EC104 Starting Questions

Topic 7: The Great Depression

1. In what ways was the international economy less integrated in the interwar period?
In the post WWI era, there was a collapse in trade. One of the contributing factors was the UKs decision to go back to the Gold Standard (with high parity relative to the USD). This action adversely
affected the exports of the UK. And during the Great Depression, the UK formed a trade bloc with
other British Commonwealth nations, whilst it implemented the General Tariff of 1932 in retaliation
to the increasing worldwide protectionism.
Germany was burdened with harsh reparations payments after the War. Its economy was not in a
position to demand a high quantity of imports. Similarly, its previous trade partners were in the same
situation. There was also a hyperinflation during the early 1920s. Thereafter, Germany halted reparations payments, and then it pursued autarkic policies, which led to rapid recovery and a boost in
employment.
There was an increase in trade during the Roaring Twenties mainly led by the boom in the US,
which quite generously lent money to the peripheral countries. However, the investors lost confidence after the 1929 Crash and started tightening credits elsewherei.e. Europe and Latin America.
This, of course, resulted in a sharp drop in trade, and the world economy become less integrated. The
crisis also spread to the peripheral countries as a result of the collapse in the commodity prices. The
Latin American countries, whose economy depended mostly on exporting primary commodities, were
particularly hit hard by the crisis as the demand for the commodities fell and overproduction exacerbated the situation. The fall in exports and the reverse in capital flows from the US encouraged the
Latin American countries to abandon the Gold Standard and default on loans. These countries abandoned trade and credit, and they began Import Substitution Industrialization (ISI).

2. What were the main causes of the Great Depression?

The three important causes of the Depression are banking crisis, deflation, and trade collapse.
Between 1929 and 1933, 10,763 of the 24,970 commercial banks in the US failed. The public increasingly held more currency and fewer deposits. There was a credit crunch as more banks failed;
and as businesses and individuals were unable to obtain credits, there was a sharp fall in consumption
and investment. Partly because of this, households demanded less imported goods, leading to a trade
collapse (which was also caused by a currency crisis).
Deflation during the Depression was partly due to the enormous contraction of credit. The large
number of bankruptcies also fostered a situation in which there was a frantic demand for money. The
Fed notably did nothing to help alleviate the situation. Instead it chose to contract the money supply
by 30%. This led to further plunges in price.

EC104 Starting Questions

3. Why was international co-ordination of monetary policy desirable but unattainable in 1931?
A good co-ordination of monetary policy would require the central banks to intervene during a banking crisis. This is easier to achieve if a country pursues easy money policy. But since most of the
countries were trying to stay on the Gold Standard, as a matter of international cooperation and
credibility, the co-ordination was somehow unattainable. We know that the Gold Standard inhibited
the kind of monetary policy intervention that the economic situation required. By 1936 the major
economies abandoned the Gold Standard, and then we started seeing recovery.

4. Why did economic policies become more protectionist in the 1930s?

It is commonly believed that the US led the movement towards greater protectionism when the
Smoot-Hawley tariff act was introduced in 1930. This action provoked intense bitterness abroad.
However, the main contributing factor was the failure of Creditanstalt in June 1931. This failure
caused a financial panic that spread to neighboring countries and around the world. The financial crisis in Germany, in which there were massive withdrawals of funds and demand of gold in exchange
for the Mark, prompted Germany to impose strict capital controls; trade and capital flows were impeded as a result. Many other countries followed these steps in order to prevent the loss of gold and
foreign exchange reserves. In addition, when the UK allowed its currency to depreciate against gold,
other countries that were on the Gold Standard responded as they sought to offset the competitive
advantage gained by the UK. This, needless to say, led to the breakdown of international trade relations.