The Great Depression

Question 1

Why was the gold standard superior to silver according to the technological theory?

Answer 1

(Flandreau, 1996)

The technological theory argues that the gold standard was superior due to the bulkiness of silver, making it more costly for international payments

Question 2

Define bimetallism

Answer 2

a system of allowing the unrestricted currency of two metals (e.g. gold and silver) as legal tender at a fixed ratio to each other.

Question 3

What was it that led to the convergence to gold in the 1870s?

Answer 3

(Flandreau, 1996).

The political economy interpretation emphasizes the properties of gold, silver, and bimetallism in terms of price stability, and argues that it was the actions of the creditors’ class (the dominant bourgeoisie) that favored a stable standard of value, leading to the convergence to gold in the 1870s

Question 4

How was the gold standard created?

Answer 4

(Flandreau, 1996)

The making of the gold standard was an “accident of history” rather than being predetermined for structural, technological, or political reasons

Result of various political and historical factors, such as the actions of the creditors’ class (the dominant bourgeoisie) in favor of a stable standard of value.

This convergence led to the adoption of the gold standard by most industrialized nations and the pegging of the value of their notes to gold.

Question 5

How was the creation of the Gold Standard an “Accident of history”?

Answer 5

(Flandreau, 1996)

“Accident of history” refers to the idea that the making of the gold standard was not predetermined or inevitable, but rather was the result of various random or unexpected events or circumstances.

Question 6

Define ‘Gold Standard’

Answer 6

(Flandreau, 1996)

The gold standard is a monetary system in which the value of a country’s currency is based on and can be exchanged for a fixed amount of gold.

Question 7

What was the adoption of the Gold Standard influenced by?

Answer 7

(Meissner, 2005)

The adoption of the gold standard was influenced by network externalities operating through trade channels, the desire to decrease borrowing costs on international capital markets, and the level of development

Question 8

Benefit of adopting the gold standard on transaction costs of international trade

Answer 8

• Adopting the gold standard can reduce transaction costs of international trade, such as exchange rate uncertainty (Mundell, 1961)
• Adopting the gold standard can increase credibility and lower the cost of borrowing on international capital markets (Bordo and Rockoff, 1996)

Question 9

Ohanian (2009)

Answer 9

• Not the gold standard
• Deflationary pressures caused by the Gold Standard were not significant enough to have caused the economic downturn (Ohanian, 2009)
• Herbert Hoover’s industrial labor program > provided protection to industry from unions in exchange for maintaining or raising nominal wages and implementing work-sharing > caused a labor market failure that contributed significantly to the severity of the Great Depression

Question 10

How did Herbert Hoover’s industrial labor program lead to economic downturn?

Answer 10

Ohanian (2009)

Program resulted in real manufacturing wages increasing by more than 10% and a decline in manufacturing hours worked and average workweek by about 40% and 20%, respectively, leading to excess supply of labor and reduction in aggregate output and hours worked.

Question 11

(Bordo et al, 2000)

Answer 11

The causes of the Great Depression included:
1. the stock market crash of 1929
2. a drop in consumption,
3. an increase in tariffs,
4. debt deflation,
5. the non-monetary effects of banking panics

Question 12

List reasons how it was other primary factors, rather than the gold standard, that caused the Great Depression.

Answer 12

1. Failure of monetary policy (Bordo et al, 2000)
2. Sluggish wage adjustment played a key role in the severity of the Depression (Bordo et al, 2000)
3. Bank distress > Keynes (1931) and Fisher (1933)
4. Real wage rigidities
5. supply of credit by banks and debt deflation

Question 13

How can the Great Depression be seen as a failure of monetary policy?

Answer 13

(Bordo et al, 2000)

Depression was a failure of monetary policy to offset a decline in the money supply caused by banking panics is the most widely subscribed.

Question 14

How did sluggish wage adjustment play a key role in the severity of the Depression?

Answer 14

A survey by the National Industrial Conference Board found that two-thirds of firms had not adjusted their nominal wage scales from December 1929 to December 1931 (NICB, 1932).

• Eichengreen and Sachs (1985) > real wages tended to be higher and industrial production lower among countries that remained on the gold standard, consistent with the sticky wage hypothesis

Question 15

By how much did monetary shocks account for in the fall in output in early 1933 according to (Bordo et al, 2000)

Answer 15

The model suggests that monetary shocks can account for about 70% of the fall in output at the Depression’s trough in early 1933

Question 16

Mazumder and Wood (2013)

Answer 16

(Mazumder and Wood, 2013)

• The Great Deflation, or fall in prices and production, was caused by the resumption of the gold convertibility of currencies at pre-war parities
• Value of a convertible currency on the Gold Standard is determined by the relative cost of producing gold and other goods, which did not significantly change between 1914 and the 1930s

Question 17

List reasons which argue that the gold standard was the primary cause of the Great Depression

Answer 17

1. The great deflation, or the deflationary spiral
2. Money contraction (fall in money supply)
3. International financial instability
4. limiting policy options

Question 18

(Eichengreen, 1992)

Answer 18

gold standard caused Great Depression

Countries unable to devalue their currencies, as they needed to increase their gold stock, and were stuck with uncompetitive exchange rates, which made it difficult for them to stimulate their economies and recover from recessions (Eichengreen, 1992).

Question 19

Meissner (2005)

Answer 19

Gold Standard may have contributed to the Depression with its impact on international capital markets.

The adoption of the gold standard > decrease borrowing costs on international capital markets > countries maintain fixed exchange rates > > limit their ability to use monetary policy to stabilise their economies.

This inflexibility made countries more vulnerable to economic shocks and contributed to the spread of the depression.

Question 20

(Friedman & Schwartz, 1963)
(it was the Gold standard)

Answer 20

Gold standard > Monetary contraction > made it more difficult for countries to stimulate their economies

Under the Gold Standard > if a country wanted to increase the money supply in order to stimulate economic growth, it had to first increase its gold reserves.

However, during the 1920s > shortage of gold > difficultly increasing their reserves > thus, unable to expand the money supply > more difficult to stimulate economic growth and recover from recessions (Eichengreen, 1992).

Question 21

Fisher (1933)

Answer 21

The Great Depression was caused by a deflationary spiral, caused by the gold standard.

Falling prices led to a decrease in demand&raquo_space; led to a further decline in prices.

Deflationary spiral fuelled by decrease in the money supply > caused by the failure of banks and the lack of credit > Countries were unable to increase the money supply to accommodate economic growth.

The spiral exacerbated the crisis by causing a decline in demand and a decrease in economic activity (Bordo et al, 2000).

Question 22

Keynes (1932)

Answer 22

Post-World War I deflationary policy depressed the U.K. economy > Nominal wages were imperfectly flexible, the contraction of the money supply, and the setting of the pound/dollar exchange rate at too high a level

• Deflation raised real wages, reduced labour input, and ended up with a high exchange rate and real wages that reduced British exports (Cole, 2001).

However, argued that deflationary pressures caused by the Gold Standard were not significant enough to have caused the economic downturn (Ohanian, 2009)

Question 23

What deflationary monetary policies were implemented?

Answer 23

1. Nominal wages imperfectly flexible, contraction of money supply, and a high pound/dollar exchange rate Keynes (1932)

Question 24

Keynes (1931)

Answer 24

Treaty of Versailles imposed harsh reparations on Germany > collapse of the German economy.

This collapse led to a contraction of international trade and a decline in the money supply, which exacerbated the Great Depression.

Question 25

What does Ohanian (2009) argue caused deflation if not the gold standard?

Answer 25

Deflation during the Great Depression was largely due to other factors, such as a decrease in aggregate demand and an increase in the supply of goods and services.

Question 26

Aldcroft (1970)

Answer 26

Average hours worked fell about 11% between 1919 and 1921.

This reduction in the supply of labour could have contributed to the economic downturn of the Great Depression.

Question 27

Benjamin and Kochin (1979, 1982)

Answer 27

Unemployment benefits that raised unemployment substantially.

This reduction in the supply of labour could have contributed to the economic downturn of the Great Depression.

Question 28

(Friedman & Schwartz, 1963)
(it wasn’t the Gold standard)

Answer 28

• Some countries were able to escape the worst effects of the crisis despite being on the Gold Standard > the US > able to recover relatively quickly thanks to the implementation of expansionary monetary and fiscal policies

Question 29

How can the Gold Standard be argued to have hindered the ability of countries to respond to the depression more effectively?

Answer 29

• It limited their policy options > countries on the gold standard > constrained in their ability to implement expansionary fiscal or monetary policies (Bordo et al, 2000), due to the constraints on increasing the money supply.
• The constraints of the gold standard in the early 1930s were regarded as a guarantor of economic stability, but in reality, they hindered the ability of countries to use expansionary monetary policy to counter the economic downturn. (Eichengreen and Temin, 2000)

Question 30

Bank distress:
Keynes (1931) and Fisher (1933)

Answer 30

Bank distress reduced the money supply available to the public, either through the closure of banks or through withdrawals of deposits by depositors.

• Banks, as intermediaries controlling money and credit, had a unique ability to transmit their distress to other sectors of the economy (Friedman & Schwartz, 1963).
  + The contraction in the money multiplier was the primary mechanism through which bank distress affected the real economy.

Question 31

What is meant by Debt deflation

Answer 31

Debt deflation > debt rising in real value because of deflation, causing people to default on their consumer loans and mortgages

Question 32

How did debt deflation occur?

Answer 32

(Bernanke, 1983).

Debt deflation, caused by fixed dollar debt obligations, weakened borrowers’ balance sheets, reducing the number of qualified borrowers and decreasing the effective supply of loanable funds.

Question 33

(Bernanke, 1983)

Answer 33

The combined effect of declining borrowers’ balance sheets and a contraction in the supply of credit was a rise in the “cost of credit intermediation,” which impaired the ability of the economy to channel funds to their best use (Bernanke, 1983).

This contraction in aggregate supply magnified adverse economic shocks and prolonged and deepened the Depression

Question 34

Why does Friedman & Schwartz (1963) blame the policy of the Federal Reserve System

Answer 34

They argue in the early 1930s, the policies were inept and led to a rise in other rates.

A reduction in the supply of money and a deterioration of banking conditions turned a substantial recession into the Great Depression.