The Great Depression: An Explanation

The Great Depression: An Explanation

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Causes of Great Depression

– One of many factors that was responsible for these large differences in the duration and scale of the depression is that the shocks—the unexpected changes in technology, preferences, endowments, or government pol icies that lead output to deviate from its existing steady-state growth path. Cole and Ohanian found that technology shocks may have contributed to the 1929–33 decline. Cole and Ohanian argue that The National Industrial Recovery Act (NIRA) of 1933 allowed much of the economy to cartelize. This policy change would have depressed employment and output in those sectors covered by the act and, consequently, have led to a weak recovery. For over 500 sectors, including manufacturing, antitrust law was suspended and incumbent business leaders

– Some economists, such as Friedman and Schwartz (1963), argue that monetary shocks were a key factor in the 1929–33 decline.

– Below are the Great Depression according book of “Macroeconomics” by N. Gregory Mankiw

The Spending Hypothesis: Shock to The Is Curve

There are several ways to explain a contractionary shift in the IS curve. No single explanation for the decline of spending. All these changes coincided and that together they led to massive reduction in spending.

The Money Hypothesis: Shock To The LM Curve

Central bank allowing money supply to fall by such a large amount.

1. Behavior of real money balances. Monetary policy leads to a contractionary shift in the LM curve only if real money balances fall. In 1929-1931 real money balances rose slightly because the fall in the money supply was accompanied by an greater fall in the price level.
2. Behavior of interest rates. If a contractionary shift in the LM curve triggered the Depression, we should have observed higher interest rates. Yet nominal interest rates fell continuously from 1929-1933.

The Money Hypothesis: The Effects Of Falling Prices

1. The stabilizing effect of deflation
2. The destabilizing effect of deflation

Bank Panics

Early 1930s, bank panics caused 30% of banks to fail, contributing to the Great Depression


– The Aggregate Demand/Aggregate Supply (AD/AS) model is a by-product of the Great Depression

– In 1936, economist John Maynard Keynes published a book that attempted to explain short-run fluctuations

– Keynes believed that recessions occur because of inadequate demand for goods and services

– Therefore, Keynes advocated policies to increase aggregate demand


– “The Great Depression in the United States from A Neoclassical Perspective” by Harold L. Cole and Lee E. Ohanian

– “Macroeconomics” by N. Gregory Mankiw and Laurence M. Ball

– “The Great Depression” by John A. Garraty

– “Depression, You Say? Check Those Safety Nets”, New York Times. by Charles Duhigg

– “Principles of Macroeconomics” by Robert H. Frank and Ben S. Bernanke



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