Contractionary Issues
The Contractionary Theory: The Great Depression itself was a time very similar to a deflationary gap, except that it lasted for an extended period of time. In this case the gap lasted approximately 5 years (1929-1934). During this period the money supply decreased, real GDP declined, stocks plumetted, savings fell, and unemployment rates soared.
http://www.shambhala.org/business/goldocean/depsupply.gif
The above graph illistrates the directly corrolation between the money supply and real gross domestic product. Everywhere money supply decreased gross domestic product followed suit. Unfortunately during the great depression the government failed to increase the money supply for upwards of 5 years, leaving the economy in a contractionary state. Should the government had taken steps to increase the money supply Gross Domestic Product most certainly would have rebounded in a much more timely fashion.
http://libertycorner.typepad.com/photos/uncategorized/private_saving_1929_2005.jpg
The graph above illistrates the severity of economic issues during the depression. Over the period from 1929-1934 americans gross national income fell from 15%-5%, in otherwords, americans were now saving 1/3rd of what they were previously. As a result people were less willing to invest money, which ultimately disrupted the cash flow within the U.S. economy.
http://www.amatecon.com/gd/djia.jpg
The graph above traces the Dow Jones Industrial Average over a 35 year duration 1915-1950. The Dow Jones itself is a very good indicator on how well the economy is doing. Following the stock market crash of 1929 the market fell astronomically. It fell approximately 75% over the following 5 years, mostly as a result of the entire nations populous being unable or unwilling to invest. With investors losing faith in the market and the lack of money to invest the market only had one place to go… down.
http://e1.newcastle.edu.au/coffee/pubs/briefs/graphics/proflecture7.jpg
With significantly less money to go around, businessmen could no longer get new loans and in many cases failed to get their old loans renewed, forcing many to stop investing or even operate their business. As a result, unemployment shot up and left the economy’s output considerably lower than it was accustomed to. Responsibility ultimately rested on the Federal Reserve, especially the New York branch, which was owned and controlled by Wall Street bankers. The Federal Reserve was not controlled by President Herbert Hoover or even the U.S. Treasury. It followed the policy suggestions of member banks and businessmen, not was the economy was dictating.
In Conclusion, what happens to the quantity of money directly effects what happens to the national income and to stock prices. The simple facts are this: during the great depression (that is the 5 years when the economy was in a contractionary stage), the U.S. failed to engage in expansionary fiscal policy, that is increasing government expeditures, increasing transfer payments, or decreasing taxes. As a result following the stock market crash of 1929 a chain reaction began that wouldnt be stopped until pre war production began for WWII. Once the money supply was cut, (as banks were failing) the economy fell to a servity seen nowhere else in U.S. history. GDP required a larger money supply to grow, people required a larger money supply to save and invest, businesses needed those investments to hire workers and survive. Ultimately the Great Depression was a depression that started in a deflationary gap, and thru the efforts of a decreased money supply and the stock market crashing (compelling investors to pull their investments and avoid the market all together), expansionary steps werent taken to pull the economy of its recession. Perhaps if the money supply had been increased, and expansionary fiscal policies pursued the great depression may have been called the great recession.
Bibliography:
“Milton Friedman: Why Money Matters.” 17 Nov. 2006. 25 Nov. 2006. <http://economistsview.typepad.com/economistsview/2006/11/milton_friedman.html>
“Money, Gold, and the Great Depression.” Bernanke, Ben S. 2 March 2004. 25 Nov. 2006. <http://www.federalreserve.gov/boarddocs/speeches/2004/200403022/default.htm>
“A Case of Unemployment.” Moore, Geoffrey H. 25 Nov. 2006. 25 Nov. 2006.
<http://www.ingrimayne.com/econ/EconomicCatastrophe/GreatDepression.html>
“The Great Depression and World War II.” 25 Nov. 2006. 25 Nov. 2006. <http://www.chass.utoronto.ca/~echist/lec9.htm>
