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Economic History II: The Great Depression, Fiscal Policy, and the Financial Crisis of 2007

02 Apr

The Great Depression, Fiscal Policy, and the Financial Crisis of 2007

Click here to be taken to Part I if you haven’t read the introduction.

To this day, the Great Depression (1929-1939) remains one of the most fascinating periods of study to historians, political scientists, and economists. Despite extensive studies, however, there remains much about this time period which yet eludes us.

This serious drag in the country’s economic performance can be attributed to several events, many of which are interrelated. To begin, there was the Stock Market Crash of 1929—a product of inflated confidence in the market through most of the 1920s—which led to an approximate loss of $40 billion. Incidentally, some of the banks had fallen prey to these very same traps and lost the money they themselves had invested into the stock market. These events led to subsequent bank failures all throughout the country as debtors became unable to repay their debts. Economic growth and recovery were essentially brought to a grinding halt as the surviving banks became more cautious in their lending practices, leading to reduced expenditures and a decreased money supply (Anari, P.676). This was, in essence, a crisis of confidence.

Consumer spending was in decline, which meant there was less demand for goods in general, which led to businesses decreasing factory inputs, spurring the country’s annual unemployment rates to new heights.

When peoples’ standards of living are at stake, they expect their government to step up and take action. It was no secret how the public was dissatisfied with the president, Herbert Hoover’s, performance as the shantytowns were referred to as Hoovervilles and the newspapers used to shelter the homeless from the cold Hoover Blankets.

Hoover’s unsuccessful policies ushered Franklin D. Roosevelt into the office of presidency, a position he would hold on to for 12 years. In contrast with his predecessor, Roosevelt wasted no time in enacting his New Deal Programs. Here are some examples of how his administration tackled the problem of the day:

  1. To counter unemployment:
    1. 1933, Public Works Administration (PWA). Large-scale public works projects. Six billion dollars. Airports, dams, aircraft carriers, schools, hospitals.
    2. 1933, Civilian Conservation Group (CCC). Public works projects.
    3. 1933, Civil Works Administration (CWA). High paying jobs in construction.
  2. To combat the housing crisis:
    1. 1933, Home Owner’s Loan Corporation (HOLC). Services to refinance homes. One million people received long term loans.
    2. 1934, Federal Housing Administration (FHA). Regulated mortgages and housing conditions.
  3. Poverty upon retirement:
    1. 1935, Social Security Act (SSA). Still active. Addresses poverty among retired, wage-earning senior citizens.

The list continues, but you get the point. Essentially, Roosevelt was a president of action and direct intervention and, as a result, his popularity soared. But how successful were his efforts? Did these programs help dig the country out of its dire situation, or can the recovery be attributed to something else? How does this compare to our current financial crisis and can we learn anything from this?

P. 676 Ali Anari

The above graphs indicate exactly how rough the times were. Industrial production hit an all time low due to a combination of decreased demand, money supply shocks, and the rise in unemployment rates (Anari, p.770). As is shown on the graph, the recovery from the Great Depression began around 1934 with the U.S. economy reaching new heights upon the country’s involvement in World War II, when the economy returned to full employment (Romer P.758).

Studies conducted on the recovery, however, suggest that the New Deal was not necessarily the engine of recovery itself, but as something which cleared the way for a natural recovery (Romer P.758). In fact, many postulate that the greatest result of these policies seems to be the resurging strength of the federal government.

So flash forward about 80 years to today’s current financial crisis. Can we link the effects of the aggregate-demand stimulus of the recovery from the Great Depression to the government bailouts in 2007 and the years following?

Definitely.

The Federal Reserve Board invoked the same authority it had invoked in 1932 to aid in the stabilization of firms through monetary aid, which allowed the Fed to rescue AIG through loans, a move which is controversial to this day (Posner, p.1613 and 1629). Through the Emergency Economic Stabilization Act of 2008, the Treasury was granted $700 billion to buy mortgage-related assets along with many additional powers to deal with the crisis (Posner, p.1614).  After the fall of the Lehman Brothers, the government “began pumping liquidity into the system at unprecedented levels” in the hopes of bolstering confidence in the markets (Bartlett, A25). The financial institutions receiving government aid include, but are not limited to, automakers, banks, saving associations, credit unions, insurance companies, etc. (Bartlett, p.1633).

The government did not stop there either. Immediately upon being elected into office, President Obama began working towards securing stimulus money, accomplishing this in early 2009 (NY Times, Economic Stimulus). But has the $819 billion stimulus package requested by President Obama and passed by Congress helped or hurt us? (Yourish, Washington Post). The following is a breakdown of the tax cuts and the program’s intended recipients:

Data from NY Times

Economists have reported that the administration’s actions led to a decrease in taxes for most Americans (NY Times, Economic Stimulus). In early May of 2009, however, it was estimated that the package fell short of the administration’s optimist forecast of unemployment peaking at 8.5% and was estimated to have saved only 150,000 jobs of the promised 600,000—unemployment surpassed 10% at one point but dropped to 9% in January 2011 (Bureau of Labor Statistics). Other benefits include an increase in the rate of home sales, tax cuts to small businesses, and increased infrastructure spending similar to Roosevelt’s plans.

Much like Roosevelt’s New Deal, perceptions of the stimulus package’s effectiveness are wide-ranging and many. It is almost universally agreed, however, that the government’s actions, while not insignificantly increasing the country’s deficit, helped stem some of the worst consequences of the crisis. Economic optimism and activity have increased in recent months but perhaps all that remains now is hoping that Adam Smith’s “Invisible Hand”, the argument that free enterprise and self-interest benefit society when transactions are voluntary to both parties, proves true and that the economy arrives at optimal levels of employment and economic prosperity (Narveson, p.201).

This is not an examination of which political party’s ideologies are correct, but more so an exploration into the effectiveness of policy in times of economic crises. My data is specific to the time period of the Great Depression and our most recent circumstances, so any conclusions I would come to would be moot in the grander scheme of things, but that does not mean that there isn’t much to learn from the subject matter I have brought to light.

 

Sources:

Anari, Ali. “Bank Asset Liquidation and the Propagation of the U.S. Great Depression.” The Wharton Financial Instiutions Center.

Bartlett, Bruce. The New York Times. “How to Get the Money Moving. Dec. 24, 2008.

Narveson, Jan. “The Invisible Hand.” Journal of Business Ethics, Vol. 46, No. 3.

The New York Times. “Economic Stimulus.” Times Topics. Dec 15, 2010.

Posner, Eric A. “Crisis Governance in the Administrative State: 9/11 and the Financial Meltdown of 2008.” The University of Chicago Law Review

Romer, Christina D. “What Ended the Great Depression?” National Bureau of Economic Research, Inc. .

Yourish. The Washington Post.

http://americanhistory.about.com/od/greatdepression/tp/new_deal_programs.htm

 


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2 Comments

Posted by on April 2, 2011 in Economic History

 

Tags: , , , , , , , , , , , , , ,

2 responses to “Economic History II: The Great Depression, Fiscal Policy, and the Financial Crisis of 2007

  1. Raimo

    April 6, 2011 at 2:44 am

    A school building was fenced off with barbed wire in Espoo, Finland in 1908 (see the picture in the link). Swedes fenced off school buildings with barbed wire, in order to ban children the access to a school.

    The Swedish government was responsible for the most iron ore the Nazis received. Kiruna-Gällivare ore fields in Northern Sweden were all important to Nazi Germany.

    These massive deliveries of iron ore and military facilities from Sweden to Nazi Germany lengthened World War II. Casualties of the war have been estimated at 20 million killed in Europe. How many of them died due to Sweden’s material support to Nazi Germany, is not known.

    http://www.thoughts.com/raimo/case-sweden

     

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