The Making of the Great Depression

            One of the most studied periods of American history, the Great Depression remains fundamental to the American experience. During the Depression, Americans confronted harsh economic realities. Few experienced little to no hardship. To put this idea into perspective, unemployment spiked from less than 4 percent in 1929, to 25 percent by 1933.[1] Over the same period, GNP fell 46 percent.[2]

While some consensus does exist on the Depression’s effects, the same cannot be said concerning its cause. Most theories are influenced by one of two schools of thought: consumption or monetary. Standard interpretations, by and large, are shaped by concerns of consumption. Episodes of irrational stock-market speculation, capitalism’s inherent instability, and Herbert Hoover’s laissez-faire policymaking, we are told, caused the Depression.[3] And FDR’s interventionist New Deal and public works programs drove America’s long-awaited return to prominence and equilibrium by the end of the 1930s.

Established by British economist John Keynes, consumption theory emphasized aggregate demand and questioned the market’s ability to quickly self-correct. To confront disequilibrium, the economy required government intervention through increased spending to restore employment and revitalize aggregate demand. In sharp contrast, free market and monetary thinkers such as American economist Milton Friedman argue failed government intervention and ill-advised monetary policies triggered and prolonged the depression. For Friedman, banking panics from decreased money supplies destroyed economic activity. Had big government resisted their emerging interventionist impulses, one can argue market cycles and circumspect government intervention alone would have prevented the Depression. In the end, this essay largely agrees with Friedman. Now let us turn our attention to American life in the 1920s.   

Due to the postwar boom, the American economy flourished until approximately 1925. Deemed the Roaring Twenties, this period represented a uniquely prosperous time in America. Americans possessed overwhelmingly more access to goods and services than ever before. Mass transportation continued to expand. Railroads headed in seemingly all directions. Urban sprawls developed at breakneck speeds. And the automotive industry was evolving as well from fierce competition and advancing technology. In fact, the industrious Henry Ford mastered efficiency so well that by 1925, he sold Model T’s for $300, a $600 reduction from its inception in 1908.

However, by the mid-1920s, the once flourishing American economy stalled. In many respects, the prosperity of the Roaring Twenties was generated by problematic monetary and fiscal policy making. Put simply, the Feds cheap money triggered speculation and the bubble eventually burst. As such, the stock market crashed in 1929, then the Depression developed. Given that the money supply increased by one-third from the early 1920s to 1929, a crash was seemingly inevitable with such sustained levels of irrational stock market speculation.

In response, the Feds, rather than increasing the money supply, did the exact opposite until 1933. Milton Friedman, as such, blamed the Federal Reserve. When the Feds failed to assist the Bank of the United States, a banking crisis resulted.[4] As public hysteria intensified, massive bank runs followed. Here we see some agreement between Friedman and Keynesian’s “animal spirits.”[5] By 1930, a stunning 352 banks closed.[6] Friedman claimed Depression could have been prevented had pre-1914 methods of payment restrictions been applied, like what transpired during the Panic of 1907.[7] Soon after restriction in 1907, the economy started recovering. However, in the case of the Depression, the Reserve System responded to bank failures in 1931, 1932, and 1933 by again tightening the money supply. Participating in “large-scale open market purchases of government bonds,” as Friedman put it, would have “provided banks with additional cash to meet the demands of its depositors.”[8] A missed opportunity to repair a rapidly deteriorating economy, to be sure.

Plagued by failing banks, and falling income and employment, Americans survived the Depression by drawing from their unique sense of grit, compassion, and ingenuity. Countless Americans focused on saving cash and decreasing consumption. At the same time, acts of humanitarianism and philanthropy swept through the country. Still, economic recovery remained elusive, as unemployment stayed in double digits until World War II.[9] To be sure, FDR’s New Deal and his public works programs put Americans back to work, but at what cost?

Today, much of the discourse surrounding the Depression concentrate on cause, effect, and how and why the Depression ended. While such conversations advance knowledge, one aspect often understudied concerns the relationship between crisis and government expansion. For Robert Higgs, bureaucracy never expanded gradually, nor was it an inevitable outgrowth of capitalism and/or urban-industrial economic dominance. Rather, government expansion during the 20th century surged during crisis and was shaped by ideology. And once order and equilibrium were restored, most, if not all newly established government formations and authority remained intact.[10] Given that government expansion remains constant even today, what might we make of this? And how might this influence how the Depression era and the New Deal is interpreted? And where does scale fit into this conversation considering America is a constitutional republic? Ultimately, Friedman and Higgins research center a myriad of concerns regarding the implications and often deleterious effects of big government.       


[1] Wheelock, 4.

[2] Ibid.

[3] Pongracic, Jr., 21.

[4] Friedman, 80.

[5] Pongracic, Jr., 23.

[6] Friedman, 82.

[7] Ibid.

[8] Ibid., 83.

[9] Wheelock, 4.

[10] Higgins, 1-3


Bibliography:

Friedman, Milton and Rose Friedman. Free to Choose: A Personal Statement. Orlando: Harcourt, Inc., 1990.

Higgs, Robert. “Crisis, Bigger Government, and Ideological Change: Two Hypotheses on the Rachet Phenomenon.” Explorations in Economic History 22, no. 1 (1985): 1-28.

Pongracic, Ivan, Jr. “The Great Depression According to Milton Friedman.” Freeman 57, no.7 (2007): 21-27.

Wheelock, David C. “Monetary Policy in the Great Depression: What the Fed Did, and Why.” Review-Federal Reserve Bank of St Louis 74, no. 2 (1992): 3-28.

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