The Great Depression (1929–1939) was a severe global economic downturn that affected many countries across the world. It became evident after a sharp decline in stock prices in the United States, leading to a period of economic depression.^[1] The economic contagion began around September 1929 and led to the Wall Street stock market crash of 24 October (Black Thursday). This crisis marked the start of a prolonged period of economic hardship characterized by high unemployment rates and widespread business failures.^[2]

Between 1929 and 1932, worldwide gross domestic product (GDP) fell by an estimated 15%. By comparison, worldwide GDP fell by less than 1% from 2008 to 2009 during the Great Recession.^[3] Some economies started to recover by the mid-1930s. However, in many countries,^[specify] the negative effects of the Great Depression lasted until the beginning of World War II. Devastating effects were seen in both rich and poor countries with falling personal income, prices, tax revenues, and profits. International trade fell by more than 50%, unemployment in the U.S. rose to 23% and in some countries rose as high as 33%.^[4]

Cities around the world were hit hard, especially those dependent on heavy industry. Construction was virtually halted in many countries. Farming communities and rural areas suffered as crop prices fell by about 60%.^[5][6][7] Faced with plummeting demand and few job alternatives, areas dependent on primary sector industries suffered the most.^[8]

Economic historians usually consider the catalyst of the Great Depression to be the devastating Wall Street Crash. However, some dispute this, seeing the crash less as a cause of the Depression and more a symptom of the rising nervousness of investors partly due to gradual price declines caused by falling sales of consumer goods (as a result of overproduction because of new production techniques, falling exports and income inequality, among other factors) that had already been underway as part of a gradual depression.^[4][9]

Overview

The unemployment rate in the U.S. during 1910–60, with the years of the Great Depression (1929–39) highlighted

The Dow Jones Industrial Average, 1928–1930

After the Wall Street Crash of 1929, where the Dow Jones Industrial Average dropped from 381 to 198 over the course of two months, optimism persisted for some time. The stock market rose in early 1930, with the Dow returning to 294 (pre-depression levels) in April 1930, before steadily declining for years, to a low of 41 in 1932.^[10]

At the beginning, governments and businesses spent more in the first half of 1930 than in the corresponding period of the previous year. On the other hand, consumers, many of whom suffered severe losses in the stock market the previous year, cut expenditures by 10%. In addition, beginning in the mid-1930s, a severe drought ravaged the agricultural heartland of the U.S.^[11]

Interest rates dropped to low levels by mid-1930, but expected deflation and the continuing reluctance of people to borrow meant that consumer spending and investment remained low.^[12] By May 1930, automobile sales declined to below the levels of 1928. Prices, in general, began to decline, although wages held steady in 1930. Then a deflationary spiral started in 1931. Farmers faced a worse outlook; declining crop prices and a Great Plains drought crippled their economic outlook. At its peak, the Great Depression saw nearly 10% of all Great Plains farms change hands despite federal assistance.^[13]

The decline in the U.S. economy was the factor that pulled down most other countries at first; then, internal weaknesses or strengths in each country made conditions worse or better.^{[citation needed]} Frantic attempts by individual countries to shore up their economies through protectionist policies – such as the 1930 U.S. Smoot–Hawley Tariff Act and retaliatory tariffs in other countries – exacerbated the collapse in global trade, contributing to the depression.^[14] By 1933, the economic decline pushed world trade to one third of its level compared to four years earlier.^[15]

Economic indicators

Course

Origins

Because the Great Depression began in the United States and then spread around the world, the origins of the Great Depression are examined in the context of the United States economy. In the aftermath of World War I, the Roaring Twenties had brought considerable wealth to the United States and Western Europe.^[17] The year 1929 dawned with considerable economic progress in the American economy. A small stock crash occurred on 25 March 1929, but the crash was stabilized. Despite signs of economic trouble, the market continued to improve through September. Stock prices began to slump in September, and were volatile at the end of September.^[18] A large sell-off of stocks began in mid-October. Finally, on 24 October, Black Thursday, the American stock market crashed 11% at the opening bell. Actions to stabilize the market failed, and on 28 October, Black Monday, the market crashed another 12%. The panic peaked the next day on Black Tuesday, when the market saw another 11% drop.^[19][20] Thousands of investors were ruined, and billions of dollars had been lost; many stocks could not be sold at any price.^[20] The market recovered 12% on Wednesday, but the damage had been done. Though the market recovered from 14 November until 17 April 1930, the market entered a prolonged slump. From 17 April 1930 until 8 July 1932, the market lost 89% of its value.^[21]

Despite the crash, the worst of the crisis did not reverberate around the world until after 1929. The crisis hit panic levels again in December 1930, with a bank run on the Bank of United States (privately run, no relation to the government). Unable to pay out to all of its creditors, the bank failed.^[22][23] Among the 608 American banks that closed in November and December 1930, the Bank of United States accounted for a third of the total $550 million deposits lost and, with its closure, bank failures reached a critical mass.^[24]

The Smoot–Hawley act and the breakdown of international trade

The Smoot–Hawley Tariff Act was passed in the United States on 17 June 1930, having been proposed the year prior. Ostensibly aimed at protecting the American economy as the Depression began to take root, it backfired enormously and may have even caused the Depression. The consensus view among economists and economic historians (including Keynesians, Monetarists and Austrian economists) is that the passage of the Smoot–Hawley Tariff exacerbated the Great Depression,^[25] although there is disagreement as to how much. In the popular view, the Smoot–Hawley Tariff was a leading cause of the depression.^[26][27] In a 1995 survey of American economic historians, two-thirds agreed that the Smoot–Hawley Tariff Act at least worsened the Great Depression.^[28] According to the U.S. Senate website, the Smoot–Hawley Tariff Act is among the most catastrophic acts in congressional history.^[29]

Many economists have argued that the sharp decline in international trade after 1930 helped to worsen the depression, especially for countries significantly dependent on foreign trade. Most historians and economists blame the Act for worsening the depression by seriously reducing international trade and causing retaliatory tariffs in other countries. While foreign trade was a small part of overall economic activity in the U.S. and was concentrated in a few businesses like farming, it was a much larger factor in many other countries.^[30] The average ad valorem (value based) rate of duties on dutiable imports for 1921–1925 was 25.9% but under the new tariff it jumped to 50% during 1931–1935. In dollar terms, American exports declined over the next four years from about $5.2 billion in 1929 to $1.7 billion in 1933; so, not only did the physical volume of exports fall, but also the prices fell by about 1⁄3 as written. Hardest hit were farm commodities such as wheat, cotton, tobacco, and lumber.^{[citation needed]}

Governments around the world took various steps into spending less money on foreign goods such as: "imposing tariffs, import quotas, and exchange controls". These restrictions triggered much tension among countries that had large amounts of bilateral trade, causing major export-import reductions during the depression. Not all governments enforced the same measures of protectionism. Some countries raised tariffs drastically and enforced severe restrictions on foreign exchange transactions, while other countries reduced "trade and exchange restrictions only marginally":^[31]

• "Countries that remained on the gold standard, keeping currencies fixed, were more likely to restrict foreign trade." These countries "resorted to protectionist policies to strengthen the balance of payments and limit gold losses." They hoped that these restrictions and depletions would hold the economic decline.^[31]
• Countries that abandoned the gold standard allowed their currencies to depreciate which caused their balance of payments to strengthen. It also freed up monetary policy so that central banks could lower interest rates and act as lenders of last resort. They possessed the best policy instruments to fight the Depression and did not need protectionism.^[31]
• "The length and depth of a country's economic downturn and the timing and vigor of its recovery are related to how long it remained on the gold standard. Countries abandoning the gold standard relatively early experienced relatively mild recessions and early recoveries. In contrast, countries remaining on the gold standard experienced prolonged slumps."^[31]

The gold standard and the spreading of global depression

The gold standard was the primary transmission mechanism of the Great Depression. Even countries that did not face bank failures and a monetary contraction first-hand were forced to join the deflationary policy since higher interest rates in countries that performed a deflationary policy led to a gold outflow in countries with lower interest rates. Under the gold standard's price–specie flow mechanism, countries that lost gold but nevertheless wanted to maintain the gold standard had to permit their money supply to decrease and the domestic price level to decline (deflation).^[32][33]

There is also consensus that protectionist policies, and primarily the passage of the Smoot–Hawley Tariff Act, helped to exacerbate, or even cause the Great Depression.^[28]

Gold standard

Some economic studies have indicated that just as the downturn was spread worldwide by the rigidities of the gold standard, it was suspending gold convertibility (or devaluing the currency in gold terms) that did the most to make recovery possible.^[35]

Every major currency left the gold standard during the Great Depression. The UK was the first to do so. Facing speculative attacks on the pound and depleting gold reserves, in September 1931 the Bank of England ceased exchanging pound notes for gold and the pound was floated on foreign exchange markets.

Japan and the Scandinavian countries joined the United Kingdom in leaving the gold standard in 1931. Other countries, such as Italy and the United States, remained on the gold standard into 1932 or 1933, while a few countries in the so-called "gold bloc", led by France and including Poland, Belgium and Switzerland, stayed on the standard until 1935–36.

According to later analysis, the earliness with which a country left the gold standard reliably predicted its economic recovery. For example, The UK and Scandinavia, which left the gold standard in 1931, recovered much earlier than France and Belgium, which remained on gold much longer. Countries such as China, which had a silver standard, almost avoided the depression entirely. The connection between leaving the gold standard as a strong predictor of that country's severity of its depression and the length of time of its recovery has been shown to be consistent for dozens of countries, including developing countries. This partly explains why the experience and length of the depression differed between regions and states around the world.^[36]

German banking crisis of 1931 and British crisis

The financial crisis escalated out of control in mid-1931, starting with the collapse of the Credit Anstalt in Vienna in May.^[37][38] This put heavy pressure on Germany, which was already in political turmoil. With the rise in violence of National Socialist ('Nazi') and Communist movements, as well as investor nervousness at harsh government financial policies,^[39] investors withdrew their short-term money from Germany as confidence spiraled downward. The Reichsbank lost 150 million marks in the first week of June, 540 million in the second, and 150 million in two days, 19–20 June. Collapse was at hand. U.S. President Herbert Hoover called for a moratorium on Payment of war reparations. This angered Paris, which depended on a steady flow of German payments, but it slowed the crisis down, and the moratorium was agreed to in July 1931. An International conference in London later in July produced no agreements but on August 19 a standstill agreement froze Germany's foreign liabilities for six months. Germany received emergency funding from private banks in New York as well as the Bank of International Settlements and the Bank of England. The funding only slowed the process. Industrial failures began in Germany, a major bank closed in July and a two-day holiday for all German banks was declared. Business failures were more frequent in July, and spread to Romania and Hungary. The crisis continued to get worse in Germany, bringing political upheaval that finally led to the coming to power of Hitler's Nazi regime in January 1933.^[40]

The world financial crisis now began to overwhelm Britain; investors around the world started withdrawing their gold from London at the rate of £2.5 million per day.^[41] Credits of £25 million each from the Bank of France and the Federal Reserve Bank of New York and an issue of £15 million fiduciary note slowed, but did not reverse, the British crisis. The financial crisis now caused a major political crisis in Britain in August 1931. With deficits mounting, the bankers demanded a balanced budget; the divided cabinet of Prime Minister Ramsay MacDonald's Labour government agreed; it proposed to raise taxes, cut spending, and most controversially, to cut unemployment benefits 20%. The attack on welfare was unacceptable to the Labour movement. MacDonald wanted to resign, but King George V insisted he remain and form an all-party coalition "National Government". The Conservative and Liberals parties signed on, along with a small cadre of Labour, but the vast majority of Labour leaders denounced MacDonald as a traitor for leading the new government. Britain went off the gold standard, and suffered relatively less than other major countries in the Great Depression. In the 1931 British election, the Labour Party was virtually destroyed, leaving MacDonald as prime minister for a largely Conservative coalition.^[42][43]

Turning point and recovery

In most countries of the world, recovery from the Great Depression began in 1933.^[9] In the U.S., recovery began in early 1933,^[9] but the U.S. did not return to 1929 GNP for over a decade and still had an unemployment rate of about 15% in 1940, albeit down from the high of 25% in 1933.

There is no consensus among economists regarding the motive force for the U.S. economic expansion that continued through most of the Roosevelt years (and the 1937 recession that interrupted it). The common view among most economists is that Roosevelt's New Deal policies either caused or accelerated the recovery, although his policies were never aggressive enough to bring the economy completely out of recession. Some economists have also called attention to the positive effects from expectations of reflation and rising nominal interest rates that Roosevelt's words and actions portended.^[45][46] It was the rollback of those same reflationary policies that led to the interruption of a recession beginning in late 1937.^[47][48] One contributing policy that reversed reflation was the Banking Act of 1935, which effectively raised reserve requirements, causing a monetary contraction that helped to thwart the recovery.^[49] GDP returned to its upward trend in 1938.^[44] A revisionist view among some economists holds that the New Deal prolonged the Great Depression, as they argue that National Industrial Recovery Act of 1933 and National Labor Relations Act of 1935 restricted competition and established price fixing.^[50] John Maynard Keynes did not think that the New Deal under Roosevelt single-handedly ended the Great Depression: "It is, it seems, politically impossible for a capitalistic democracy to organize expenditure on the scale necessary to make the grand experiments which would prove my case—except in war conditions."^[51]

According to Christina Romer, the money supply growth caused by huge international gold inflows was a crucial source of the recovery of the United States economy, and that the economy showed little sign of self-correction. The gold inflows were partly due to devaluation of the U.S. dollar and partly due to deterioration of the political situation in Europe.^[52] In their book, A Monetary History of the United States, Milton Friedman and Anna J. Schwartz also attributed the recovery to monetary factors, and contended that it was much slowed by poor management of money by the Federal Reserve System. Chairman of the Federal Reserve (2006–2014) Ben Bernanke agreed that monetary factors played important roles both in the worldwide economic decline and eventual recovery.^[53] Bernanke also saw a strong role for institutional factors, particularly the rebuilding and restructuring of the financial system,^[54] and pointed out that the Depression should be examined in an international perspective.^[55]

Role of women and household economics

Women's primary role was as housewives; without a steady flow of family income, their work became much harder in dealing with food and clothing and medical care. Birthrates fell everywhere, as children were postponed until families could financially support them. The average birthrate for 14 major countries fell 12% from 19.3 births per thousand population in 1930, to 17.0 in 1935.^[56] In Canada, half of Roman Catholic women defied Church teachings and used contraception to postpone births.^[57]

Among the few women in the labor force, layoffs were less common in the white-collar jobs and they were typically found in light manufacturing work. However, there was a widespread demand to limit families to one paid job, so that wives might lose employment if their husband was employed.^[58][59][60] Across Britain, there was a tendency for married women to join the labor force, competing for part-time jobs especially.^[61][62]

In France, very slow population growth, especially in comparison to Germany continued to be a serious issue in the 1930s. Support for increasing welfare programs during the depression included a focus on women in the family. The Conseil Supérieur de la Natalité campaigned for provisions enacted in the Code de la Famille (1939) that increased state assistance to families with children and required employers to protect the jobs of fathers, even if they were immigrants.^[63]

In rural and small-town areas, women expanded their operation of vegetable gardens to include as much food production as possible. In the United States, agricultural organizations sponsored programs to teach housewives how to optimize their gardens and to raise poultry for meat and eggs.^[64] Rural women made feed sack dresses and other items for themselves and their families and homes from feed sacks.^[65] In American cities, African American women quiltmakers enlarged their activities, promoted collaboration, and trained neophytes. Quilts were created for practical use from various inexpensive materials and increased social interaction for women and promoted camaraderie and personal fulfillment.^[66]

Oral history provides evidence for how housewives in a modern industrial city handled shortages of money and resources. Often they updated strategies their mothers used when they were growing up in poor families. Cheap foods were used, such as soups, beans and noodles. They purchased the cheapest cuts of meat—sometimes even horse meat—and recycled the Sunday roast into sandwiches and soups. They sewed and patched clothing, traded with their neighbors for outgrown items, and made do with colder homes. New furniture and appliances were postponed until better days. Many women also worked outside the home, or took boarders, did laundry for trade or cash, and did sewing for neighbors in exchange for something they could offer. Extended families used mutual aid—extra food, spare rooms, repair-work, cash loans—to help cousins and in-laws.^[67]

In Japan, official government policy was deflationary and the opposite of Keynesian spending. Consequently, the government launched a campaign across the country to induce households to reduce their consumption, focusing attention on spending by housewives.^[68]

In Germany, the government tried to reshape private household consumption under the Four-Year Plan of 1936 to achieve German economic self-sufficiency. The Nazi women's organizations, other propaganda agencies and the authorities all attempted to shape such consumption as economic self-sufficiency was needed to prepare for and to sustain the coming war. The organizations, propaganda agencies and authorities employed slogans that called up traditional values of thrift and healthy living. However, these efforts were only partly successful in changing the behavior of housewives.^[69]

World War II and recovery

The common view among economic historians is that the Great Depression ended with the advent of World War II. Many economists believe that government spending on the war caused or at least accelerated recovery from the Great Depression, though some consider that it did not play a very large role in the recovery, though it did help in reducing unemployment.^{[9][70][71][72]}

The rearmament policies leading up to World War II helped stimulate the economies of Europe in 1937–1939. By 1937, unemployment in Britain had fallen to 1.5 million. The mobilization of manpower following the outbreak of war in 1939 ended unemployment.^[73]

The American mobilization for World War II at the end of 1941 moved approximately ten million people out of the civilian labor force and into the war.^[74] This finally eliminated the last effects from the Great Depression and brought the U.S. unemployment rate down below 10%.^[75]

World War II had a dramatic effect on many parts of the American economy.^[76] Government-financed capital spending accounted for only 5% of the annual U.S. investment in industrial capital in 1940; by 1943, the government accounted for 67% of U.S. capital investment.^[76] The massive war spending doubled economic growth rates, either masking the effects of the Depression or essentially ending the Depression. Businessmen ignored the mounting national debt and heavy new taxes, redoubling their efforts for greater output to take advantage of generous government contracts.^[77]

Causes

The two classic competing economic theories of the Great Depression are the Keynesian (demand-driven) and the Monetarist explanation.^[78] There are also various heterodox theories that downplay or reject the explanations of the Keynesians and monetarists. The consensus among demand-driven theories is that a large-scale loss of confidence led to a sudden reduction in consumption and investment spending. Once panic and deflation set in, many people believed they could avoid further losses by keeping clear of the markets. Holding money became profitable as prices dropped lower and a given amount of money bought ever more goods, exacerbating the drop in demand.^[79] Monetarists believe that the Great Depression started as an ordinary recession, but the shrinking of the money supply greatly exacerbated the economic situation, causing a recession to descend into the Great Depression.^[80]

Economists and economic historians are almost evenly split as to whether the traditional monetary explanation that monetary forces were the primary cause of the Great Depression is right, or the traditional Keynesian explanation that a fall in autonomous spending, particularly investment, is the primary explanation for the onset of the Great Depression.^[81] Today there is also significant academic support for the debt deflation theory and the expectations hypothesis that – building on the monetary explanation of Milton Friedman and Anna Schwartz – add non-monetary explanations.^[82][83]

There is a consensus that the Federal Reserve System should have cut short the process of monetary deflation and banking collapse, by expanding the money supply and acting as lender of last resort. If they had done this, the economic downturn would have been far less severe and much shorter.^[84]

Mainstream explanations

Modern mainstream economists see the reasons in

• A money supply reduction (Monetarists) and therefore a banking crisis, reduction of credit, and bankruptcies.
• Insufficient demand from the private sector and insufficient fiscal spending (Keynesians).
• Passage of the Smoot–Hawley Tariff Act exacerbated what otherwise might have been a more "standard" recession (both Monetarists and Keynesians).^[28]

Insufficient spending, the money supply reduction, and debt on margin led to falling prices and further bankruptcies (Irving Fisher's debt deflation).

Monetarist view

The monetarist explanation was given by American economists Milton Friedman and Anna J. Schwartz.^[85] They argued that the Great Depression was caused by the banking crisis that caused one-third of all banks to vanish, a reduction of bank shareholder wealth and more importantly monetary contraction of 35%, which they called "The Great Contraction". This caused a price drop of 33% (deflation).^[86] By not lowering interest rates, by not increasing the monetary base and by not injecting liquidity into the banking system to prevent it from crumbling, the Federal Reserve passively watched the transformation of a normal recession into the Great Depression. Friedman and Schwartz argued that the downward turn in the economy, starting with the stock market crash, would merely have been an ordinary recession if the Federal Reserve had taken aggressive action.^[87][88] This view was endorsed in 2002 by Federal Reserve Governor Ben Bernanke in a speech honoring Friedman and Schwartz with this statement:

Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression, you're right. We did it. We're very sorry. But thanks to you, we won't do it again.

— Ben S. Bernanke^[89][90]

The Federal Reserve allowed some large public bank failures – particularly that of the New York Bank of United States – which produced panic and widespread runs on local banks, and the Federal Reserve sat idly by while banks collapsed. Friedman and Schwartz argued that, if the Fed had provided emergency lending to these key banks, or simply bought government bonds on the open market to provide liquidity and increase the quantity of money after the key banks fell, all the rest of the banks would not have fallen after the large ones did, and the money supply would not have fallen as far and as fast as it did.^[91]

With significantly less money to go around, businesses could not get new loans and could not even get their old loans renewed, forcing many to stop investing. This interpretation blames the Federal Reserve for inaction, especially the New York branch.^[92]

One reason why the Federal Reserve did not act to limit the decline of the money supply was the gold standard. At that time, the amount of credit the Federal Reserve could issue was limited by the Federal Reserve Act, which required 40% gold backing of Federal Reserve Notes issued. By the late 1920s, the Federal Reserve had almost hit the limit of allowable credit that could be backed by the gold in its possession. This credit was in the form of Federal Reserve demand notes.^[93] A "promise of gold" is not as good as "gold in the hand", particularly when they only had enough gold to cover 40% of the Federal Reserve Notes outstanding. During the bank panics, a portion of those demand notes was redeemed for Federal Reserve gold. Since the Federal Reserve had hit its limit on allowable credit, any reduction in gold in its vaults had to be accompanied by a greater reduction in credit. On 5 April 1933, President Roosevelt signed Executive Order 6102 making the private ownership of gold certificates, coins and bullion illegal, reducing the pressure on Federal Reserve gold.^[93]

Keynesian view

British economist John Maynard Keynes argued in The General Theory of Employment, Interest and Money that lower aggregate expenditures in the economy contributed to a massive decline in income and to employment that was well below the average. In such a situation, the economy reached equilibrium at low levels of economic activity and high unemployment.

Keynes's basic idea was simple: to keep people fully employed, governments have to run deficits when the economy is slowing, as the private sector would not invest enough to keep production at the normal level and bring the economy out of recession. Keynesian economists called on governments during times of economic crisis to pick up the slack by increasing government spending or cutting taxes.

As the Depression wore on, Franklin D. Roosevelt tried public works, farm subsidies, and other devices to restart the U.S. economy, but never completely gave up trying to balance the budget. According to the Keynesians, this improved the economy, but Roosevelt never spent enough to bring the economy out of recession until the start of World War II.^[94]

Debt deflation

Irving Fisher argued that the predominant factor leading to the Great Depression was a vicious circle of deflation and growing over-indebtedness.^[95] He outlined nine factors interacting with one another under conditions of debt and deflation to create the mechanics of boom to bust. The chain of events proceeded as follows:

1. Debt liquidation and distress selling
2. Contraction of the money supply as bank loans are paid off
3. A fall in the level of asset prices
4. A still greater fall in the net worth of businesses, precipitating bankruptcies
5. A fall in profits
6. A reduction in output, in trade and in employment
7. Pessimism and loss of confidence
8. Hoarding of money
9. A fall in nominal interest rates and a rise in deflation adjusted interest rates^[95]

During the Crash of 1929 preceding the Great Depression, margin requirements were only 10%.^[96] Brokerage firms, in other words, would lend $9 for every $1 an investor had deposited. When the market fell, brokers called in these loans, which could not be paid back.^[97] Banks began to fail as debtors defaulted on debt and depositors attempted to withdraw their deposits en masse, triggering multiple bank runs. Government guarantees and Federal Reserve banking regulations to prevent such panics were ineffective or not used. Bank failures led to the loss of billions of dollars in assets.^[97]

Outstanding debts became heavier, because prices and incomes fell by 20–50% but the debts remained at the same dollar amount. After the panic of 1929 and during the first 10 months of 1930, 744 U.S. banks failed. (In all, 9,000 banks failed during the 1930s.) By April 1933, around $7 billion in deposits had been frozen in failed banks or those left unlicensed after the March Bank Holiday.^[98] Bank failures snowballed as desperate bankers called in loans that borrowers did not have time or money to repay. With future profits looking poor, capital investment and construction slowed or completely ceased. In the face of bad loans and worsening future prospects, the surviving banks became even more conservative in their lending.^[97] Banks built up their capital reserves and made fewer loans, which intensified deflationary pressures. A vicious cycle developed and the downward spiral accelerated.

The liquidation of debt could not keep up with the fall of prices that it caused. The mass effect of the stampede to liquidate increased the value of each dollar owed, relative to the value of declining asset holdings. The very effort of individuals to lessen their burden of debt effectively increased it. Paradoxically, the more the debtors paid, the more they owed.^[95] This self-aggravating process turned a 1930 recession into a 1933 great depression.

Fisher's debt-deflation theory initially lacked mainstream influence because of the counter-argument that debt-deflation represented no more than a redistribution from one group (debtors) to another (creditors). Pure re-distributions should have no significant macroeconomic effects.

Building on both the monetary hypothesis of Milton Friedman and Anna Schwartz and the debt deflation hypothesis of Irving Fisher, Ben Bernanke developed an alternative way in which the financial crisis affected output. He builds on Fisher's argument that dramatic declines in the price level and nominal incomes lead to increasing real debt burdens, which in turn leads to debtor insolvency and consequently lowers aggregate demand; a further price level decline would then result in a debt deflationary spiral. According to Bernanke, a small decline in the price level simply reallocates wealth from debtors to creditors without doing damage to the economy. But when the deflation is severe, falling asset prices along with debtor bankruptcies lead to a decline in the nominal value of assets on bank balance sheets. Banks will react by tightening their credit conditions, which in turn leads to a credit crunch that seriously harms the economy. A credit crunch lowers investment and consumption, which results in declining aggregate demand and additionally contributes to the deflationary spiral.^{[99][100][101]}

Expectations hypothesis

Since economic mainstream turned to the new neoclassical synthesis, expectations are a central element of macroeconomic models. According to Peter Temin, Barry Wigmore, Gauti B. Eggertsson and Christina Romer, the key to recovery and to ending the Great Depression was brought about by a successful management of public expectations. The thesis is based on the observation that after years of deflation and a very severe recession important economic indicators turned positive in March 1933 when Franklin D. Roosevelt took office. Consumer prices turned from deflation to a mild inflation, industrial production bottomed out in March 1933, and investment doubled in 1933 with a turnaround in March 1933. There were no monetary forces to explain that turnaround. Money supply was still falling and short-term interest rates remained close to zero. Before March 1933, people expected further deflation and a recession so that even interest rates at zero did not stimulate investment. But when Roosevelt announced major regime changes, people began to expect inflation and an economic expansion. With these positive expectations, interest rates at zero began to stimulate investment just as they were expected to do. Roosevelt's fiscal and monetary policy regime change helped make his policy objectives credible. The expectation of higher future income and higher future inflation stimulated demand and investment. The analysis suggests that the elimination of the policy dogmas of the gold standard, a balanced budget in times of crisis and small government led endogenously to a large shift in expectation that accounts for about 70–80% of the recovery of output and prices from 1933 to 1937. If the regime change had not happened and the Hoover policy had continued, the economy would have continued its free fall in 1933, and output would have been 30% lower in 1937 than in 1933.^{[102][103][104]}

The recession of 1937–1938, which slowed down economic recovery from the Great Depression, is explained by fears of the population that the moderate tightening of the monetary and fiscal policy in 1937 were first steps to a restoration of the pre-1933 policy regime.^[105] Zdroj:https://en.wikipedia.org?pojem=Great_Depression
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