An Economic Analysis of the Great Depression: Implications for 2009 National Council for the Social Studies November 13, 2009 Mark 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. History Lesson 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, 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 Money 100% Reserves AssetsLiabilities Reserves$ Deposits$ Loans

Hint: Banks Create Money Bank 1: 10% Reserves AssetsLiabilities Reserves$100.00Deposits$ Loans$900.00

Hint: Banks Create Money Bank 2: 10% Reserves AssetsLiabilities Reserves$90.00Deposits$ Loans$ $900 + $810 = $1,710 and still moving…

The Fed The Federal Reserve System was created in The Fed has 4 parts Board 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, Year Number of Bank Closings

Visual 30.3 Money in Circulation Year Money in Circulation* 1929$ $ $ $ $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 90 th 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 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 Market Share Increases Freddie Mac/Fannie Mae Share of Outstanding Mortgages Source: Office federal Housing Enterprise Oversight,

What Caused the Crisis of 2008? FACTOR 2: The Fed under Greenspan’s chairmanship follows a low interest rate policy during

Short-Term Interest Rates Federal Funds Rate and 1-Year T-Bill Rate Source: and

Subprime, Alt-A, and Home Equity Loans Subprime, Alt-A, and Home Equity as a Share of Total Source: Data from is from the Federal Reserve Board while is from the Joint Center for Housing Studies at Harvard University

ARM Loans Outstanding Source: Office of Federal Housing Enterprise Oversight, ARM Loans Outstanding

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:

The FED Acted Differently The Fed acted differently in 2008 than it did in 1929.

U.S Monetary Base Expands to Grease the Wheels of Exchange Monetary Base in Billions of Dollars, 2000-present Source: The Federal Reserve Bank of St. Louis,

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,

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?