Whatdunnit? The Great Depression Mystery Lesson 30 Presented by Dr. Norman Cloutier Director, UW-Parkside Center for Economic Education Wisconsin Council for the Social Studies March 15, 2010

Whatdunnit? In the 1920s … Jobs were plentiful. Incomes were rising. Home and car ownership increased. 60% of all households had cars, up from 26%. More teenagers were attending high school.

Whatdunnit? By 1933… Unemployment= 25%. Families were losing their homes. Many people were going hungry. Children dropped out of school to look for work.

What happened? The US possessed the same productive resources in the 1930s as it had in the 1920s. 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. For the first time, large numbers of consumers made purchases on installment plans.

The Multiplier at Work Consumer demand created jobs for workers who produced cars and homes. One person’s spending is another’s income. Increased employment Increased income Increased consumer demand Increased employment Increased income...

End of the 1920s Toward the end of the decade businesses over- produced durable goods. As sales began to decline, unemployment increased.

The Multiplier in Reverse 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.

The Business Cycle Normally, people start buying again as durable goods wear out and prices decline.

The Business Cycle

In a Normal Recovery 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.

No Normal Recovery … but this was no normal recovery.  Stock market crash of October 1929 further decreased demand. Banks began to fail in record numbers as businesses defaulted on loans. As banks failed, and depositors lost money, the money supply declined.

Bank Failures Increased Year Number of Bank Closings , , , ,004

Money in Circulation Declined Year Money in Circulation* 1929$ $ $ $ $19.2 *Currency plus bank deposits, in billions of dollars.

The Gold Standard and the Fed The Federal Reserve Act of 1913 established the Fed as the “lender of last resort.” The U.S. and other major industrialized countries were on the gold standard.  Currency conversion to gold.  International transmission of financial crises. The Fed found itself in a policy dilemma of taking action to (1) save failing banks, or (2) protect the U.S. dollar.

Supporting the U.S. dollar Supporting the dollar would require tight monetary policy. Tight monetary policy involves the Fed:  Increasing interest rates.  Increasing the reserve requirement.  Selling government bonds.

Saving the Banking Sector Helping the troubled banking sector would require loose monetary policy. Loose monetary policy involves:  Decreasing interest rates.  Decreasing the reserve requirement.  Buying government bonds.

The world financial system that emerged after WWI was based upon the gold standard. The United States and Great Britain guaranteed that they would exchange their currencies for gold at a fixed rate ($20.67) for an ounce of gold. Other major countries agreed to exchange their currencies for gold, US dollars or British pounds. In 1927, several countries, most notably Germany and Austria, experienced serious bank runs. To stabilize their currencies, they exchanged their dollars and pounds for gold. The United States experienced a serious loss of gold. To encourage foreign investors to buy American investments, the Federal Reserve Banks raised interest rates.

What Would You Have Done? A) If you were an American business owner planning to build a new factory or buy new equipment, what would you have done after interest rates were increased?

What was the Result? The Federal Reserve lowered interest rates after a time, but in 1930 and 1931, when the American economy had already taken a downturn, more bank runs occurred in many countries, and again gold flowed out of the United States. To keep gold in the United States, the Federal Reserve Banks again raised interest rates. B) What was the result?

What Would You Have Done? Now imagine that you are an American citizen with a bank account. You read the newspapers. You see that banks are collapsing in other countries and that the rate of bank failures in the United States has risen. C) What might you do?

What Would You Have Done? In 1932 Congress creates the Reconstruction Finance Corporation (RFC), which lends money to businesses that are in trouble, including banks. The law requires that the names of banks receiving loans from the RFC must be published. You read in the newspaper that the bank in which your money is deposited is receiving help from the RFC. D) What are you likely to do?

Current Fed Policy? Has the Federal Reserve under Ben Bernanke been following a loose or tight monetary policy? Federal Funds Rate is practically zero.

The Federal Reserve Bank has injected massive liquidity into the banking system

Conclusion Over-production of goods. The multiplier in reverse.  Unemployment caused declines in income, further decreasing consumer spending. Federal Reserve Bank policy deepened and prolonged the Depression.

Resources This entire lesson plan can be downloaded from the Council on Economic Education: Ben Bernanke lecture on the role of the Fed during the Great Depression: ches/2004/ /default.htm ches/2004/ /default.htm