OF THE GREAT DEPRESSION:
A review of Keynesian theory
To understand the Great Depression, it is important to know the
theories of John Maynard Keynes (rhymes with "rains"). Keynes
is known as the "father of modern economics" because he was the
first to accurately describe some of the causes and cures for recessions
In a normal economy, Keynes said, there is a circular flow of money.
My spending becomes part of your earnings, and your spending becomes part
of my earnings. For various reasons, however, this circular flow can falter.
People start hoarding money when times become tough; but times become tougher
when everyone starts hoarding money. This breakdown results in a recession.
To get the circular flow of money started again, Keynes suggested that
the central bank -- in the U.S., the Federal Reserve System -- should expand
the money supply. This would put more money in people's hands, inspire
consumer confidence, and compel them to start spending again.
A depression, Keynes believed, is an especially severe recession in
which people hoard money no matter how much the central bank tries to expand
the money supply. In that case, he suggested that government should do
what the people were not: start spending. He called this "priming
the pump" of the economy. Indeed, most economists believe that only
massive U.S. defense spending in preparation for World War II cured the
After its success during the war, almost all free governments around
the world became Keynesian. Its policies have dramatically reduced the
severity of recessions since then, and appear to have completely eliminated
the depression from the world's economies. (More)
Events of the 1920s
The Roaring Twenties were an era dominated by Republican presidents:
Warren Harding (1920-1923), Calvin Coolidge (1923-1929) and Herbert Hoover
(1929-1933). Under their conservative economic philosophy of laissez-faire
("leave it alone"), markets were allowed to operate without government
interference. Taxes and regulation were slashed dramatically, monopolies
were allowed to form, and inequality of wealth and income reached record
levels. The country was on the conservative's preferred gold standard,
and the Federal Reserve was not allowed to significantly change the money
The fact that the Great Depression began in 1929, then, on the Republicans'
watch, is a great embarrassment to conservative economists. Many try to
blame the worsening of the Depression on Hoover, for supposedly betraying
the laissez-faire ideology. As the time line in the next section
will show, however, almost all of Hoover's government action occurred during
his last year in office, long after the worst of the Depression had hit.
In fact, he was voted out of office for doing "too little too late."
The only notable exception to his earlier idleness was the Smoot-Hawley
tariff of 1930, whose minor impact we shall explore in more detail later
But much more importantly, the economy was clearly turning downward
even before Hoover took office in 1929. Entire sectors of the economy were
depressed throughout the decade, like agriculture, energy and mining. Even
the two industries with the most spectacular growth -- construction and
automobile manufacturing -- were contracting in the year before the stock
market crash of 1929. About 600 banks a year were failing. Half the American
people lived at or below the minimum subsistence level. By the time the
stock market crashed, there was a major glut of goods on the market, with
inventories three times their normal size.
The fact that all this occurred even before the first act of
government intervention is a major refutation of laissez-faire ideology.
Next Section: Timeline of the Great Depression
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