Economic Theory of the Great Depression: Goverment Failure?

            America in the 1920’s was very prosperous and full of optimism.  The decade is known as the “Roaring Twenties” and despite nuisances, such as prohibition, the decade is often depicted as one long party.  And why not?  The Great War had ended; The 19th Amendment was passed, giving women the right to vote; and economic prosperity.  All of this came to an abrupt halt in 1929. 

Roaring 20’s

            What seemed like overnight, America and the world was thrown into chaos as the Great Depression enveloped around them.  What caused the world to enter the Great Depression is a complicated economic and political question.  There perhaps is no one reason that historians or economist can agree upon.  Historians looking at the Great Depression have focused their attention on several reason.  One reason is the Stock Market Crash in October of 1929.   This can be summed up by, Michael Bernstein in his work “The Great Depression as Historical Problem” when he wrote, “… that the resulting devaluation of wealth and disruption of the banking system explained the intensity of the crisis.  The “business confidence” thesis was perhaps the best example of this school of thought.  It held that regardless of the mechanisms that caused the collapse, the dramatic slide of the stock market created intensely pessimistic expectations in the business community.   The shock to confidence was so severe and unexpected that a dramatic panic took hold, stifling investment and thereby a full recovery.”[1]

            A second reason for the Great Depression is the Economic policies, or lack thereof, during the stock market crash.  According to Bernstein, “… the slump was the result of systematic policy errors.  According to this school of thought, inadequate theory, misleading information, and political pressures distorted the policy-making process.”[2]  There is no doubt that once the stock market crashed, President Herbert Hoover was unable to instill confidence in the economic system.

President Herbert Hoover

            President Hoover took office on March 4, 1929, the stock market was at unprecedented high.  Investors where trading stock on credit, due to extremely low interest rates and no government oversight.  However, on Monday, October 28, 1929, the market crashed.  “The epic boom ended in a cataclysmic bust.  On Black Monday, October 28, 1929, the Dow declined nearly 13 percent.  On the following day, Black Tuesday, the market dropped nearly 12 percent.  By mid-November, the Dow had lost almost half of its value.  The slide continued through the summer of 1932, when the Dow closed at 41.22, its lowest value of the twentieth century, 89 percent below its peak.  The Dow did not return to its pre-crash heights until November 1954.”[3]

            Clarence Barber wrote on the origins of the Great Depression.  In his work he quotes, J.R. Hicks, “The first thing to be said about (the Great Depression) is that it was a double slump.  It began with the Wall Street crash in 1929, a repetition, at least at first sight, of that of 1907, leading to a depression just as that had done.  But the recovery from the depression, which on previous experience might have been expected to follow within a year or two, did not take place.  Instead here was a double slump, superimposed upon the first. Now there is no doubt at all that this second slump was monetary in character; it is to be explained by the fragility of the international monetary system, reconstructed no more than imperfectly after the first World War.  First of all came the European monetary collapse, beginning with the Kreditanstalt crash in July 1931; there followed, as a consequence of that, the 1933 crisis in America.”[4]

            Eleanore Douglas describes how President Hoover and his economic philosophy failed to stop the Great Depression.  “Hoover and his political philosophy in many ways exemplified the best aspects of the Republican retrenchment strategy of the 1920s.  His approach seemed successful during an extended period of American economic growth and relative international quiescence.  Unlike more traditional proponents of laissez-faire government, Hoover adopted a strategy of retrenchment explicitly offered a positive vision for action in response to modern problems and even crises.  Hoover faithfully adhered to his approach as the austerity crisis of the Great Depression unfolded.  In response to the failure of retrenchment policies either to prevent or to mitigate the conditions of the Depression crisis…”[5]  Douglas further argues that his response “to scale back U.S. security commitments in the face of events to focus on the economic crises at home and abroad, despite evidence of dramatic changes to key elements of the post-war international security architecture. In so doing, some have argued that Hoover signaled too strongly America’s lack of interest in maintaining the stability of the international system and opened the door to the rise of new threats from Japan and Germany.”[6]

            Ultimately, the Great Depression would end, but how is still controversial.  One theory is that recovery occurred because of self-corrective measures.  However, this is disputed by Christiana Romer in her work on the Great Depression, Romer states, “my findings appear to dispute studies that suggest that the recovery from the Great Depression was due to the self- corrective powers of the U.S. economy in the 1930s. I find that aggregate-demand stimulus was the main source of the recovery from the Great Depression.  Thus, the Great Depression does not provide evidence that large shocks are rapidly undone by the forces of mean reversion.  Rather, it suggests that large falls in aggregate demand are sometimes followed by large rises, the combination of which leaves the economy back on trend.”[7] 

            However, others credit it to the New Deal created by President Franklin D. Roosevelt.  However, “New Deal labor and industrial policies did not lift the economy out of the Depression as President Roosevelt had hoped.  Instead, the joint policies of increasing labor’s bargaining power and linking collusion with paying high wages prevented a normal recovery by creating rents and an inefficient insider-outsider friction that raised wages significantly and restricted employment.  Not only did the adoption of these industrial and trade policies coincide with the persistence of depression through the late 1930s, but the subsequent abandonment of these policies coincided with the strong economic recovery of the 1940s.”[8]  While still others claim it was the economic needs and boom of World War II.

[1] Michael A. Bernstein, “The Great Depression as Historical Problem.” OAH Magazine of History 16, no. 1 (2001): 4.

[2] Ibid, 5.

[3] Gary Richardson, Alejandro Komai, Michael Gou and Daniel Park, “Stock Market Crash of 1929,” Federal Reserve History (November 22, 2013).  Stock Market Crash of 1929 | Federal Reserve History.

[4] Clarence L. Barber, “On the Origins of the Great Depression,” Southern Economic Journal 44, no. 3 (1978): 434.

[5] Eleanore Douglas, STRATEGIC RETRENCHMENT AND RENEWAL IN THE AMERICAN EXPERIENCE. Report. Edited by Peter Feaver, Strategic Studies Institute, US Army War College, 2014: 71.

[6] Ibid, 72.

[7] Christina D. Romer, “What Ended the Great Depression?” The Journal of Economic History 52, no. 4 (1992): 783.

[8] Harold L. Cole and Lee E. Ohanian, “New Deal Policies and the Persistence of the Great Depression: A General Equilibrium Analysis,” Journal of Political Economy 112, no. 4 (2004): 813.

Published by Mark King

Currently, Mark King works for the Marion County Public Defender’s Office in the Juvenile CHINS Division. He represents families that have become involved with the Department of Child Services. Like most people, Mark enjoys spending time with family and friends and enjoys golf, working out and traveling. He has been lucky with his career-- started as a prosecutor, joined the FBI, had a private practice and has appeared before the Georgia and Indiana trial courts, Indiana Court of Appeals, the United States District Court for both the Southern and Northern Districts of Indiana, and the United States Court of Appeals for the 7th Circuit. Mark has a Juris Doctorate from Indiana University and a Master of Arts in Military History from Norwich University. His passion for history has pushed him to begin working on his second doctorate, a PhD in History. Mark is married and lives on the south side of Indianapolis.

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