rethinking the great depression
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Rethinking the Great Depression. ECO 473 – Money & Banking Dr. D. Foster. Myth vs. Reality of the Great Depression. The myths: Capitalism failed. Markets failed. Government intervention was necessary. The New Deal saved capitalism. Growth in the 1920s was illusory. - PowerPoint PPT PresentationTRANSCRIPT
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Rethinkingthe
Great Depression
ECO 473 – Money & BankingDr. D. Foster
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Myth vs. Reality of the Great Depression
The myths:•Capitalism failed.•Markets failed.•Government intervention was necessary.•The New Deal saved capitalism.•Growth in the 1920s was illusory.•Herbert Hoover was a do-nothing President.
The reality:
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Myth vs. Reality of the Great Depression
What happened in the 1920s?:•Increased auto ownership.•The country became increasingly electrified.•Increased income.•Stock market boom.
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Myth vs. Reality of the Great Depression
What happened in the 1920s?:•Increased auto ownership.•The country became increasingly electrified.•Increased income.•Stock market boom.
What precipitated the Great Depression?•Failure to maintain the gold standard.•Collapse of sound monetary policy.
Problem areas:
wheat, coal
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The Gold Standard$20.67 = 1 oz. 1 oz. = £4.25 1 oz. = £4.25
$4.86 = £1
• American firms export goods to England … tractors. Value = $50 m.• British firms export goods to U.S. … fish & chips. Value = £10.29 m.• At exchange rate of $4.86 = £1, the £ earned by U.S. firms will just trade for the $ earned by the British firms.• Suppose that British exports fall by 23% and that there is only £8 mill available in foreign exchange market (to buy $).
£10.29mill.
$50 mill.
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The Gold Standard$20.67 = 1 oz. 1 oz. = £4.25
£8 mill.$50 mill.
1 oz. = £4.25
$4.86 = £1
• Now, American exporters can’t exchange all of their £10.29 mill. for $.• They can only exchange £8 mill. at the going exchange rate.
. . . receiving $38,880,000. But, they aren’t going to lose here…• They would cash the rest out in gold: £2.29 mill. = 538,823 oz.• They would redeem in U.S. for dollars: 538,823 oz. = $11,120,000• Total value received = $50,000,000
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The Gold Standard$20.67 = 1 oz. 1 oz. = £4.25
$50 mill. £10.29 mill.
1 oz. = £4.25
$4.86 = £1
• The flow of gold from England to U.S. won’t persist over time.
gold = MS MS = Pinflation
M•V=P•Y gold = MS MS = Pdeflation
• U.S. exports fall, British exports rise; trade flows balanced.
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Confounding The Gold Standard
In England, deflation means an In England, deflation means an economic slowdown and a economic slowdown and a (hopefully) mild recession (hopefully) mild recession
((unemployment).unemployment).M•V=P•Y
To counteract these effects, the Bank of England can raise interest rates. This will attract foreign investment (capital inflows) that will offset the trade imbalance and end the outflow of gold.
• If it persists, higher interest rates will cause a recession.
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Confounding The Gold Standard
In the U.S., expanding the In the U.S., expanding the money supply means money supply means
inflation and falling exports.inflation and falling exports.M•V=P•Y
To counteract these effects, the Federal Reserve can “sterilize” gold inflows by acquiring the gold (buy with taxes or sell securities). This prevents
inflation and protects exporting firms.
• This counteracts what the British are trying to do . . .
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Stress on the Gold Standard
WWI - Combatant countries go off gold standard to spending.Gold rushes into the U.S. as countries buy war material.
Post-WWI, gold stocks insufficient for existing price levels.Worldwide deflation (i.e., depression) is required.Victors can ease burden by acquiring gold stocks.Burden on losers is unsustainable.Eventually, U.S. lends gold to Germany.
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Stress on the Gold StandardThe Gold Exchange The Gold Exchange
Standard:Standard:U.S. & U.K. hold goldU.S. & U.K. hold gold
Other countries hold gold, $, Other countries hold gold, $, ££U.K. recession restores gold value by 1925.France devalues currency; gold inflows.
1927 - France redeems pounds; more gold inflows.Fed lowers i; gold flows from U.S.; burden on U.K. lessened.1927 - 9% of world’s gold; 1929 - 17%; 1931 - 22%Gold inflows sterilized and MS in France was constant.
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The Gold Standard Collapses
U.S. monetary policy is erratic:U.S. monetary policy is erratic:1927 - lowers i (3.5%) and gold flows out.1928 - raises i to stop gold outflows.By Sept. 1929, i up to 6%; gold inflows
1929/1930.After crash, i lowered; down to 1.5% in April
1931.Gold outflows 1931; raised i to 3.5%.March 1932 Fed begins OMO which stops
deflation.OMO stop in July 1932.Devaluation concerns drive gold outflow Jan-Mar
1933.
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Why did the depression last until 1932?
Herbert Hoover•Commerce Secretary in the 1920s.•Rallied business leaders in 1922.•Believed solution was to maintain wages & prices.
How a Depression becomes “Great”How a Depression becomes “Great”•Smoot-Hawley tariffs kick off trade war (1930).•Congress increases taxes to cover deficits (1932).•Hoover’s policy erodes business profits and raises unemployment.•Banks fail en masse in 1931-1932.
Why Why didn’t didn’t it end?it end?
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Rethinkingthe
Great Depression
ECO 473 – Money & BankingDr. D. Foster
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