Understanding the Great Depression

♪ [music] ♪ [Alex] Now that we have covered
the mechanics of the aggregate demand–
aggregate supply model, let’s use the model
to help us to understand the worst recession
in U.S. history: The Great Depression. The Great Depression was unlike
any recession in recent times. Unemployment rose above 20%. 40% of all banks failed. GDP plummeted by 30%. And the stock market lost
two-thirds of its value in just ten years. The Great Depression
was largely caused by a series of negative
aggregate demand shocks. But real shocks also contributed
and slowed recovery. Let’s start in the 1920s —
The Roaring Twenties. ♪ [ragtime music] ♪ The economy was growing
by almost 3% per year in per capita terms, and inflation was 0%. In 1929, however,
the stock market crashed, partly caused by a reduction
in the money supply. Investors lost a lot of wealth
in the crash, and they reduced their consumption. Pessimism began to grow. And as pessimism grew, bank depositors began
to worry about the banks, and some of them began
to withdraw their money. This was a time
before deposit insurance, so if you thought that your bank
might go bankrupt, it made sense to run to the bank
and withdraw your money before everyone else did. During The Great Depression,
thousands of banks failed, in four waves. And with each wave of bank failure, fear and uncertainty increased, leading to further reductions
in consumption. Businesses began to look around,
and they began to think — “Maybe I should hold off
on building a new factory. Let’s just wait,
and see what happens.” This decline in investment spending
was another shock to aggregate demand. Overall, investment dropped
by an astounding 75% between 1929 and 1933. By 1940, the capital stock
was actually lower than it had been in 1930. Aggregate demand had already
been reduced drastically by 1931, and the U.S. economy
was in bad shape. But then, in the early 1930s, the Federal Reserve allowed
the money supply to plunge by nearly 30% — the largest negative shock
in aggregate demand in U.S. history. By 1932, economists estimate that America’s
real growth rate was -13%, and inflation was -10%, adeflation.This extreme deflation
made the situation even worse, because deflation
increases the burden of debt. Suppose you owe $100. If prices fall by 10%, then your real debt has,
in effect, been increased by 10%. You have to work harder and longer
to pay the same debt. The deflation made debtors
worse off — bankrupting some, and causing others
to cut back spending even more. Now, in theory,
the creditors were better off. But, in practice, the debtors
cut back on their spending more than the creditors
increased spending. So deflation increased
the burden of the debt and led to further falls
in aggregate demand. The uncertainty,
and the shrinking economy meant that even people
who had money, they didn’t want to spend — not much on consumption, and certainly not on investment. The bottom line is that pretty much
everyone wanted to spend less, but the only way
that everyone can spend less is if the economy shrinks. And that’s exactly what happened. The Great Depression is,
in many ways, the great fall in aggregate demand. But real shocks also
contributed to, and slowed the economy’s recovery. The bank failures mentioned earlier
actually had two effects. When people lost their money,
they couldn’t spend, and so aggregate demand fell. But, in addition, the banks
were financial intermediaries. And so when the banks failed, the bridge between saving
and investment collapsed, and the economy
became less efficient. As is often the case, real shocks are often intertwined
with aggregate demand shocks. As if all this wasn’t bad enough, Mother Nature added to the problems
of the U.S. economy. The Dust Bowl —
that was another real shock. In the early years
of the Great Depression, farmland in Texas,
Oklahoma, New Mexico, Colorado, and Kansas —
farmland dried up, and literally blew away. Farming became less productive
as crops failed, and there wasn’t enough water
for all of the livestock. Between 1930 and 1940, some three and a half million people
in the Plains States picked up and moved — a mass migration,
like the Gold Rush, but in reverse. This was a tremendous hit to the productive capacity
of the U.S. agricultural sector. Finally, several policy decisions
also caused negative real shocks. The Smoot-Hawley Tariff,
for example, enacted in 1930, taxed foreign goods. If nothing else had changed, this might have increased
aggregate demand by encouraging spending
on domestic goods. But in reality, other countries
retaliated with similar tariffs, so our exports fell. Tariffs were also
a real shock to the economy, because trade
is a kind of technology. Trade lets us take one good, and transform it into another good. Tariffs make that technology
less efficient, just like a productivity shock. Finally, the National
Industrial Recovery Act was aterriblepiece of legislation. Under the Act,
hundreds of industries adopted government-mandated codes that reduced competition, and prevented firms
from lowering prices. In one famous case
a tailor was fined and thrown in jail for charging 35 cents
to press a suit instead of the legally
required 40 cents. Moreover, at a time
when investment was far too low, the Act put quotas on investment, and made competition
in many industries illegal. Industries became monopolized
and filled with cartels. Higher prices, lower output,
less competition — all of this delayed recovery. Fortunately, some
of the worst parts of the Act were declared unconstitutional
in 1935. All of these real shocks, both natural and manmade — they made an already
bad situation even worse. It’s impossible to cover
the full complexity of the Great Depression
in a short video. But that gives you a good overview
of the essence of the crisis. But if you’d like to hear more
about the Great Depression, vote here. [Narrator] You’re on your way
to mastering economics. Make sure this video sticks by taking a few
practice questions. Or, if you’re ready
for more macroeconomics, click for the next video. Still here? Check out Marginal Revolution
University’s other popular videos. ♪ [music] ♪

About the author


  1. I have to give a lot of credit to the producer of these videos. The sound effects make them that much more enjoyable. Well done.

  2. We are all at the mercy of the federal reserve.

    The moment the federal reserve bank decides to massively contract the money supply is the moment the federal reserve has sentenced a lot of people to death, or at the very least destitution.

    I thank you for preparing me to face the federal reserve and for me come out the victor.

  3. Why didn't you show FDR name on newspaper? Bias or just to keep the conversation on economics and not politics?

  4. Nice video! I would emphasize that the cause and exacerbation of the Great Depression can be laid at the feet of the government (and especially the Fed). We had plenty of prior panics and recessions, but it took the existence of the Fed (established in 1913) and statist presidents (Hoover and Roosevelt) to plunge the U.S. into full-blown depression. The NLRB, AAA, CCC, FDIC, etc. were either ineffectual or downright disasters (e.g., misallocated capital, paying farmers to dump perfectly-good milk in the street, digging ditches and filling them back in again, creating a moral hazard in terms of bank deposits).

    Perhaps a video comparing the recession of 1907 to 1921 to 1929 would be a valuable place to start. Also, a video explaining why it wasn't government diverting otherwise productive resources to building bombs and tanks and blowing things up (i.e., the broken window fallacy) that ultimately took us out of the Depression.

    This video came up on my feed, and is actually a decent primer on the subject: https://www.youtube.com/watch?v=2Ce6z-u_Wk0

  5. I think it would be great to have a video about the recovery of 1933 due to the dollar devaluation, gold clause ban, and leaving the gold standard.

  6. Amen for bringing up the Smoot Hawley tariff! People rarely talk about how much it contributed to the depression.

  7. I disagree with the main premise. First of all, inflation was very high in the 1920s because credit consumption did not permit prices to fall even though the period was one of high capital investment and great productivity increases. The monetary inflation created malinvestments that had to be liquidated in the future. When the malinvestments were liquidated, the economy should contract as it did. What made the correction a Great Depression was the huge expansion of government and the regime uncertainty that Hoover and FDR introduced. (See Rothbard and Higgs on this explanation.) The high taxes, tariffs, and regulations also added to the problems but without the massive increase in Fed-created credit from 1924 to 1929 there would have been no artificial boom and no need for the bust that followed.

  8. Can you please answer the following questions
    1.Why is there no inflation in those time?
    2.What are the bad effects of deflation?

  9. Was it possible to save the economy from the great depression by printing more currency notes and then supplying those new notes in the economy ?

  10. Business people's use Economic regression period to buy stocks and shares if they try to buy them in Economic depression time means will it be more cheaper?

  11. Pretty terrible, why weren't things so bad in other countries? You model doesn't explain anything, nor help to plan for the future.

  12. very well explained.. Thanks a lot.. Can you please help me out with the recovery from Great Depression- experiences of UK and USA?

  13. INTEREST RATE SUPPRESSION…. Ironic how we claim to practice 'free market capitalism' when the most important price in an economy (the price of capital) is centrally planned all over the world. The federal reserve artificially suppressed interest rates in 1924 to help Great Britain get back on a gold standard. They then proceeded to back off the interest rate suppression in 1928… Coincidence?

  14. That's completely incorrect. Inflation doesn't make things worse. It is the one breath the economy gets and it cushions the fall. Ever tried stagflation?

  15. Talking about financial shocks in 1929 compare to the shocks today. We have tornados and flooding (instead of drought) in the plains so farmers can not plant food. Soybean, Corn and Meat farmers have tariffs with Mexico and China so there are lower sales there. We have the federal reserve unable to hit their inflation target. We have student debt at record levels so the younger generation can not spend money on consumerism. We already had the banks fail back in 2008. We have people moving due to higher property taxes in some states. We have the government looking to break up tech companies as anti trust.

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