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Transcript of An Economic Analysis of the Great Depression: Implications for 2009 National Council for the Social...
An Economic Analysis of the Great Depression: Implications for 2009
National Council for the Social StudiesNovember 13, 2009Mark C. Schug, Ph.D.University of Wisconsin-Milwaukee
Overview
Overview of Focus: Understanding Economics in U.S. History
Demonstration of Lesson 30: Causes of the Great Depression
Implications for today
Table of Contents
Unit 1 Three World Meet
Unit 2: Colonization and Settlement
Unit 3: Revolution and the New Nation
Unit 4: Expansion and Reform
Unit 5: Civil War and Reconstruction
Table of Contents
Unit 6: The Development of the Industrial United States
Unit 7: The Emergence of Modern America
Unit 8: The Great Depression and World War II
Unit 9: Postwar United States
Unit 10: Contemporary United States
Whatdunnit? The Great Depression Mystery
Focus: Understanding Economics in U.S. HistoryLesson 30
Whatdunnit?
In the 1920s, jobs were plentiful and the economy was growing and the standard of living was rising.
Between 1920 and 1929 homeownership doubled.
Most home-owning families enjoyed amenities such as electric lights and flush toilets.
60% of all households had cars, up from 26%.
More teenagers were attending high school.
Whatdunnit?
By 1933… One fourth of the labor
forces was unemployed. Families were losing
their homes and many were going hungry.
Adolescents who should be in school were riding around the country in freight cars, looking for jobs.
Whatdunit?
What happened?• The United states possessed the same
productive resources in the 1930s as it had in the 1920s.
• Great factories and productive machinery were still present.
• Workers had the same skills and were willing to work just as hard.
• How could life have become so miserable for so many in such a short period of time?
1920s
Prosperity of the 1920s was based largely on purchases of homes and cars.
Toward the end of the decade sales began to decline.
End of the 1920s
Machinery workers stand. Car sales people stand. Auto workers stand. Steel workers stand. Construction workers stand. Furniture sellers stand. Furniture workers stand. Clothing sellers stand. Restaurant workers stand. Grocery workers stand.
1929
Normally, people start buying again as automobiles wear out and incomes improve.
Expansion Begins Again
Machinery workers sit. Car sales people sit. Auto workers sit. Steel workers sit. Construction workers sit. Furniture sellers sit. Furniture workers sit. Clothing sellers sit. Restaurant and grocery
workers sit. Grocery workers sit.
What Are the Alleged Causes of the Great Depression?
The Stock Market Crash of October 29, 1929. Excessive borrowing to purchase stocks and
consumer goods. Overproduction of goods and services High tariffs which prevented imports and hurt
exports. Low farm prices and low wages, leading to an
uneven distribution of income.
Why did a mild recession in 1929 become the Great Depression of the 1930s? A Hint
Its mainly about money, banks, and the Federal Reserve System
How is Money Created?
Banks are not just businesses.
Hint: Banks Create Money100% Reserves
Assets Liabilities
Reserves $1000.00 Deposits $1000.00
Loans
Hint: Banks Create MoneyBank 1: 10% Reserves
Assets Liabilities
Reserves $100.00 Deposits $1000.00
Loans $900.00
Hint: Banks Create MoneyBank 2: 10% Reserves
Assets Liabilities
Reserves $90.00 Deposits $900.00
Loans $810.00
$900 + $810 = $1,710 and still moving…
The Fed
The Federal Reserve System was created in 1913.
The Fed has 4 partsBoard of Governors (Washington D.C.)Federal Open Market Committee (FOMC)Reserve Banks (12 members)Member Banks
Conducting Monetary Policy
Inflation: Enemy Number 1
The Federal Reserve System has 3 tools to control inflation:
1. Sets reserve requirements for banks. Raise reserve requirement = reduce
money supply Lower reserve requirement = increase
money supply
Conducting Monetary Policy
2. Manages the Federal Open Market Committee (FOMC).
The FOMC sets a target rate for the Federal Funds rate. This is the rate for loans made from bank to bank.
This is almost always what the media is referring to when it says the Federal Reserve "changing interest rates".
To increase the money supply, the Fed instructs the Open Market Desk at the New York Fed to buy bonds to try and hit the target rate.
To decrease the money supply, the Fed instructs the Open Market Desk at the New York Fed to sell bonds.
Conducting Monetary Policy
3. Sets the discount rate for members who borrow money from the Fed.
Banks can borrow funds to keep up their required reserves is by taking a loan from the Fed Reserve at the discount window.
The discount rate is usually higher than the federal funds rate.
Raise discount rate = reduce money supply Lower discount rate = increase money supply
Visual 30.2 Number of U.S. Banks Closing Temporarily or Permanently, 1920-1933
Year Number of Bank Closings
1920 168
1921 505
1922 367
1923 646
1924 775
1925 618
1926 976
1927 669
1928 499
1929 659
1930 1352
1931 2294
1932 1456
1933 4004
Visual 30.3 Money in Circulation
Year
Money in Circulation*
1929 $26.2
1930 $25.1
1931 $23.5
1932 $20.2
1933 $19.2
*Currency plus bank deposits, in billions of dollars.
Why Did the Fed Fail to Act?
1. The Board of Governors believed that many banks were unsound.
2. They wished to protect the value of the dollar by keeping interest rates high.
3. They wished to protect the nation against inflation which they thought was the main problem.
Why Did the Fed Fail to Act?
1. The Board of Governors believed that many banks were unsound.
2. They wished to protect the value of the dollar by keeping interest rates high.
3. They wished to protect the nation against inflation which they thought was the main problem.
“We Did It.”
In 2002, at Milton Friedman’s 90th birthday Ben Bernanke, then Federal Reserve Board Governor, said:
“ I would like to say to Milton and Anna: Regarding the Great Depression, you were right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”
The Current Crisis: Four Possible Factors
1. Erosion of conventional lending standards
2. Low interest rate polices of the Federal
Reserve System during 2002-2006
3. Increased leverage lending of Government
Sponsored Enterprises (GSEs) and
investment banks
4. Increased household debt to income ratio
What Caused the Crisis of 2008?
FACTOR 1: Beginning in the mid-1990s, government regulations change the conventional lending standards.
Fannie Mae/Freddie Mac MarketShare Increases
Freddie Mac/Fannie Mae Share of Outstanding Mortgages
Source: Office federal Housing Enterprise Oversight, www.ofheo.gov.
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
20%
25%
30%
35%
40%
45%
50%
What Caused the Crisis of 2008?
FACTOR 2: The Fed under Greenspan’s chairmanship follows a low interest rate policy during 2002-2006.
Short-Term Interest Rates
Federal Funds Rate and 1-Year T-Bill Rate
Source: www.federalreserve.gov and www.economagic.com
1995
1995
1996
1996
1997
1997
1998
1999
1999
2000
2000
2001
2002
2002
2003
2003
2004
2004
2005
2006
2006
2007
2007
2008
0%
1%
2%
3%
4%
5%
6%
7%
8%
Federal Funds 1 year T-bill
Subprime, Alt-A, and Home Equity Loans
Subprime, Alt-A, and Home Equity as a Share of Total
Source: Data from 1994-2003 is from the Federal Reserve Board while 2001-2007 is from the Joint Center for Housing Studies at Harvard University
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 20070%
10%
20%
30%
40%
50%
Subprime (FRB) Subprime (JCHS) Subprime + Alt-A Subprime + Alt-A + Home Equity
ARM Loans Outstanding
Source: Office of Federal Housing Enterprise Oversight, www.ofheo.gov.
ARM Loans Outstanding
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
0%
5%
10%
15%
20%
25%
What Caused the Crisis of 2008?
FACTOR 3: A Securities and Exchange Commission (SEC) Rule change adopted in April 2004 led to highly leverage lending practices by investment banks and their quick demise when default rates increased as housing prices fell.
What Caused the Crisis of 2008?
FACTOR 4: The Debt/Income Ratio of Households since the mid-1980s doubles. America falls in love with debt!
Household Debt to Disposable Personal Income Ratio
Source: www.economagic.com
1953
1955
1958
1960
1963
1965
1968
1970
1973
1975
1978
1980
1983
1985
1988
1990
1993
1995
1998
2000
2003
2005
2008
20%
40%
60%
80%
100%
120%
140%
The FED Acted Differently
The Fed acted differently in 2008 than it did in 1929.
U.S Monetary Base Expands toGrease the Wheels of Exchange
Monetary Base in Billions of Dollars, 2000-present
Source: The Federal Reserve Bank of St. Louis, www.stlouisfed.org
2000
2000
2001
2001
2002
2002
2003
2003
2004
2004
2005
2005
2006
2006
2007
2007
2008
2008
2009
$500
$600
$700
$800
$900
$1,000
$1,100
$1,200
$1,300
$1,400
$1,500
$1,600
$1,700
$1,800
And U.S. Excess Reserves Increase to Make Lending Possible
Excess Reserves in Billions of Dollars, 2000-present
Source: The Federal Reserve Bank of St. Louis, www.stlouisfed.org
$0
$100
$200
$300
$400
$500
$600
$700
$800
And We Have the Lessons Learned From the Great Depression
Carefully consider those governmental policies which distort incentives and create unintended consequences with negative results:
Monetary contraction of the Great Depression Era
Trade restrictions (Smoot-Hawley Tariff Act of 1930)
Tax increases (Revenue Tax Act of 1932)
Constant changes in monetary and fiscal policy
generates uncertainty and delays private sector
recovery.
Conclusions?
Could the crisis have been avoided if regulators had done more? Less?
Is this a crisis of capitalism or a crisis of businesses and households responding to distorted incentives created by government?
Is this crisis a result of the unintended consequences of well-intended monetary and fiscal officials?