Transcript An Overview of the Great Depression

An Overview of the Great Depression
• EQ- How did the decline in the global
economy lead to a rise in totalitarianism?
• GQ- What were the primary causes of the
Great Depression and how do these causes
mirror the recent economic problems?
• SWBAT- compare and contrast the causes
of the GD and housing bubble
• Mission Statement connections: A, C, D
What makes a Depression Great?
• Recession: When your neighbor loses his or her job.
• Depression: When you lose your job.
Why study the Great Depression?
• Worst economic disaster of the 20th century.
• Cause or causes are still debated.
• A defining event, especially for the
government’s involvement in the economy.
• Useful for learning important macroeconomic
concepts.
Some Concepts
• Gross Domestic Product (GDP): Comprehensive
measure of the nation’s output of final goods and
services.
• Real GDP: GDP measured at a fixed price level
(i.e., inflation adjusted).
• Nominal GDP: GDP measured at current prices.
• Inflation: A sustained increase in the general price
level (often calculated in terms of the Consumer
Price Index (CPI)).
More Concepts
• Deflation: A sustained decrease in the general
price level.
• Recession: Sustained decline in real GDP
(approximately two quarters).
• Depression: Very severe recession.
• Money Stock: The stock of assets that serve as
media of exchange (e.g., coin, currency, checking
accounts).
• Real Interest Rate: Measure of the cost of
borrowing adjusted for inflation/deflation.
How Great was the Great Depression?
• Real
output (GDP) fell 29% from
1929 to 1933.
• Unemployment increased to 25%
of labor force.
• Consumer prices fell 25%;
wholesale prices 32%.
• Some 7000 banks failed.
Why Did It Happen? Some Suggested Causes
• The stock market crash – end of the party
Stock Market Boom and Bust
S&P Composite Index
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Sept. 1929
30
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July 1932
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Jan-21
Jan-23
Jan-25
Jan-27
Jan-29
Jan-31
Jan-33
Jan-35
Jan-37
Jan-39
The Stock Market Crash
The timing of the crash (Oct. 1929) is suggestive.
Possible channels:
• Destruction of wealth
• Increased uncertainty
• Role of banks
Conclusion: Probably had some effect, but not big
enough by itself.
Why Did It Happen? Some Suggested Causes
• The stock market crash – end of the party
• Collapse of world trade – globalization in reverse
The Collapse of World Trade
$ value imports of 75 countries
Why Did It Happen? Some Suggested Causes
• The stock market crash – end of the party
• Collapse of world trade – globalization in
reverse
• Monetary collapse
Bank Failures
• 7000 banks failed -- many during
“panics”
• Number of banks fell from 25,000 in
1929 to 15,000 by 1934
Possible Channels:
• Loss of deposits  decline in
expenditures
• Customer relationships broken 
harder to borrow
• Money supply contraction
Commercial Bank Failures, 1920-2004
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Banking Panics
• Bank depositors lost confidence  bank runs
• Banks lost gold, currency and other reserve assets
• Loss of reserves caused banks to reduce loans and
deposits (causing money stock to fall)
• Contracting money stock reduced spending
• Reduced spending led to lay-offs (increased
unemployment), falling prices (deflation) and lower
output.
The Fed’s Monetary Policy
• Fed officials did not watch (or even
measure) the money supply. But, why didn’t
they respond to bank panics?
• Most failed banks were small,
nonmember banks.
• Interest rates were falling
Recovery
• Rapid money supply growth (end of banking
panic, gold inflows)
 rising price level
 falling real interest rate
 and increased spending.
Recovery
• Rapid money supply growth (end of banking
panics, gold inflows)  rising price level, falling
real interest rate and increased spending.
• FDR and the New Deal?
– Restored confidence in banking system (FDIC)
– Early years marked by regulation/reform, little
new spending (alphabet programs, e.g., NRA,
WPA, PWA, CCC, etc.)
– Later years saw increased spending
Recovery
• Rapid money supply growth (end of banking
panics, gold inflows)  rising price level, falling
real interest rate and increased spending.
• FDR and the New Deal?
– Restored confidence in banking system (FDIC)
– Early years marked by regulation/reform, little
new spending (alphabet programs, e.g., NRA,
WPA, PWA, CCC, etc.)
– Later years saw increased spending
• World War II (when unemployment finally fell
below 10%)
Could It Happen Again?
• The Depression was not a failure of capitalism or
markets, but rather a failure of the Federal
Reserve.
• Monetary policy should maintain price stability –
avoid deflation and inflation.
• The Fed should respond to financial crises that
increase the demand for money or threaten to
disrupt the payments system.
United States 2008
Housing Bubble
What is a housing bubble?
• A run-up in housing prices fueled by
demand, speculation and the belief that
recent history is an infallible forecast of the
future.
The Perfect Storm
• Four Causes of the bursting of the bubble:
–
–
–
–
Low mortgage interest rates
Low short-term interest rates
Relaxed standards for mortgage loans
Irrational exuberance
1) Low mortgage rates
• U.S. mortgage rates peaked at 18% in 1982
• From late 2002 through most of 2005
mortgage rate are below 6%
1) Low mortgage rates
Fannie Mae and
Freddie Mac
• Investors “purchase”
mortgages from Fannie and
Freddie.
• They make money on the
mortgage payments made by
homeowners
Mortgage-backed securities
• Wall Street firms also sell
similar items called
Mortgage
Why would low mortgage rates
contribute to the Great
Depression?
• Low mortgage rates kept monthly payments
affordable for more buyers even as home
prices rose.
2) Low short-term interest rates
• Low short-term interest rates encouraged
the use of adjustable rate mortgages
(ARMs)
• More people were able to afford mortgages
at this rate, further driving up home values
2) Low short-term interest rates
• Low short-term interest rates encourage
leveraging
– Borrowing at short-term rates to invest in longterm, higher profitable investments (mortgage
backed securities)
– Leveraging increased the availability of
mortgages and thus caused home values to
continue to rise
Relaxed standards for
mortgages
• 1995, The Community Reinvestment Act
– Compel banks to increase loans to lowerincome households
• 1996, the Department of Housing and
Urban Development
- increase the % of mortgage loans to lowerincome households that Fannie and Freddie
were required to hold
Relaxed standards for
mortgages
• Increased competition in the mortgage
market due to the internet and other sources
led to lenders lowering their standards.
– Fees and down payments were lowered or
eliminated
Relaxed standards for
mortgages
• “Originate to Sell”
– Mortgages that were intended to be sold as
securities shortly after closing
– Lessens incentive of mortgage companies to
ensure the quality of the loan
– Mortgages grouped together and sold as
mortgage-backed securities
Irrational Exuberance
• “a heightened state of speculative fervor”
• Investors act under the assumption that real
estate prices will continue to rise
– They had not fallen since the Great Depression
Your Assignment
• Compare and contrast the stock market
crash of 1929 to the bursting of the housing
bubble in 2008
– Create an organizer with similarities and
differences of the two economic crises