An Economic Analysis of the Great
Depression: Lessons for Today
Council for Economic Education
March 21, 2009
Mark C. Schug, Ph.D.
University of Wisconsin-Milwaukee
Whatdunnit? The Great
Depression Mystery
Focus: Understanding
Economics in U.S.
History
Lesson 30
Whatdunnit?
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In the 1920s, jobs were
plentiful and the economy
was growing and the
standard of living was rising.
Between 1920 and 1929
homeownership doubled.
Most home-owning families
enjoyed amenities such as
electric lights and flush
toilets.
60% of all households had
cars, up from 26%.
More teenagers were
attending high school.
Whatdunnit?
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By 1933…
One fourth of the labor
forces was unemployed.
Families were losing
their homes and many
were going hungry.
Adolescents who should
be in school were riding
around the country in
freight cars, looking for
jobs.
Whatdunit?
What happened?
• The United states possessed the same
productive resources in the 1930s as it had
in the 1920s.
• Great factories and productive machinery
were still present.
• Workers had the same skills and were
willing to work just as hard.
• How could life have become so miserable
for so many in such a short period of time?
1920s

Prosperity of the
1920s was based
largely on purchases
of homes and cars.
 Toward the end of
the decade sales
began to decline.
End of the 1920s
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Machinery workers stand.
Car sales people stand.
Auto workers stand.
Steel workers stand.
Construction workers stand.
Furniture sellers stand.
Furniture workers stand.
Clothing sellers stand.
Restaurant workers stand.
Grocery workers stand.
1929

Normally, people
start buying again
as automobiles
wear out and
incomes improve.
Expansion Begins Again
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Machinery workers sit.
Car sales people sit.
Auto workers sit.
Steel workers sit.
Construction workers sit.
Furniture sellers sit.
Furniture workers sit.
Clothing sellers sit.
Restaurant and grocery
workers sit.
Grocery workers sit.
What Are the Alleged Causes of the
Great Depression?
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The Stock Market Crash of October 29, 1929.
Excessive borrowing to purchase stocks and
consumer goods.
Overproduction of goods and services
High tariffs which prevented imports and hurt
exports.
Low farm prices and low wages, leading to an
uneven distribution of income.
Why did a mild recession in 1929 become
the Great Depression of the 1930s? A Hint
Its mainly about money, banks, and
the Federal Reserve System
How is Money Created?
Banks are not just businesses.
Hint: Banks Create Money
100% Reserves
Assets
Reserves
Loans
Liabilities
$100.00
Deposits
$100.00
Hint: Banks Create Money
Bank 1: 10% Reserves
Assets
Liabilities
Reserves
$10.00
Loans
$90.00
Deposits
$100.00
Hint: Banks Create Money
Bank 2: 10% Reserves
Assets
Liabilities
Reserves
$9.00
Loans
$81.00
Deposits
$90.00
The Fed
The Federal Reserve System was
created in 1913.
 The Fed has 4 parts

Board of Governors (Washington D.C.)
 Federal Open Market Committee (FOMC)
 Reserve Banks (12 members)
 Member Banks
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Conducting Monetary Policy
Inflation: Enemy Number 1
The Federal Reserve System has 3
tools to control inflation:
1. Sets reserve requirements for banks.
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Raise reserve requirement = reduce
money supply
Lower reserve requirement = increase
money supply
Conducting Monetary Policy
2.
Manages the Federal Open Market Committee
(FOMC).
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The FOMC sets a target rate for the Federal
Funds rate. This is the rate for loans made from
bank to bank.
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This is almost always what the media is referring
to when it says the Federal Reserve "changing
interest rates".
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To increase the money supply, the Fed instructs
the Open Market Desk at the New York Fed to
buy bonds to try and hit the target rate.
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To decrease the money supply, the Fed instructs
the Open Market Desk at the New York Fed to
sell bonds.
Conducting Monetary Policy
3. Sets the discount rate for members who
borrow money from the Fed.
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Banks can borrow funds to keep up their required
reserves is by taking a loan from the Fed Reserve
at the discount window.
The discount rate is usually higher than the
federal funds rate.
Raise discount rate = reduce money supply
Lower discount rate = increase money supply
Visual 30.2 Number of U.S. Banks Closing
Temporarily or Permanently, 1920-1933
Year
Number of Bank Closings
1920
168
1921
505
1922
367
1923
646
1924
775
1925
618
1926
976
1927
669
1928
499
1929
659
1930
1352
1931
2294
1932
1456
1933
4004
Visual 30.3 Money in Circulation
Year
Money in
Circulation*
1929
$26.2
1930
$25.1
1931
$23.5
1932
$20.2
1933
$19.2
*Currency plus bank deposits, in billions of dollars.
Why Did the Fed Fail to Act?
1.
2.
3.
The Board of
Governors believed
that many banks were
unsound.
They wished to
protect the value of
the dollar by keeping
interest rates high.
They wished to
protect the nation
against inflation which
they thought was the
main problem.
“We Did It.”
In 2002, at Milton Friedman’s
90th birthday
Ben Bernanke, then Federal
Reserve Board Governor,
said:
“ I would like to say to Milton
and Anna: Regarding the
Great Depression, you were
right, we did it. We’re very
sorry. But thanks to you, we
won’t do it again.”
The Crash of 08
After 24 Consecutive Quarters of
Growth…
The Cliff
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And then we
went off the cliff.
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20
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20
08
House Price Change
20.0%
15.0%
10.0%
5.0%
0.0%
-5.0%
-10.0%
-15.0%
-20.0%
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Default Rate
6%
5%
4%
3%
2%
1%
0%
Foreclosure Rate
1.4%
1.2%
1.0%
0.8%
0.6%
0.4%
0.2%
0.0%
79 980 981 982 984 985 986 987 989 990 991 992 994 995 996 997 999 000 001 002 004 005 006 007
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Doubling of Household Debt as a
Share of Income
140%
120%
100%
80%
60%
40%
20%
53 955 958 960 963 965 968 970 973 975 978 980 983 985 988 990 993 995 998 000 003 005 008
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Consumption
Causes of the Crash of 08?
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The likely suspects:
The erosion of
government
regulations of
conventional lending
standards.
 The Fed’s
manipulation of
interest rates during
2002-2006.
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Causes of the Crash of 08?
An SEC Rule change
adopted in April 2004
led to highly leveraged
lending practices by
investment banks and
their quick demise when
default rates increased.
 Doubling of the
Debt/Income Ratio of
Households since the
mid-1980s.
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Is It 1929 All Over Again?
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Primary causes of the
Great Depression were:
 Poor monetary policy
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Poor fiscal Policy
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Reduced money supply
High interest rates
Failure of Fed to act
Tax increase to balance the
budget
Increasing protectionism
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Smoot-Hawley tariff
Banks Are Not Lending
Today, the problem
is not liquidity per
se.
 Many banks are
holding Mortgage
Backed Securities
(MBS) and other
bad paper.
 Who do you trust?
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So far …
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Actions taken so far
have been mainly
aimed at increasing
liquidity and spending
rather than getting rid
of bad assets.
What are the Characteristics of
Money?
Medium of exchange
 Standard of value
 Store of value
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What is Money?
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M1
Currency
 Checking accounts (63%)
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M2: add in
Savings accounts
 CDs
 Money market accounts
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Jobs of the Fed
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Services to Banks
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Check clearing
Loans to member
banks
Services to
Government
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Federal checkbook
Federal deposits
Supervise members
banks
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Conduct monetary
policy
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Managing the
nation’s money
supply.
Auction
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Distribute 10 “dollars” in envelops to the class.
Ask them to count the money but do not stress
the amount they have.
Auction off one or two items (T-shirts?),
recording the prices. Figure the average price.
Distribute 20 “dollars” to the class.
Auction off one or two more items, recording
the prices. Figure the average price.
Explain the price change according to the
amount of money in circulation.
Activity 30.3 What Would You Have
Done?
1. The world financial system that emerged after World
War I was based upon the gold standard. The United
States and Great Britain guaranteed that they would
exchange their currencies for gold at a fixed rate
($20.67) for an ounce of gold.
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Other major countries agreed to exchange their currencies for
gold, dollars or pounds.
In 1927, several countries, most notably Germany and
Austria, experienced serious bank runs. To stabilize their
currencies, they exchanged their dollars and pounds for gold.
The United States experienced a serious loss of gold
To encourage foreign investors to buy American investments,
the Federal Reserve Banks raised interest rates.
If you were an American business owner planning to build a
new factory or buy new equipment, what would you have
done after interest rates were increased?
Activity 30.3 What Would You Have
Done?
2. The Federal Reserve lowered interest rates after a
time, but in 1930 and 1931, when the American
economy had already taken a downturn, more bank
runs occurred in many countries, and again gold
flowed out of the United States.
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To keep gold in the United States, the Federal Reserve Banks
again raised interest rates.
What was the result?
Activity 30.3 What Would You Have
Done?
3. Now imagine that you are an American citizen with a
bank account.
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You read the newspapers. You see that banks are collapsing
in other countries and that the rate of bank failures in the
United States has risen.
What might you do?
Activity 30.3 What Would You Have
Done?
4. In 1932 Congress creates the Reconstruction Finance
Corporation (RFC), which lends money to businesses
that are in trouble, including banks.
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The law requires that the names of banks receiving loans from
the RFC must be published.
You read in the newspaper that the bank in which your money
is deposited is receiving help from the RFC.
What are you likely to do?
Overview

Overview of Focus:
Understanding
Economics in U.S.
History
 Demonstration of
Lesson 30: Causes
of the Great
Depression
 Implications for today
Today’s Stock Market Report
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Paper stocks were
stationary.
Fluorescent tubing
dimmed in light trading.
Knives were up sharply.
Elevators rose, while
escalators continued
their slow decline.
Mining equipment hit
rock bottom.
Diapers remain
unchanged.
Today’s Stock Market Report
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Coca Cola fizzled.
Caterpillar stock inched
up a bit.
Balloon prices were
inflated.
Scott Tissue touched a
new bottom.
And batteries exploded
in an attempt to
recharge the market...
Table of Contents
Unit 1 Three World Meet
Unit 2: Colonization and Settlement
Unit 3: Revolution and the New Nation
Unit 4: Expansion and Reform
Unit 5: Civil War and Reconstruction
Table of Contents
Unit 6: The Development of the
Industrial United States
Unit 7: The Emergence of Modern
America
Unit 8: The Great Depression and World
War II
Unit 9: Postwar United States
Unit 10: Contemporary United States
Federal Reserve Banks
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New York
Boston
Philadelphia
Richmond
Atlanta
Cleveland
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Minneapolis
Chicago
St. Louis
Kansas City
Dallas
San Francisco
Job Number One for the FED
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Conduct monetary
policy
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Managing the
nation’s money
supply.