Keynesian Economics and the Great Depression
Photograph of Works Progress Administration Worker Receiving Paycheck.
Local Identifier: 69-N-19626; National Archives Identifier: 594956
Sandwiched between World War I and World War II lays one of the worst economic depressions in the history of the United States. After World War I, unlike other countries, the American economy was left intact, leading to a decade of prosperity and an overabundance of spending. So, what caused the most significant depression in American history? More importantly, what factors caused the American economy to awaken and roar back to life? Economists and historians alike have different ideas about what caused the great crash and what factors led to the revival of the American economy. To better understand this period in history and attempt to answer these questions, today's discussion will focus on the Keynesian Theory of Economics.
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Before getting into Keynesian Economics, it is essential to understand the economic factors of the time. The roaring twenties was a decade of American prosperity and abundance. Companies like Ford made luxury items like automobiles affordable for the average American. New inventions and conveniences opened the market for consumer goods at a rate the nation had never seen before. One way to understand this from an economic viewpoint is by looking at the decade's Gross National Product (GNP). Between 1920-1929 the GNP steadily increased at an annual rate of 4.2%, while simultaneously, the employment rate saw an average increase of 5.44%.[1] Prosperity abounded, and the economic outlook of the nation never looked stronger.
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1920s Newspaper article
advertising the stock market |
So, what happened? While things
appeared to be going great, the stock market crashed on October 29, 1929. The
shock waves of the crash set into motion economic factors that could not easily
be undone. Due to speculations and market volatility, the Dow Jones dropped
nearly 40% in one day, causing mass panic. Originally the blame for the Great Depression was placed on the stock market crash. However, the truth is that in
1929 the portion of Americans investing in the stock market was minimal. According
to Galbraith's book The Great Crash of 1929, "the vested interest
in euphoria [that] leads men and women, individuals and institutions to believe
that all will be better, that they are meant to be richer and to dismiss as
intellectually deficient what is in conflict with that conviction." [2] In his article, "The
Stock Market Boom and Crash of 1929 Revisited," Eugene White explains that
this attitude created an environment of "eagerness to buy stocks." Still, these investments were all based on credit leading to banks and investors
being overleveraged.[3] The ramifications were
that investors flooded the market, not allowing for correction. When investing
slowed, it crashed the market and destroyed the demand, thus the need to self-correct. Between 1929 – 1930 private investments fell by
nearly 80%.[4]
However, further investigation reveals that the market started to correct
itself and started to bounce back by April 1930. So, if things were starting to come back,
what was the problem?
What resulted from the stock market
crash was what Ben Bernanke calls a loss of consumer confidence in the system
that had previously allowed for such growth and prosperity.[5] While growth was exceptional
throughout the 1920s, from 1929-1930, the GNP fell
10.2% a year.[6] According to the classical
economic theories, supply and demand work together to decide market conditions
and prices of goods and services. When there are changes in supply, it triggers
a change in demand. These two factors determine market conditions and determine
price structures for all markets. Most economists suggest that a change in the
supply signal triggered the Great Depression. However, Keynes argues the opposite
is true of the Great Depression that it was not a supply issue but an aggregate
demand issue. He explains that there was an abundance of people looking for work. Thus, supply was not the factor for change.
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| John Maynard Keynes (1883-1946), circa 1940 |
John Maynard Keynes, a British economist
who studied at Cambridge University and later taught economics at King's College,
was one of the leading economists in the twentieth century. In Keynesian Theory,
he argued that the trigger of the Great Depression was that aggregate
demand fell. Several reasons contributed to the fall of demand, one being the
loss of consumer confidence which led to the aggregate demand of products to drop. People chose to save money instead of spending it, which
led to increased unemployment. Fewer people spending money triggered less
demand, increasing unemployment as companies balanced input and output. According
to Keynes, this could have been avoided had the government stepped in. Keynes
believed that the government could increase its spending and level out or
increase the aggregate demand.[7]
In his book The General Theory
of Employment, Interest, and Money, Keynes argued that the government's
role is to step into these types of situations and generate solutions and
employment. However, he admits that the markets would have eventually
self-corrected. The economy did not have to be destroyed over a more
extended period if there were things that the government could do to shorten
the suffering. For Keynes, aggregate demand caused the recession, leading to other
more significant problems throughout the economy. However, by helping with the
demand issues, the economy could recover, and it is the government's job to
step in and increase demand through various government spending programs.[8]
When applying Keynesian Theory to
the Great Depression, the proof lies in creating the Works Progress
Administration (WPA) formed by President Franklin Delano Roosevelt in May 1935
through executive order 7034.[9] These government programs sparked
life back into the American economy. According to Keynes, "the central
controls necessary to ensure full employment, will, of course, involve a large
extension of the traditional functions of government." [10] With the onset of WWII, government
spending attributed to the revitalization of the American economy. Thus, it further proved what Keynes argued at the heart of his theory that
governmental interference or spending revived the economy.
It is easy to focus on one aspect
of the event when assessing historical events. However, this leads to a
dangerous interpretation of the past. A wise and prudent historian will evaluate
all factors and not focus on only one sliver of the pie. While Keynesian
Economics is a viable theory, the truth is that Americans feared that a more
significant catastrophic fall would occur after the stock market crash in
October 1929. The issues that caused the stock market to crash had been set in
motion early in the 1920s. One such cause was decreased governmental spending
after World War I. However, the stock market crash signaled that not
everything in the economy was roaring. Due to this fear, Americans held back on
their spending, thus increasing their savings. Conversely, banks began to loan
less money. All these actions together triggered a chain of reactions and
events, leading historians and economists to consider that the Great Depression
was caused by a multitude of events and not just the singular failure of the
stock market.[11]
Food for thought: The lockdowns of 2020 triggered a chain of events that set the economies of every nation into a tailspin. From what is known of Keynesian Economics now, was it wise for the government to step in with massive spending plans? Would there have been a wiser way to revitalize the American economy?
Bibliography
Bernanke, Ben
S. "The Macroeconomics of the Great Depression: A Comparative Approach."
Journal of Money, Credit and Banking 27, no. 1 (1995): 1–28.
_________ "Nonmonetary
Effects of the Financial Crisis in the Propagation of the Great Depression." The American Economic Review 73, no. 3 (1983): 257-76.
Caporale, Tony
and Marc Poitras. "The Trouble with Naïve Keynesianism." Economic
Affairs (Harlow) 40, no. 2 (2020): 259-276.
Galbraith, John
Kenneth. The Great Crash 1929. Boston: Houghton Mifflin Company, 1954.
Keynes, John
Maynard. The General Theory of Employment, Interest, and Money.
Palgrave MacMillan, 2018.
Records of the Work
Projects Administration and Its Predecessor. Records of the Work Projects
Administration (WPA). National Archives and Records Administration.
Smiley, Gene. "US
Economy in the 1920s". EH.Net Encyclopedia, edited by Robert Whaples. June 29, 2004.
U.S. Bureau of
Economic Analysis, Real Gross Private Domestic Investment [B006RO1Q156NBEA],
FRED, Federal Reserve Bank of St. Louis.
White, Eugene N. "The Stock Market Boom and Crash of
1929 Revisited." The Journal of Economic
Perspectives 4, no. 2 (1990): 67–83.
Wolfram, Gary.
"Keynesian Economics and the Great Depression." Lecture, Hillsdale
College, online, October 19, 2015.
[1] Gene Smiley, "US Economy in the 1920s" EH.Net Encyclopedia, edited by Robert Whaples. June 29, 2004.
[2]
John Kenneth Galbraith, The Great
Crash 1929 (Boston: Houghton Mifflin Company, 1954).
[3]
Eugene N. White, "The Stock Market Boom
and Crash of 1929 Revisited," The Journal of Economic Perspectives 4, no. 2 (1990): 68.
[4] US Bureau of Economic Analysis,
Real Gross Private Domestic Investment [B006RO1Q156NBEA], FRED, Federal Reserve
Bank of St. Louis.
[5] Ben S. Bernanke, "Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression," The American Economic Review 73, no. 3 (1983): 258.
[6] Smiley, "US Economy in the 1920s.
[7] Gary Wolfram, "Keynesian Economics and the Great Depression" (lecture, Hillsdale College, online, October 19, 2015).
[8] Ben S. Bernanke, "The Macroeconomics of the Great Depression: A Comparative Approach." Journal of Money, Credit and Banking 27, no. 1 (1995): 1–28.
[9] Records of the Work Projects Administration and Its Predecessor. Records of the Work Projects Administration (WPA). National Archives and Records Administration.
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