Back to the future: lessons from the Great Depression

• Author: Farah Ebrahimi
• Position: IMF Institute
• Pages: 382-384

Page 382

The Great Depression of the interwar period is widely regarded as the most important economic event of the twentieth century and the worst economic downturn of modern times. Its toll in human terms was incalculable and particularly poignant, according to Professor Christina Romer of the University of California at Berkeley, because the extensive damage it caused was largely avoidable. The lessons of this prolonged worldwide crisis underscore the dangers of policy failures in times of great economic uncertainty.

It is difficult to overestimate the scale and the impact of the Great Depression. In the United States, where the depression began and where it hit the hardest, real GDP plummeted 27 percent from its peak in 1929 to its trough in 1933.Unemployment rates reached double digits in nearly every industrial country, climbing to roughly 25 percent in the United States. Developing countries suffered as well, mostly because exports of their primary products declined. Globally, prices of goods fell substantially.Deflation reached more than 10 percent a year in the United States.

Speaking at an IMF Institute seminar on October 3, Romer, a distinguished scholar of the Great Depression, drew on her own research, historical narrative, and the works of other noted economists to piece together the causes and effects of the depression. The story, she noted, was one of repeated shocks to aggregate demand. The shocks, particularly in the United States, were largely monetary-precipitous, repeated drops in the money supply-and had a number of causes. Also, in the United States, banking panics and policy failures played a key role. In a number of other countries, international financial strain and the gold standard were important.

What triggered the U S. depression?

Although the Great Depression ultimately became a global phenomenon, its epicenter was the United States. Why? Romer emphasized that the depression was not a structural adjustment to correct the excesses of the 1920s. The Roaring Twenties were not the sustained boom they are often made out to be. The decade was characterized by moderate growth, punctuated by three short recessions, and remarkably steady prices.Nothing about the 1920s made the Great Depression inevitable.

The Great Depression in the Unites States came in phases: first, as a mild recession, then as a downward spiral as different shocks hit the economy. These shocks were primarily domestic because the United States had become, after World War I, a nearly closed economy: by the end of the 1920s, imports and exports made up only 5 percent of GDP.

Uncertainty. The first shock was the one now famously connected with the Great Depression-the stock market crash of 1929. For years, the crash was viewed as a side issue. But Romer said her research suggested a more central role for the crash in explaining the initial downturn of the U.S. economy. By the summer of 1929, the economy was sliding into recession as a result of monetary tightening.What had been a gradual decline, however, became a dramatic one when, in October...