explain the monetary history that produced the Federal Reserve, the weaknesses of the late-1920s economy, and the main explanations of the Great Depression, and evaluate the responses of the Federal Reserve, Congress, Hoover and Roosevelt.
Instruction
Between 1929 and 1933 the American economy shrank by roughly a quarter and about one worker in four lost their job. Economists and historians still argue about why. This lesson gives you the evidence and the main explanations, and asks you to weigh them.
The monetary background. In the late nineteenth century the United States had no central bank. The supply of currency could not expand when demand for money rose, so banking panics struck in 1873, 1893 and 1907. In 1907 the banker J. P. Morgan personally organized a rescue. Congress concluded that the country needed an “elastic currency,” and the Federal Reserve Act of 1913 created twelve regional reserve banks and a board in Washington to lend to banks in a crisis. You met the other half of this story — the Populists’ fight over gold and silver — in the first semester.
Weak foundations. The prosperity of the 1920s rested on uneven ground. Farm prices had been depressed since 1920. Coal and textiles were declining. The richest Americans took a growing share of income, while many families bought cars and appliances on credit. Thousands of small banks had no deposit insurance. Investors bought stocks “on margin,” borrowing most of the price. Europe owed large war debts and depended on American loans to pay them.
The crash and the collapse. Stock prices fell sharply on 24 and 29 October 1929. The Dow Jones average, about 381 at its 1929 peak, fell to about 41 by July 1932 — a loss of nearly 90 percent. The crash alone did not cause the Depression, but it destroyed wealth and confidence. Then came waves of bank failures: about 9,000 banks failed between 1930 and 1933, and depositors lost their savings.
Four explanations. (1) Demand collapse. Following John Maynard Keynes, many economists argue that spending fell — consumers, businesses and foreign buyers all cut back — and without demand, firms cut production and jobs in a downward spiral. The remedy is government spending. (2) Monetary contraction. Milton Friedman and Anna Schwartz argued in 1963 that the Federal Reserve let the money supply fall by about a third as banks failed, turning a recession into a depression. In the reading, a Federal Reserve governor accepts their verdict. (3) The gold standard. Barry Eichengreen showed that countries tied to gold had to keep interest rates high to protect their reserves, and that the nations that abandoned gold earliest recovered first. (4) Structural weakness and trade. Inequality, farm debt and the Smoot-Hawley tariff of 1930, which raised duties and provoked retaliation, weakened the economy; most economists think the tariff made things worse but was not the main cause.
What leaders did. The Federal Reserve raised interest rates in 1928-1929 to curb speculation, did little to stop the bank runs, and raised rates again in October 1931 to defend the dollar’s gold value. Hoover did more than his reputation suggests: he urged business to hold wages, expanded public works, and in 1932 created the Reconstruction Finance Corporation to lend to banks and railroads. But he opposed direct federal relief to individuals, and in 1932 signed a large tax increase to balance the budget. When the Bonus Army of unemployed veterans camped in Washington that summer, the army drove them out. Roosevelt, inaugurated in March 1933, declared a national bank holiday, reopened sound banks under federal inspection, created deposit insurance (FDIC) and took the country off the gold standard.
Skill: indicators. HI.6 asks you to apply economic indicators. The unemployment rate is the number of unemployed divided by the labor force. Worked example: roughly 13 million unemployed out of a labor force of about 52 million is 13 ÷ 52 = 0.25, or 25 percent. Each explanation predicts different evidence: the monetary view predicts that money supply fell before output did; the gold view predicts faster recovery after leaving gold. HR.3 asks you to judge each interpretation by how well its evidence supports it.
Reading: Two laws and an apology
Federal Reserve Act, 23 December 1913, title; Tariff Act of 1930 (Smoot-Hawley), title; Ben S. Bernanke, remarks at the Conference to Honor Milton Friedman, University of Chicago (8 November 2002), published by the Board of Governors of the Federal Reserve System · Public domain (U.S. government works)
Bernanke was a Federal Reserve governor speaking at Milton Friedman’s ninetieth birthday. Whose explanation of the Depression is he accepting?
Federal Reserve Act (1913): An Act To provide for the establishment of Federal reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes.
Tariff Act of 1930: An Act To provide revenue, to regulate commerce with foreign countries, to encourage the industries of the United States, to protect American labor, and for other purposes.
Bernanke (2002): Regarding the Great Depression. You’re right, we did it. We’re very sorry.
Formative check
Work through these before moving on. They are not graded — they tell you, and your teacher, whether the standard below has landed yet.
About 13 million people are unemployed and the labor force is about 52 million. What is the unemployment rate?
Why did Congress create the Federal Reserve in 1913?
Herbert Hoover took no federal action against the Depression.
Complete the chart: for each of the four explanations, state its claim, the evidence that supports it, and the evidence it struggles to explain. Then write a paragraph (150-200 words) ranking them and explaining what evidence would change your ranking. Use Bernanke’s remarks as one piece of evidence and say what his position and audience add to or take from its weight.
How confident are you that you can explain and weigh the main explanations of the Great Depression and the responses of the Fed, Hoover and Roosevelt?
Practice
Work these on paper or in your notebook, then open Check your answer. Aim for all of Fluency and Application; try at least one Challenge.
Printable version: this unit’s practice workbook (PDF)
Fluency
Build speed and accuracy with the core skill.
- Order: Reconstruction Finance Corporation created; Black Tuesday; Federal Reserve Act; Smoot-Hawley Tariff; national bank holiday.
Check your answer
Answer: Federal Reserve Act (1913); Black Tuesday (29 October 1929); Smoot-Hawley (1930); RFC (1932); bank holiday (March 1933). - Define ‘buying on margin’ and explain why it made the 1929 crash worse.
Check your answer
Answer: Buying stock with a small down payment and borrowed money. When prices fell, borrowers had to sell to repay loans, pushing prices down further. - About 13 million people are unemployed in a labor force of about 52 million. Compute the unemployment rate.
Check your answer
Answer: About 25 percent.13 ÷ 52 = 0.25.
Application
Use the skill in context. Show your reasoning.
- Source Bernanke’s 2002 remark to Milton Friedman: ‘Regarding the Great Depression. You’re right, we did it. We’re very sorry.’ Who was speaking, in what role, and which explanation of the Depression does it support? How much weight should it carry?
Check your answer
Answer: Ben Bernanke, then a Federal Reserve governor, at Friedman’s ninetieth birthday conference. It endorses the monetarist explanation that the Fed let the money supply collapse. It carries weight because an official of the institution concedes its failure, but it is a celebratory remark, not a full analysis, and other explanations still apply. - Read the title of the Federal Reserve Act: it was meant ‘to furnish an elastic currency.’ Corroborate with the lesson: what problem was this solving, and did the Fed deliver an elastic currency in 1930-1933?
Check your answer
Answer: Repeated panics (1873, 1893, 1907) caused by an inflexible money supply and no lender to banks. In 1930-1933 the Fed let the money supply fall by about a third as banks failed, so by the monetarist account it failed at the task it was created for. - The stock market crashed in October 1929 and the Depression followed. Did the crash cause the Depression?
Check your answer
Answer: Model answer: the crash destroyed wealth and confidence, but it does not by itself explain a decade-long depression. Strong answers bring in at least two of the lesson’s explanations — collapsing demand, monetary contraction, the gold standard, structural weakness and trade — and explain how they interacted.
Review
Keep earlier skills sharp.
- Semester A review: which 1896 speech attacked the gold standard with the image of a ‘cross of gold’?
Check your answer
Answer: William Jennings Bryan’s speech to the Democratic National Convention.