Intro Stuff, Feb. 10, 2015 GREAT DEPRESSION ECONOMICS

My Man Godfrey opening (go to 13:14 or to 14:40) https://www. youtube Bank Run scene from It’s a Wonderful Life: https://www.youtube.com/watch?v=lbwjS9iJ2Sw

GREAT DEPRESSION ECONOMICS Buying on the Margin It’s the 1920s. The stock market is soaring. Everybody is buying stocks, watching the market go up and then re-selling the stocks at higher prices, pocketing the profits. You’re a young New Yorker with $1000 in your pocket. You can buy 10 shares of General Electric Company, which cost $100 a share. If they go up to $150 a share in a month, and you sell them, you will make $ ________________.

GREAT DEPRESSION ECONOMICS Buying on the Margin It’s the 1920s. The stock market is soaring. Everybody is buying stocks, watching the market go up and then re-selling the stocks at higher prices, pocketing the profits. You’re a young New Yorker with $1000 in your pocket. You can buy 10 shares of General Electric Company, which cost $100 a share. If they go up to $150 a share in a month, and you sell them, you will make $ ________________. But it’s even better than that: Brokers don’t ask you to pay the full share price of your stock at the beginning. In fact, many say you won’t have to pay the full price until you sell your stock. They only ask for 10% of the price down. So, how many shares do you buy with your $1000? __________. And how much money do you make? ____________________.

GREAT DEPRESSION ECONOMICS Buying on the Margin Unfortunately for you, the stock market doesn’t go up: It crashes (Oct. 29, 1929). Your broker calls you and tells you he’s making a “margin call” – requiring you to pay off the full price of your stock now. This means, instead of making a profit, you now owe $_________________________.

GREAT DEPRESSION ECONOMICS Farm Foreclosures Meanwhile, in the Midwest, you own a wheat farm – well, you own some of it, and the bank owns the rest: You have a mortgage (that is, a loan you took out from the bank to buy the farm, which you’ve partially paid off). The farm itself is collateral on the mortgage. But wheat prices are so low it’s not worth planting and harvesting your crop. Without your crop, you have no money to pay your loan payments on the mortgage. Once you’ve missed a few payments, the bank decides to foreclose – to take ownership of your farm.

Bank Runs & Bank Failures GREAT DEPRESSION ECONOMICS Bank Runs & Bank Failures Now that you (the New Yorker) are deep in debt to your broker, and you (the Midwestern farmer) have lost your farm, you’ll need some money to live. Where are you going to get it? __________________________________.

Bank Runs & Bank Failures GREAT DEPRESSION ECONOMICS Bank Runs & Bank Failures Now that you (the New Yorker) are deep in debt to your broker, and you (the Midwestern farmer) have lost your farm, you’ll need some money to live. Where are you going to get it? __________________________________. Let’s say the bank has $100 million in deposits. It lends out $99 million to businesses, home loans, etc. and keeps $1 million on hand as a reserve to give out to people who want to make withdrawals. Now, on a normal day, only a small number of people come to make withdrawals. Say, 4,000 people come each day and each one withdraws $100. Will the bank be able to pay them all? _________________________.

Bank Runs & Bank Failures GREAT DEPRESSION ECONOMICS Bank Runs & Bank Failures Your bank’s deposits: $100 million Your bank’s reserves: $1 million Unfortunately, today isn’t a normal day. The stock market has just crashed, and a large number of farmers have just lost their farms to foreclosure. Today 20,000 people come to your bank asking for money, and each one wants $100. Will the bank be able to pay them? __________________.

Bank Runs & Bank Failures GREAT DEPRESSION ECONOMICS Bank Runs & Bank Failures Your bank’s deposits: $100 million Your bank’s reserves: $1 million By the next morning, people all over town have heard that the bank wasn’t able to pay people trying to make withdrawals. What happens today? ________________________________________________. What happens to the bank? ________________________________________________. Oh, by the way, was the bank doing anything wrong? Was it financially healthy, the day before the stock market crash, or wasn’t it? ________________________________________.

Bank Runs & Bank Failures GREAT DEPRESSION ECONOMICS Bank Runs & Bank Failures Now let’s look at a clip from It’s a Wonderful Life that explains the whole thing. George Bailey and his wife were just on their way to a long- delayed honeymoon when they saw something happening on the street in Bedford Falls. George is the president of the savings-and-loan, a type of bank that specializes in mortgages to homeowners.

Keynesian Macroeconomics GREAT DEPRESSION ECONOMICS Keynesian Macroeconomics For a hundred years, economists had wondered how to explain “panics” and “depressions.” The British economist John Maynard Keynes came up with a solution in the 1920s: An economy, he said, could suffer a general shortage of demand. If the demand for goods were to suddenly fall, producers would slow down their production of new goods. They would pay less to their employees because of this; the employees would have less money, and so they would spend less money; and demand would fall farther. John Maynard Keynes

Keynesian Macroeconomics GREAT DEPRESSION ECONOMICS Keynesian Macroeconomics But how could there possibly be a “general shortage of demand” in the first place? When the stock market crashed and banks started to fail, a lot of families had to go over their household budgets and figure out what to do. Let’s say this is your budget, before and after the crash. Try to fill in the blanks… Before Crash After Crash Your Salary $1,000 $1,000 Profit from Stocks 200 0 Rent - 700 ______ Car Payments - 200 ______ Paying Off Broker 0 - 200 Food - 200 ______ Entertainment - 100 ______

Franklin Delano Roosevelt GREAT DEPRESSION ECONOMICS Deficit Spending So what can a government do when there’s a general shortage of demand, and the country spirals into depression? Keynes had an answer for this too: It should spend enough money to make up for the shortage in demand. But it would ruin the whole thing if the government raised taxes to pay for its new spending. (People who had to pay the taxes would reduce their spending – think of your budget.) So the government would have to go into debt (a.k.a., run a deficit) by spending money without raising taxes. Franklin Delano Roosevelt

GREAT DEPRESSION ECONOMICS Deficit Spending But the deficit spending had to be on a huge scale – enough to make up for the shortfall in private demand. Neither FDR nor his opponents were ready for spending on that scale… U.S. Production (GDP) in 1929: $103 billion Industrial Production by 1932: $58 billion Difference: - $45 billion U.S. gov’t budget deficit, 1939: $3 billion U.S. gov’t budget deficit, 1943: $55 billion