Week 2 - The Great Depression Flashcards Preview

Macroeconomics 1 > Week 2 - The Great Depression > Flashcards

Flashcards in Week 2 - The Great Depression Deck (17):

Define the Great Depression

The Great Depression was a catastrophic worldwide downturn which began in 1929 and continued until WWII. The exact cause is still debated.


What was the prevailing view prior to the Great Depression

The consensus view was that microeconomics, the 'neoclassical' model, explained everything and if individual markets worked, so would the economy.

Government did not have a role in ensuring markets functions as the view was that the markets were capable of sorting themselves out.


Describe the stock market crash

Prior to the GD, the Dow Jones Indisustrial Average was booming and people were borrowing to invest.

In October 1929, the US stock market collapses, despite the efforts of the bank to support it. Thus caused panic as $30 bn was lost in a single day. This destroyed people's livelihood and impacted the real economy be eroding confidence and ruining corporate profits.


Explain the impact on banks

As businesses failed (corporate shares were plummeting), borrowers could no longer pay their loans. At the same time, assests held as collateral devalues.

Banks relied on fractional reserve banking (lending more than they held) and this became an issue as people ran on the banks. By 1932, 10,00 (40%) of banks had failed. Capital investment also plummeted and collapsing output lead to unemployment.


What was the unemployment figure for the US in 19933



Define deflation

Deflation refers to a sustained decrease in price levels (negative inflation)


What happened to inflation in GD?

Low demand lead to deflation. This caused people to put off making purchases which put further strain on businesses and lead to falling wages and increased unemployment.

Existing debt increased as the value of homes and assets fell this caused increasing default rates.


What was the impact of protectionism?

Trade of goods and services plummetet during the GD as countries attempted to 'keep demand at home' by implementing tariffs (which lead to retaliation and a trade war).

This reduced domestic output and employment as foreign demand wasn't there to prop up domestic economies. Firms couldn't import inputs and the decreased demand for their product lead to lower supply, lower wages and higher unemployment.


What was the initial policy response?

The prevailing 'sound finance' doctrine called for financial management as it was believed this would restore individual and business confidence and inefficient producers would be weeded out. Taxed were raised and spending cut.

The policy of non-interventionism worsened the economic contraction.


Define a recession

Falling GDP (output) for 2 consecutive quarters


What did Roosevelt do to improve the economic situation

- Closed the banks for a national holiday to stabalise the crisis and boost confidence
- Provided individual relief (food, shelter etc)
- Started large infrastructure programmes to create work
- Federal deposit insurance was created to allow gov to insure individual deposits and stop runs
- Abandoned the gold standard
- Focused on agriculture


Was the New Deal intended to be permanent

The New Deal (1933) was intended to be a group of temporary measures to support demand and restabalise the economy. However, the attempt to scale it back in 1937 lead to recession.


What was the impact of Roosevelt's policy on economic thought?

Policy improvisation and the resulting New Deal ushered in the managed economy paradigm (mixed economy) where the gov deferred to the market but monitored the performance of the overall economy ready to intervene.


What was the situation in Germany?

-Germany suffered from banking runs and German banks suffered due to their reliance of foreign capital. -- Banks called in loans and refused to issue new ones leading to skyrocketing interest rates.
- Germany was paying reparations
- Taxes were raised and spending cut
- chaos erupted in the streets
-eventually Hitler took power as faith in 'modern capitalism' was lost


What was the impact of deflation and why was no new equilibrium reached?

Wages were falling more than prices leading to falling demand. This caused decreases in supply, lower production, firm closures, lower wages and higher unemployment which restarts the cycle.


Can the PPF be applied to GD?

The PPF is a supply side model and cannot explain all factors that were important in the great depression (such as fear and the fall in general demand due to unemployment and low wages).

In the great depression, there was initially an oversupply causing prices to fall, staffing cuts and closures as no more needed to be produced.

When this happened, supply fell and production moved inside the curve (inefficient and not using all resources). Labour was not being utilised and productivity fell. In other words, capacity to produce shrank as companies failed and productive capacity was withdrawn.


What happened in the economy?

Equity plummeted as there were massive sales. House values decreased and people lost money. This caused demand and production to fall.

Deflation occurred due to less demand and decreasing asset value.