What Caused the Great Depression from the Federal Reserve Bank of St. Louis
What Caused the Great Depression?
Federal Reserve Bank of St. Louis, www.stlouisfed.org/education
Economists continue to study the Great Depression because they still disagree on what caused it. Many theories have been advanced over the years, but there remains no single, universally agreed-upon explanation as to why the Depression happened or why the economy eventually recovered.
The 1929 stock market crash often comes to mind first when people think about the Great Depression. The crash destroyed considerable wealth. Perhaps even more important, the crash sparked doubts about the health of the economy, which led consumers and firms to pull back on their spending, especially on big-ticket items like cars and appliances. However, as big as it was, the stock market crash alone did not cause the Great Depression.
Some economists point a finger at protectionist trade policies and the collapse of international trade. The Smoot-Hawley tariff of 1930 dramatically increased the cost of imported goods and led to retaliatory actions by the United States’ major trading partners. The Great Depression was a worldwide phenomenon, and the collapse of international trade helped spread this global phenomenon.
Other experts offer different explanations for the Great Depression. Some historians have called the Depression an inevitable failure of capitalism. Others blame the Depression on the “excesses” of the 1920s: excessive production of commodities, excessive building, excessive financial speculation or an excessively skewed distribution of income and wealth. . . .
One explanation that has stood the test of time focuses on the collapse of the U.S. banking system and resulting contraction of the nation’s money supply. Economists Milton Friedman and Anna Schwartz make a strong case that when there was less money available (i.e., because banks did not loan it or people hoarded it) it caused a sharp decline in prices. As the money supply fell, spending on goods and services declined, which in turn caused firms to cut prices and output and to lay off workers. The resulting decline in incomes made it harder for borrowers to repay loans. Defaults and bankruptcies soared, creating a vicious spiral in which more banks failed, the money supply contracted further, and output, prices and employment continued to decline.