Thursday, March 19, 2009

Myths of the Great Depression

The Great Depression is often studied in history. There has been a resurgence of interest since fears of our current 'great recession' Some myths have developed around the Great Depression.

1. The Fall in Output Lasted Until WW2.

US GDP 1920 - 1940

If we look at data for the US economy, the fall in output lasted 4 years from 1929 to March 1933. There then followed a period of economic expansion where growth increased until 1937 regaining previous output levels. The US then experienced a double dip recession in 1937-38, but soon recovered.

Many economists say the depression lasted 10 years because even in 1937, unemployment was in double digit figures. It was not until 1941 and the US entries into the war that unemployment fell to pre-1929 levels.

2. Hoover was a follower of neo clasical Economics.

Hoover oversaw an increase in national debt from 20% to 40% between 1929 and 1933. 1930 to 1931. The federal government’s share of GNP soared from 16.4 percent to 21.5 percent. This was partly due to the fall in tax revenues due to the economic downturn and some attempts to increase government spending. But, Hoover was no Keynesian he was appauled at the rise in National Debt and sought to raise taxes to reduce debt in the early 1930s.

Hoover also sought to protect wages and implemented the Smoot-Hawley Tariff Act - a measure to reduce international trade.
He is associated with the laissez faire approach because he shared a belief that the depression was a necessary 'penance' for previous excesses. He felt that if his policies were given longer enough they would enable a recovery. But, after 3 devastating years he was never given chance to see whether his approach would lead to recovery.

3. Roosevelt was A Good Keynesian

Because of Roosevelt's New Deal, many assume he was an adherent and follower of John M.Keynes and his policies for expansionary fiscal policy. Schemes such as Public Works Administration (PWA) and Works Progress Administration (WPA) did provide some fiscal boost and provided relief to a significant number of unemployment. But, Roosevelt was always a reluctant adherent of Keynes. In particular he was nervous over the idea of government borrowing to finance fiscal expansion. The effect was that the fiscal expansion was much less than Keynes would have advocated leading to only a moderate, insufficient fiscal boost to the economy. Roosevelt increased the top rate of income tax to 73% and later increased it to 90%.
In 1937, worried about government borrowing, Roosevelt increased taxes and cut spending. Unsurprising, the economy returned to another recession.

Also many of Roosevelt's New Deal policies were of dubious value. For example, the National Industrial Recovery Act (NIRA) was really a license for firms to form cartels and raise prices. Because of this it was declared unconstitutional by the Supreme Court. It was a set back for Roosevelt but had nothing to do with Keynesian demand management. The National Recovery Act was also renowned for having a large amount of rules and regulations which created administrative headaches for firms and workers. The problem is that lazy critics say that because some government intervention created problems such as these rules and regulations then QED all government intervention must make things worse.

4. The Stock Market Crash of 1929 is Synonymous with Great Depression.

Many assume the Great depression was caused by great stock market crash of October 1929. Many may equate the two events as being the same thing. However, stock market crashes don't always cause recessions. For example, 1987 stock crash had no effect on the real economy.

The Wall Street Crash was certainly a precipitating factor. The crash reflected the fact the economy was already slowing down; it also helped to reduce confidence, reduce bank liquidity and push the economy into recession. But, the great depression occured because of many more factors:
  • the credit bubble
  • deflation
  • being in the gold standard
  • bank collapses and fall in money supply.
  • Inappropriate government responses.

1 comment:

Lawrence Low said...

Hi, I would actually like to know more about the basic rate of income tax in UK, the new rate of 20% & also its computation

Would appreciate if you can write on these. Thanks so much!