Great Depression 1929-1932

Question 1

1920s (“Roaring Twenties”) a boom period for the US & RoW (except UK) (6)

Answer 1

• Makes sense given rationing during the war and deferred investment
• However, interest rate sensitive sectors boomed in particular (real estate, autos & household appliances), suggesting a role for MP
• Indeed, US MP very accommodative to facilitate return to gold/monetary system
• European growth was also MP led (construction)
• RoW had boomed due to US capital flows due to low r (e.g. Latin America)
• Therefore, US fuelled foreign expansion, hinging on a triangular pattern of international settlements – stability hinged on US lending to Europe/Latin America

Question 2

1928-29 - Fed raises interest rates (4)

Answer 2

• Concerned with stock market boom diverting resources from more productive uses
• Went global due to gold standard meaning countries had to mirror US policy
• 1927-28, US foreign lending fell by 30% – rising rates diverted funds to US
• Weakness of foreign BoPs (reliance on US capital flows) created an exaggerated response in the RoW (27-28: US M down 3%; Europe/Latin America M down 8%)

Question 3

Dow (1998) (3)

Answer 3

• Sees capital flows as consequence not cause
• Attributes Depression to swings in consumer and business confidence, propelled by MP/stock market crash (October 1929)
• By 1932, S&P index had fallen 81% in real terms, meaning private wealth fell 10%

Question 4

Upward pressure on world interest rates also comes from France (Thomas, 1994) (3)

Answer 4

• From early 1928 onwards, massive amounts of gold flow to Paris due to high interest rate and undervalued ER, so France’s share of world gold supply doubles (1928-32)
• Not self-correcting because Bank of France prohibited from Open Market Operations, so hoards gold
• This creates upward pressure on world interest rates (lower gold supply)

Question 5

Severity results from several factors

Answer 5

• Exceptional stock market crash severely undermined confidence
• Wage rigidity higher in interwar (benefits etc.), so real wage adjustment more tricky
• Trade policy (rise of protectionism) cast a shadow over future of int’l trading system
• Bank failures
• Monetary/fiscal policy inertia in response

Question 6

Great Depression in the UK - statistic (1)

Answer 6

Very mild – 6% output loss (29-31) compared to 26% in Germany or 29% in USA (Morys, ‘14)

Question 7

Great Depression in the UK - Solomou & Weale (1996)

Answer 7

• Use balanced GDP measure (not just an average, but weighted by reliability/errors)
• Reveals that 1928 is a year of recession for the UK
• Primary cause is domestic – 22% fall in construction output, due to high interest rate to sustain £ on gold standard – depresses construction
• Secondary cause is 7.3% fall in export of services in 1928 creating an overall stagnation in exports – due to less overseas American investment imposing BoP constraints on primary producers, constraining their purchases of UK traded services
• However, this is not in monthly GDP estimates of Mitchell, Solomou & Weale (2012)

Question 8

International shocks transmitted to GB via trade – real exports fall by 38% (1929-31) (4)

Answer 8

• Collapse in US demand for primary products & collapse in capital flows constrained primary producers, so demanded many less exports from GB
• 40% of GB trade done with primary producers, so had a big effect (Solomou, 1996)
• Dow (1998) estimates it caused 4% fall in UK GDP, although ToT partially offset this
• Dow (1998) estimates exports caused around 50% of UK Depression & rest was ‘domestic multipliers’ i.e. confidence etc.

Question 9

How important is MP in explaining origins/amplitude? (4)

Answer 9

• Not important in the origins of the shock – M1 up 3% and M2 up 5% 1929-30 (Solomou, 1996)
• Hick’s 2 phase schema of depression suggest MP does explain amplitude (Solomou, 1996)
• Phase 1 – real causes (in this case, exports) drive economy into depression
• Phase 2 – compounded by financial/monetary repercussions (here, ↑r in 1931)

Question 10

Why UK Depression so mild? (3)

Answer 10

1. No Bank Failures (Grossman, 1984)
2. Export collapse didn’t feed through to Investment (grows until 1931-32) or C (grows until 1932)
3. MP response

Question 11

Why UK Depression so mild? 1. No Bank Failures

Answer 11

• UK had a very stable financial system with no bank failures at all (Morys, 2014)
• Grossman (1994) shows decline in GNP much smaller for non-banking crisis countries
• US saw 2,000 bank failures 1930-31 (Thomas, 1994), 40% fall in no. of banks (Dow, 1998)
• Bernanke & James (1991) argue that bank failures are key to size of US slump
• Dow (1998) says via C/I effects, this caused 10% fall in GDP in the US (approx.)

Question 12

Why UK Depression so mild? 2. Export collapse didn’t feed through to I (grows until 1931-32) or C (grows until 1932) (2)

Answer 12

• Monetary/financial stability
• Terms of trade effect via fall in commodity prices

Question 13

Why UK Depression so mild? 3. MP response

Answer 13

• Bank of England keen to ameliorate slump, so money supply grew 1929-30 and only contracted slightly in 1930-31 (ct massive slumps elsewhere)
• Later, abandonment of gold standard helped significantly