The Great Depression: A Sudden Crash or Anticipated Disaster?

The COVID-19 pandemic has affected our lives, causing various problems in almost every aspect of our lives. While undeniably the most damaging impact of COVID-19 is the ever-increasing numbers of the confirmed and death, the economy is also hit hard by the pandemic. The lives of millions are affected by the economic shutdown due to COVID-19,the unemployment rate approaching 25%. Many people are being reminded of the Great Depression by the recent economic crisis, pointing out some striking similarities: stock market crash, lack of demands, high unemployment, and perhaps weak responses from the government. One question is whether this economic crisis will be a temporary downturn, with immediate recovery as soon as the pandemic ends, or a beginning of another Great Depression that may define the decade. To answer this question, we must look at the origins of the Great Depression
It is still a subject of debate whether the Great Depression was caused by short-term crashes and mistakes or long-term problems of the U.S economic structure. There are two simple explanations from the two extremes. One argument is that the Great Depression was solely caused by the Stock Market Crash of 1929 and following panic; the other extreme from Marxist approach is that the Great Depression is a result of inherent problems of capitalism, which could only be solved by a social revolution. However, both of these two extremes fail to propose any solutions for us. There were underlying economic problems in the seemingly prosperous 1920s, but it does not mean that we have to abandon capitalism. Instead, we have to look at various theories of the causes of the Great Depression, and find what we can learn from them


Keynesian Theory – Insufficient Demands


One well-known theory for the causes of the Great Depression is the Keynesian theory. Keynes argued that insufficient demands and reduced investment, caused by the panic of 1929, were the origins of the Great Depression. If people are not spending money, then businesses are less likely to make investment and more likely to reduce spending. That will result in fewer employments and slower economic development, which will then lead to more people spending less money, fearing upcoming economic hardship. According to Keynesian theory, this self-reinforcing cycle of less consumption – less growth will continue until there is a government intervention (the New Deal) or a sudden boom of demands (World War II). Therefore, Keynes advocated deficit spending of the government, in which government spends more money to create more demands in the economy. This was shown in the case of the United States, in which the economy started to recover as the government created jobs through large public works, or in the case of Germany, in which the government increased the demands through war preparation.The Keynesian model also explains what is going on right now fairly well. As people are sheltered-in-place, the consumption is limited, and many businesses are temporarily closed or reduced. As a result, people whose income previously came from those businesses are spending less money, creating the cycle of less demand and less production. However, one difference between the 1920s and today is that the insufficiency of demands right now is out of our control. Unlike the 1930s, the government cannot create jobs through large public works or constructions. All we can do is to wait for the end of the pandemic. After the pandemic, the consumption must return to normalcy in order to make sure that this economic downturn is not long-lasting. It is yet unclear how that can be done, or whether people will be willing to go back to normal life immediately. 


Monetarist Theory – Contraction of Money Supply


Another theory for the emergence of the Great Depression is the monetarist theory, proposed by Milton Friedman and Anna Schwartz. In this theory, the cause of the Great Depression is ultimately the contraction of money supply, which means that the amount of money available in the market was reduced in the beginning of the Great Depression, and inadequate responses of the Federal Reserve. There was an economic downturn in 1929, which could have been just a temporary economic downturn, but the Federal Reserve failed to respond when the money supply contracted as people wanted to hoard money. People withdrew their savings to put them under their bed mattress, causing bank runs. When banks collapsed, the money supply further contracted, and people panicked more, withdrawing more money from the bank. The Federal Reserve failed to provide enough money supply to stabilize the situation and to stop bank runs. As a result, what might have been a short economic depression became a serious long-term problem that was not fully solved until World War II.The Federal Reserve seemed to have learned a lesson from the Great Depression, and more recently from the Great Recession, responding to the current economic crisis by lowering the interest rate. Lower interest rate encourages people to borrow money and to invest, creating a flow of money in the economy. The Federal Reserve also lent money to various sectors of the economy, ensuring that there was enough money to support the economy. There is still one large issue in this solution: the root of the recession is not economic. Although the Federal Reserve is able to provide money supply for now, the recession will continue if the current COVID-19 pandemic is unresolved. The policies of the Federal Reserve is to minimize the permanent economic damage after the pandemic, not to minimize the economic damage during the pandemic. Therefore, the most important thing that can be done to revitalize the economy is to end this pandemic as soon as possible, which is not only up to what the government does, but also up to what all of us do. Ending the pandemic is not only going to save hundreds of thousands of people from the disease, but also going to save the economy from another Great Depression.

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