as large numbers of stock investors tried to liquidate their shares to no avail. Millionaire
margin investors went bankrupt almost instantly when the stock market crashed on October 28th
and 29th. During November of 1929, the Dow sank from 400 to 145. In just three days, over $5
billion worth of market capitalization had been erased from stocks that were trading on the New
York Stock Exchange. By the end of the 1929 stock market crash, a staggering $16 billion worth of
market capitalization had been lost from NYSE stocks.

To make matters worse, many banks had invested their deposits in the stock market, causing these
banks to lose their depositors savings as stocks plunged. Bank runs soon occurred when bank
patrons tried to withdraw their savings from banks all at the same time. Major banks and brokerage
firms became insolvent, adding more fuel to the stock market crash. The financial system was in
shambles. Many bankrupt speculators, some who were once very affluent, committed suicide by
jumping out of buildings. Even bank patrons who had not invested in shares became broke as $140
billion of depositor money disappeared and 10,000 banks failed.
What Caused the Great Depression of 1929?
The Great Depression was a global financial crisis that consumed most of the developed world
throughout the 1930s. While the first real indications of its onset can be seen at the end of 1929,
most countries did not feel its true effects until 1930 or later. When it ended also varied from
country to country but signs of recovery were seen in the late 1930s, with things looking up for
most economies by 1940.
Importantly, although the Wall Street Crash which took place in October 1929 is often seen as
an interchangeable term for the Great Depression, this event is simply one of the causes emanating
from the US, which led to the longest and deepest worldwide recession of the 20th century. The
Great Depression may have come soon after the collapse of the stock market but this does not mean
it happened because of it; there are many other factors at play that resulted in a more far-reaching
economic crisis.
Farm Depression of the 1920s
One of the critical faults that led to the Great Depression was overproduction. This was not just a
problem in industrial manufacturing, but also an agricultural issue. From as early as the middle of
the 1920s, American farmers were producing far more food than the population was consuming. As
farmers expanded their production to aid the war effort during WWI they also mechanized their
techniques, a process which both improved their output but also cost a lot of money, putting
farmers into debt. Furthermore, land prices for many farmers dropped by as much as 40 per cent
as a result, the agricultural system began to fail throughout the 20s, leaving large sections of the
population with little money and no work. Thus, as demand dropped with increasing supply, the
price of products fell, in turn leaving the over-expanded farmers short-changed and farms often
foreclosed. This caused unemployment rise and food production fall by the end of the 1920s.
Overproduction in Industry
While agriculture struggled, industry soared in the decade preceding the Wall Street Crash. In the
boom period before the bust, a lot of people were buying things like cars, household appliances
and consumer products. Importantly, however, these purchases were often made on credit. And as
production continued apace the market quickly dried up; too many products were being produced
with too few people earning enough money to buy them the factory workers themselves, for
example, could not afford the goods coming out of the factories they worked in. The economic crisis
that soon would engulf Europe for reasons to be explained, meant that goods could not be sold
across the Atlantic either, leaving Americas industries to create an unsustainable surplus of
products.
Uneven incomes
In the 1920's American economic policy was laissez faire. Businesses were left alone and for
sometime things appeared to fine. American businesses reported record profits, production was at
an all time high. The problem was that while earnings rose and the rich got richer, the working class
received a disproportionally lower percentage of the wealth. This uneven distribution of wealth got
so bad that 5% of America earned 33% of the income. What this meant was that there was less and
less real spending. Despite the fact that the working class had less money to spend businesses
continued to increase production levels
Low Interest Rate

The run up to the 1929 Equity Market Crash was characterized by easy monetary policy. The FED
cut rates in 1927, and borrowing was cheap until the spring of 1928, when it became only a little
more expensive. Low interest rates made borrowing attractive, so both corporate and financial
leverage increased.

Credit Boom:
In the 1920s, there was a rapid growth in bank credit and loans. Encouraged by the strength of the
economy people felt the stock market was a one way bet. Some consumers borrowed to buy shares.
Firms took out more loans for expansion. Because people became highly indebted, it meant they
became more susceptible to a change in confidence. When that change of confidence came in 1929,
those who had borrowed were particularly exposed and joined the rush to sell shares and try and
redeem their debts.
Buying on the Margin
Related to buying on credit was the practice of buying shares on the margin. This meant you only
had to pay 10 or 20% of the value of the shares; it meant you were borrowing 80-90% of the value
of the shares. This enabled more money to be put into shares, increasing their value. It is said there
were many margin millionaire investors. They had made huge profits by buying on the margin and
watching share prices rise. But, it left investors very exposed when prices fell. These margin
millionaires got wiped out when the stock market fall came. It also affected those banks and
investors who had lent money to those buying on the margin.
Irrational Exuberance
A lot of the Stock Market crash can be blamed on over exuberance and false expectations. In the
years leading up to 1929, the stock market offered the potential for making huge gains in wealth. It
was the new gold rush. People bought shares with the expectations of making more money. As
share prices rose, people started to borrow money to invest in the stock market. The market got
caught up in a speculative bubble. Shares kept rising and people felt they would continue to do so.
The problem was that stock prices became divorced from the real potential earnings of the share
prices. Prices were not being driven by economic fundamentals but the optimism / exuberance of
investors. The average earning per share rose by 400% between 1923 and 1929. Yet, those who
questioned the value of shares were often labeled doom-mongers.
In March 1929, the stock market saw its first major reverse, but this mini-panic was overcome
leading to a strong rebound in the summer of 1929. By October 1929, shares were grossly
overvalued. When some companies posted disappointing results on October 24 (Black Thursday),
some investors started to feel this would be a good time to cash in on their profits; share prices
began to fall and panic selling caused prices to fall sharply. Financiers, such as JP Morgan tried to
restore confidence by buying shares to prop up prices. But, this failed to alter the rapid change in
market sentiment. On October 29(Black Tuesday) share prices fell by $40 billion in a single day. By
1930 the value of shares had fallen by 90%. The bull market had been replaced by a bear market.
Weak banking system
A major issue with Americas economic system, above and beyond speculative margin buying, was
its weak banking system. The country had too many small banks, which did not have the resources
to cope with the high demand of people wanting to take their money out when they got nervous
about the state of the stock market. In 1930 a wave of banking closures swept through the mid-
eastern states of the US for this reason. With banks having to sell assets, borrow off other banks or
shut down, lending and credit dried up as this was a large part of fuelling Americas boom period,
when it came to an end so too did the rush of consumer purchasing.
American Economic Policy with Europe
As businesses began failing, the government created the Smoot-Hawley Tariff in 1930 to help
protect American companies. This charged a high tax for imports thereby leading to less trade
between America and foreign countries along with some economic retaliation.
European recession
As America witnessed a turbulent decade of boom and bust in the 1920s and early 30s, Europe too
suffered from its own economic problems.
Most of the economies were left crippled by the effects of WWI, which had seen the workforces
depleted and large amounts of debt incurred, mainly owed to the US. When Americas economy
faltered and it needed money to prevent its ongoing deflation, it called on Britain and France
(among other countries) to repay their debts while also making Germany pay the war reparations.
The fragile economies of Western Europe were not able to survive without the money they had
relied on from the US. As lending from across the Atlantic stopped and President Herbert Hoover
requested the debts to be repaid, these European economies suffered a similar fate as their wartime
allies. None of these countries were able to buy Americas consumer goods, a problem exacerbated
by the fact that America raised tariffs on imports to an all-time high, which all but ended world
trade at a time when trade and economic stimulus was needed the most.
European economies collapsed when they were already struggling to rebuild themselves
unemployment levels rose, products became overproduced with fewer people able to buy them, the
value fell, and deflation ensued as the economic structure collapsed in on itself. This pattern, first
seen in America, spread to much of the developed world.

Hoovers failures
As has been established, the Great Depression was the result of a multitude of socio-economic
factors over a number of years, not one single event. As such, the finger of blame has often been
pointed at Herbert Hoover, President of the US from 1929-1933; his term as President coincided
with the period in which action needed to be taken to prevent deflation from escalating and
government needed to stabilize a shaky economy. Instead Hoovers policies and actions and he
did work hard to try find a solution to the economic problems are often argued to have worsened
the issue around the world, with not enough being done to prevent the crisis in America getting to
the scale it did. Moreover, his decisions then impacted on other Western countries, which is what
brought the depression to a truly great level.
Although he did try launching initiatives and investing money back into schemes to encourage
lending and unemployment something he often is not credited with enough these tend to be seen
as being too little, too late. His decision to increase tariffs on imports through the Smoot-Hawley
tariff stifled trade with other countries and shrank the size of the market American manufacturers
could sell to. Furthermore, under Hoover the federal government raised its discount rate, making
credit even harder to come by. Other actions he took also came too late plans made in 1932 could
not do enough to bail out banks and put people back in work as the depression had fully taken
effect.
Hoovers lack of a proactive approach was exposed by the more substantial action taken by
Franklin D Roosevelt, who succeeded him as President. Initiatives like the New Deal put large
numbers back in work and stopped the downward spiral of unemployment and deflation.
The gold standard
The decision to return to and then stick with the gold standard after WWI by Western nations is
often cited as a key factor in the outbreak of the Great Depression. The gold standard is a system in
which money is fixed against an actual amount of gold. In order for it to work, countries need to
maintain high interest rates to attract international investors who bought foreign assets with
gold. When this stops, as it did at the start of the 1930s, governments often must abandon the gold
standard to prevent deflation from worsening but when this decision had to be made by all
countries in order to maintain fixed exchange rates it wasnt, and the delay in abandoning the gold
standard let economic problems worsen and the size and scale of the Great Depression increase.







Effects of the Great Depression
The Great Depression was one of the major economic events in world history. It affected every
sphere of life. The outcomes were such that they changed the face of world economy.

1. Economic Effects : As it was a major economic phenomenon it had serious and widespread
economic effects.

Trade Collapse

The Depression became a worldwide business downturn of the 1930s that affected almost all
countries. International commerce declined quickly. There was a sharp reduction in tax revenues,
profits and personal incomes. It affected both countries that exported raw materials and the
industrialized countries. It led to a sharp decrease in world trade as each country tried to protect
their own industries and products by raising tariffs on imports. World Trade collapsed with trade in
1939 still below the 1929 level. It set the wheels rolling towards the end of international gold
standards and consequently the emergence of the fixed exchange rate system.


Reduction in Government Spending

Governments all around the world reduced their spending, which led to decreased consumer
demand. Construction came to a standstill in many nations. As a consequence of government
actions, the real Gross National Product of nations like United States and Britain fell by 30.5%,
wholesale prices fell by 30.8%, and consumer prices fell by 24.4%.

Employee Distress

Wages were scaled down to 20 percent, whereas 25 percent of the workforce was left unemployed.
This led to decrease in the standard of living pushing the economy further into the depth of the
Depression.

Breakdown of the Financial Machinery

Thousands of investors lost large sums of money and several were wiped out, losing everything.
Banks, stores, and factories were closed and left millions of people jobless, penniless and homeless.
In 1929, 659 public sector banks were shut and by the end of 1931 this number rose to 2294. Many
people came to depend on the government or charities to provide them with food.

Effect on Agriculture

Due to lack of subsidies and loans, farmers were unable to support mass produce leading to under-
capacity output. Textile farming faced the major blow. The period served as a precursor to one of
the worst droughts in modern American history that struck the Great Plains in 1934. Although a
few segments under agriculture - e.g. cotton - benefited from the crisis, in general the whole
agricultural sector experienced a setback.




Political Effects

The Depression had profound political effects. In countries such as Germany and Japan, reaction to
the Depression brought about the rise to power of militarist governments who adopted the
aggressive foreign policies that led to the Second World War. In Germany, weak economic
conditions led to the rise to power of Adolf Hitler. Germany suffered greatly because of the huge
debt the country was burdened by following World War I. The Japanese invaded China and
developed mines and industries in Manchuria. Japan thought that this economic growth would
relieve the Depression.

In countries such as the United States and Britain, the government intervened which ultimately
resulted in the creation of welfare systems. Franklin D. Roosevelt became the United States
President in 1933. He promised a "New Deal" under which the government would intervene to
reduce unemployment by work-creation schemes such as painting of the post offices and street
cleaning. Both agriculture and industry were supported by policies to limit output and increase
prices.

2. Social and Cultural Effects: This economic catastrophe hit the humans in the worst way
possible. They were surrounded by miseries from all sides. Due to failure of the financial
machinery, masses' faith over the economic system shattered. This resulted in a sudden rise
in the crime rate. Theft, burglary and felony became common occurrences. With no income
and several mouths to feed, workers were pushed to commit suicides. Malnutrition was
one of the severe outcomes of the Depression. Higher education was beyond anyone's reach
which resulted in contraction of the student bodies in all the universities. Due to lack of
public spending, many schools were closed down or understaffed. Professional education
was no longer a priority. One of the key features of this phase was the mass migration. It
reshaped the whole American scenario, people relocated to other countries in search of
better employment opportunities and increased standard of living. Many shifted to
California and Arizona to save themselves from the adversities of the Great Plains. This
movement paved the way for various cultural changes resulting in the diversities we
witness today.
A positive outcome of the whole Depression was the emergence of labor unions and the
concept of welfare state. It brought the trend of collective bargaining used during that phase
to voice the concerns of the labor distress, which is a well-defined form of communication in
companies today. In United States, union membership doubled in its size from 1930 to
1940.

Sources of recovery
Given the key roles of monetary contraction and the gold standard in causing the Great Depression,
it is not surprising that currency devaluations and monetary expansion were the leading sources of
recovery throughout the world. There is a notable correlation between the times at which countries
abandoned the gold standard (or devalued their currencies substantially) and when they
experienced renewed growth in their output.
For example, Britain, which was forced off the gold standard in September 1931, recovered
relatively early, while the United States, which did not effectively devalue its currency until 1933,
recovered substantially later. Similarly, the Latin American countries of Argentina and Brazil, which
began to devalue in 1929, experienced relatively mild downturns and had largely recovered by
1935. In contrast, the Gold Bloc countries of Belgium and France, which were particularly wedded
to the gold standard and slow to devalue, still had industrial production in 1935 well below that of
1929.
Devaluation, however, did not increase output directly. Rather, it allowed countries to expand their
money supplies without concern about gold movements and exchange rates. Countries that took
greater advantage of this freedom saw greater recovery. The monetary expansion that began in the
United States in early 1933 was particularly dramatic. The American money supply increased
nearly 42 percent between 1933 and 1937. This monetary expansion stemmed largely from a
substantial gold inflow to the United States, caused in part by the rising political tensions in Europe
that eventually led to World War II. Monetary expansion stimulated spending by lowering interest
rates and making credit more widely available. It also created expectations of inflation, rather than
deflation, thereby giving potential borrowers greater confidence that their wages and profits would
be sufficient to cover their loan payments if they chose to borrow. One sign that monetary
expansion stimulated recovery in the United States by encouraging borrowing was that consumer
and business spending on interest-sensitive items such as cars, trucks, and machinery rose well
before consumer spending on services.
Fiscal policy played a relatively small role in stimulating recovery in the United States. Indeed, the
Revenue Act of 1932 increased American tax rates greatly in an attempt to balance the federal
budget, and by doing so it dealt another contractionary blow to the economy by further
discouraging spending. Franklin D. Roosevelts New Deal, initiated in early 1933, did include a
number of new federal programs aimed at generating recovery. For example, the Works Progress
Administration (WPA) hired the unemployed to work on government building projects, and the
Tennessee Valley Authority (TVA) constructed dams and power plants in a particularly depressed
area. However, the actual increases in government spending and the government budget deficit
were small relative to the size of the economy. This is especially apparent when state government
budget deficits are included, because those deficits actually declined at the same time that the
federal deficit rose. As a result, the new spending programs initiated by the New Deal had little
direct expansionary effect on the economy. Whether they may nevertheless have had positive
effects on consumer and business sentiment remains an open question.
Some New Deal programs may have actually hindered recovery. The National Industrial Recovery
Act of 1933, for example, set up the National Recovery Administration (NRA), which encouraged
firms in each industry to adopt a code of behavior. These codes discouraged price competition
between firms, set minimum wages in each industry, and sometimes limited production. Likewise,
the Agricultural Adjustment Act of 1933 created the Agricultural Adjustment Administration (AAA),
which set voluntary guidelines and gave incentive payments to farmers to restrict production in
hopes of raising agricultural prices. Modern research suggests that such anticompetitive practices
and wage and price guidelines led to inflation in the early recovery period in the United States and
discouraged reemployment and production.
Recovery in the United States was stopped short by another distinct recession that began in May
1937 and lasted until June 1938. One source of the 193738 recession was a decision by the Federal
Reserve to greatly increase reserve requirements. This move, which was prompted by fears that the
economy might be developing speculative excess, caused the money supply to cease its rapid
growth and to actually fall again. Fiscal contraction and a decrease in inventory investment due to
labor unrest are also thought to have contributed to the downturn. That the United States
experienced a second, very severe contraction before it had completely recovered from the
enormous decline of the early 1930s is the main reason that the United States remained depressed
for virtually the entire decade.
World War II played only a modest role in the recovery of the U.S. economy. Despite the recession
of 193738, real GDP in the United States was well above its pre-Depression level by 1939, and by
1941 it had recovered to within about 10 percent of its long-run trend path. Therefore, in a
fundamental sense, the United States had largely recovered before military spending accelerated
noticeably. At the same time, the U.S. economy was still somewhat below trend at the start of the
war, and the unemployment rate averaged just under 10 percent in 1941. The government budget
deficit grew rapidly in 1941 and 1942 because of the military buildup, and the Federal Reserve
responded to the threat and later the reality of war by increasing the money supply greatly over the
same period. This expansionary fiscal and monetary policy, together with widespread conscription
beginning in 1942, quickly returned the economy to its trend path and reduced the unemployment
rate to below its pre-Depression level. So, while the war was not the main impetus for the recovery
in the United States, it played a role in completing the return to full employment.
The role of fiscal expansion, and especially of military expenditure, in generating recovery varied
substantially across countries. Great Britain, like the United States, did not use fiscal expansion to a
noticeable extent early in its recovery. It did, however, increase military spending substantially
after 1937. France raised taxes in the mid-1930s in an effort to defend the gold standard but then
ran large budget deficits starting in 1936. The expansionary effect of these deficits, however, was
counteracted somewhat by a legislated reduction in the French workweek from 46 to 40 hoursa
change that raised costs and depressed production. Fiscal policy was used more successfully in
Germany and Japan. The German budget deficit as a percent of domestic product increased little
early in the recovery, but it grew substantially after 1934 as a result of spending on public works
and rearmament. In Japan, government expenditures, particularly military spending, rose from 31
to 38 percent of domestic product between 1932 and 1934, resulting in substantial budget deficits.
This fiscal stimulus, combined with substantial monetary expansion and an undervalued yen,
returned the Japanese economy to full employment relatively quickly