Cause and Effect of the Great Depression

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Economy: Cause and Effect of the Great Depression
Cause and effect are two correlated aspects of an event or occurrence. Whereas causes describe the events preceding an outcome, the effects refer to the events which follow the outcome that actually result from it. Causes and effects are thus intended to provide a connection between events or phenomena hence understanding them helps generate relevant solutions to particular problems. This essay presents a cause and effect analysis of the great economic depression of 1929-1939which went down in records as “the longest, deepest and most pervasive depression in American history”.
Before embarking on the cause and effect analysis of the great economic depression, it is important to consider briefly a background review. The great economic depression started after the crash of the New York stock market in the U.S in 1929 and spilt over to many parts of the world. Sooner than later; banks failed and stock values dropped significantly. Bank failure was a result of multiple factors including; loan defaulters, accounts closures by panicked customers, and declining stock values among others. Other activities and policies which worsened the situation consisted of those whose general effect was to reduce levels of demand. These include; adherence to the gold standard, monetary policy mistakes and implementation of the voluntary wage-and-price controls by the National Recovery Administration. Because of reduced demand, production declined hence led to increased unemployment levels.
The great depression having begun in the U.S, it spread so fast to Britain, Germany and other parts of the world because at that time, the U.S was the main creditor and financier of Europe during the post war period. The desperate measures by some nations such as imposition of quotas and tariffs with view to protect their domestic production had the effect of reducing the value of the international trade. However, the timing and severity of the great economic depression was not the same among the many affected countries. For instance, the depression was milder in Japan and Latin America compared to the U.S and Europe where it was particularly long and severe. In the next section, this essay outlines the causes of the great depression.
The great depression began in the U.S due to a decline in spending (i.e. decline in aggregate demand). This generated a decline in production because manufacturers realized as well as merchandisers realized that inventories were accumulating. The decline in aggregate demand in America was transmitted to other parts of the world as a result of adhering to the gold standard which will be discussed below. Different other country specific factors contributed to the economic downturn in respective countries.
The New York stock market crash in the U.S which occurred largely due to adoption of the tight monetary policy with view to limit speculations in the stock market was a major cause of the initial decline in output witnessed in the U.S. The early 1920s had witnessed prosperity though not exceptionally booming. Mild recessions had been recorded in 1924 and 1927. However, for close to a decade, the wholesale product prices had remained fairly stable. In the stock market on the other hand, there was notable excess to the extend that the Federal Reserve decided to increase the interest rates in the period 1928-1929 with the major aim to tame the rapid rise in stock prices. The sharp rise in interest rates had the effect of depressing spending in areas that were interest sensitive such as the construction and automobile purchases. As a result, production went down significantly. When the stock markets reached unreasonable limits in 1929, investors lost confidence resulting into the stock market bubble burst. On October 24th 1929, (also known as the black Thursday), panic selling started in the sock market because investors had already purchased many stocks on margin. What followed then was the liquidation of holdings by the investors who were in panic mode due to the inherent uncertainty regarding future income and this caused further price declines. An estimation weighed on Cowel’s Index showed that U.S stock prices had fallen by 33% between their peak and low in September and November respectively.
Banking panics and monetary contraction were a major cause of the great economic depression too. This is because they had a direct bearing to the aggregate demand. The U.S experienced the first four sweeping waves of bank panics in the fall of 1930. Depositors who had lost confidence in banks’ solvency simultaneously rushed to banks to claim back their deposits in cash. Since Banks usually hold a small fraction of the deposits in form of cash reserves, it forced the banks to resort to loan liquidation so as to raise the required cash to pay back the depositors. The bank panics were so disastrous to the extend that President Franklin Roosevelt had to declare 6th March 1933 a bank holiday after which banks could only reopen upon being declared solvent by government. According to economic historians, there was a significant amount of arm debts in the 1920s which combined with the U.S policies that promoted upcoming of small undiversified banks to lay a foundation upon which bank panics emerged and spilt.
The World War 1period had caused increases in prices of agricultural products hence the reason for the heavy farm debts that were being witnessed. Farmers had engaged in heavy borrowing from banks in order to sustain land production, but became unable to service their loan repayments due to the decline in farm commodity prices after World War 1. With a vacuum in the Federal Reserve Bank of New York following the death of Benjamin Strong (its governor), the Federal R...