What Was the Great Depression?

What Was the Great Depression?

12 Min.

The Great Depression, which occurred between 1929 and 1941, is considered the longest and most significant economic downturn in modern world history. The recession was caused by investing in the speculative market. It led to the stock market crash of 1929, resulting in a significant loss of nominal wealth. While the stock market crash was an important factor, most historians and economists agree that other elements, such as inactivity followed by overaction by the Fed, also contributed to the Great Depression. Both Presidents Hoover and Roosevelt implemented government policies to alleviate the impact of the economic downturn.


The term "Great Depression" signifies the most extensive and enduring economic downturn in recent global history, spanning from 1929 to 1941. This pivotal period coincided with the United States' entry into World War II in 1941, marked by several severe economic setbacks, including the infamous 1929 stock market crash and the banking crises of 1930 and 1931. Economists and historians frequently regard the Great Depression as one of the 20th century's most monumental, if not the most catastrophic, economic calamities.

The Forgotten Depression and the Stock Market Crash

In the brief economic downturn of 1920-1921, referred to as the Forgotten Depression, the U.S. stock market experienced a nearly 50% decline, and corporate profits plummeted by over 90%. However, the subsequent decade, famously known as the Roaring Twenties, witnessed substantial economic growth as the American populace enthusiastically embraced the stock market.

Speculative fervor permeated the real estate and New York Stock Exchange (NYSE) markets, driven by a loose money supply and heightened margin trading. By October 1929, equity prices had surged to historic highs, with price-to-earnings ratios exceeding 19 times after-tax corporate earnings. The Dow Jones Industrial Index (DJIA) had also skyrocketed by 500% in just five years, ultimately leading to the infamous stock market crash.

The cataclysmic burst of the NYSE bubble occurred on Black Thursday, October 24, 1929, followed by a brief rally on Friday, the 25th, and a half-day session on Saturday, the 26th. However, the subsequent week witnessed the devastating Black Monday (October 28) and Black Tuesday (October 29), resulting in a DJIA decline of more than 20% over those two days. The stock market would ultimately plummet by nearly 90% from its 1929 peak.

The repercussions of the crash reverberated across the Atlantic to Europe, triggering financial crises, including the collapse of Austria's most significant bank, the Boden-Kredit Anstalt. By 1931, the economic catastrophe had fully engulfed both continents.

The 1929 Stock Market Crash: Catalyst for Economic Turmoil

The explosive 1929 stock market crash obliterated both corporate and private nominal wealth, plunging the U.S. economy into a downward spiral. At the outset of 1929, the U.S. unemployment rate stood at a modest 3.2%. However, by 1933, it had skyrocketed to a staggering 25% and beyond.

Despite unprecedented government interventions and fiscal spending efforts by the Hoover and Roosevelt administrations, the unemployment rate remained stubbornly high, exceeding 18.9% in 1938. Real per capita gross domestic product (GDP) failed to surpass 1929 levels, a situation that persisted until the late 1941 Japanese attack on Pearl Harbor.

While the stock market crash is often considered the trigger for the decade-long economic downturn, historians and economists concur that it alone did not instigate the Great Depression. It also falls short of elucidating the reasons behind the profound and enduring nature of the slump. Many distinct events and policies collectively contributed to the Great Depression, prolonging its impact throughout the 1930s.

The Federal Reserve's Missteps and Their Impact

In its early years, the Federal Reserve, established in 1913, struggled with managing money and credit before and after the 1929 crash. Renowned monetarists like Milton Friedman and former Federal Reserve Chair Ben Bernanke have acknowledged this mismanagement.

During the period following the 1920-1921 depression recovery, the Federal Reserve underwent significant monetary expansion. Between 1921 and 1928, the total money supply surged by $28 billion, marking a substantial 61.8% increase. Concurrently, bank deposits witnessed a 51.1% uptick, savings and loan shares soared by 224.3%, and net life insurance policy reserves leaped by 113.8%. All of these developments occurred after the Federal Reserve had reduced required reserves to 3% in 1917, with gains in gold reserves from the Treasury and the Fed totaling a mere $1.16 billion.

The Fed's policy of increasing the money supply and maintaining low-interest rates during the 1920s fueled a rapid expansion that preceded the eventual collapse. This surplus money supply predominantly inflated the stock market and real estate bubbles.

However, after these bubbles burst and the market crashed, the Federal Reserve adopted an opposite approach, slashing the money supply by nearly a third. This reduction created significant liquidity challenges for numerous small banks and stifled hopes for a swift recovery. Despite these challenges, the open trade routes established during World War II remained operational throughout the Great Depression, ultimately aiding the market's recovery.

The Federal Reserve's Role in Economic Crises

Historically, before the existence of the Federal Reserve, bank panics were relatively short-lived, typically resolved within weeks. In such cases, larger private financial institutions would extend loans to bolster smaller, more resilient banks, ensuring the financial system's stability. An illustration of this occurred during the Panic of 1907.

During this event, intense selling pressure triggered a downward spiral on the New York Stock Exchange (NYSE) and prompted a bank run. In response, the prominent investment banker J.P. Morgan rallied support from Wall Street to inject substantial capital into underfunded banks. Ironically, the Panic of 1907 played a pivotal role in the government's decision to establish the Federal Reserve, reducing its reliance on individual financiers like Morgan.

In the wake of Black Thursday, several New York banks attempted to restore confidence by purchasing significant quantities of blue-chip stocks at prices exceeding market rates. While this temporarily halted the panic, the following Monday witnessed renewed frenzied sell-offs. Over the decades since 1907, the stock market had grown beyond the capacity of individual efforts, and only the Federal Reserve possessed the resources to stabilize the U.S. financial system.

However, during the critical period between 1929 and 1932, the Federal Reserve failed to inject sufficient cash into the economy, allowing the money supply to dwindle and permitting the closure of thousands of banks. Regulatory constraints at the time made it exceedingly difficult for banks to expand and diversify adequately to withstand significant deposit withdrawals or runs.

While the Federal Reserve's actions may appear puzzling, some argue that their reluctance to bail out imprudent banks stemmed from a fear that such actions would encourage future fiscal irresponsibility. Consequently, historians posit that the Federal Reserve may have inadvertently contributed to the economic overheating and exacerbated the existing dire economic conditions.

Herbert Hoover's Post-Crash Measures

Contrary to his "do-nothing" reputation, Herbert Hoover took active steps in response to the economic crash. Between 1930 and 1932, Hoover initiated:

  1. A 42% increase in federal spending, channeling funds into extensive public works programs like the Reconstruction Finance Corporation (RFC).
  2. The implementation of new taxes to fund these programs.
  3. The enforcement of a 1930 immigration ban to prevent an influx of low-skilled workers into the labor market.

Hoover's primary concern was the potential wage cuts resulting from the economic downturn. He believed that maintaining high prices was essential to sustain robust paychecks across industries. However, this strategy hinged on consumers' ability to afford these elevated prices.

Unfortunately, the crash had left the public financially strained, curtailing their ability to spend lavishly on goods and services. Additionally, overseas trade was hampered as foreign nations were unwilling to purchase overpriced American goods, mirroring the reluctance of American consumers. Many of Hoover and Congress' subsequent interventions, including wage controls, labor regulations, trade restrictions, and price controls, adversely affected the economy's adaptability and resource allocation.

U.S. Protection Measures

In response to the grim economic reality, Herbert Hoover turned to legislative actions to support prices and, consequently, wages by limiting competition from cheaper foreign products. Aligning with protectionist traditions, and despite opposition from over 1,000 economists, Hoover enacted the Smoot-Hawley Tariff Act of 1930.

Initially aimed at safeguarding the agricultural sector, the act evolved into a broad-based tariff, imposing substantial duties on over 880 foreign goods. In retaliation, nearly three dozen countries implemented countermeasures, leading to a sharp decline in imports from $7 billion in 1929 to just $2.5 billion in 1932. By 1934, international trade had plummeted by 66%, exacerbating global economic challenges.

While Hoover's intentions to preserve employment and income levels were well-founded, his encouragement of businesses to maintain high wages and avoid layoffs, even when economic conditions dictated otherwise, deviated from historical patterns. In previous cycles of recession and depression, the United States had experienced one to three years of low wages and unemployment before falling prices triggered a recovery. Unable to sustain these artificially elevated levels, coupled with a significant reduction in global trade, the U.S. economy deteriorated from a recession into a full-blown depression.

The Transformative Era of Franklin Roosevelt

In 1933, President Franklin Roosevelt assumed office with a pledge of sweeping change. The New Deal he introduced marked an innovative and unprecedented array of domestic initiatives and legislations aimed at bolstering American industry, reducing unemployment, and safeguarding the public.

Loosely rooted in Keynesian economics, the New Deal operated on the premise that government could and should stimulate the economy. It set ambitious objectives to develop and maintain national infrastructure, achieve full employment, and ensure fair wages. These objectives were pursued by implementing price, wage, and production controls.

Critics contend that Roosevelt continued many of Hoover's interventions, albeit on a grander scale. He maintained a strong focus on price support and minimum wages while abandoning the gold standard and prohibiting the hoarding of gold coins and bullion. Additionally, Roosevelt addressed monopolistic business practices and established numerous public works programs and job-creation agencies. Under the Roosevelt administration, farmers and ranchers were incentivized to curtail or reduce production, even as excess crops were destroyed, creating a poignant paradox amid the pressing need for affordable food.

To fund these initiatives, federal taxes experienced a threefold increase between 1933 and 1940. These tax hikes encompassed excise taxes, personal income taxes, inheritance taxes, corporate income taxes, and an excess profits tax, funding not only the New Deal but also new programs like Social Security.

The New Deal: Mixed Outcomes

The New Deal achieved notable successes, including reforming and stabilizing the financial system and instilling public confidence. President Roosevelt's decisive action during the bank crisis 1933 included a week-long bank holiday to prevent institutional collapse due to panicked withdrawals. Subsequently, a construction program featuring dams, bridges, tunnels, and roads was launched, providing employment opportunities through federal work programs for thousands.

However, despite some economic improvement, the recovery was insufficient to unequivocally classify the New Deal as a success in pulling America out of the Great Depression. Historians and economists offer varying perspectives on the reasons behind this:

  1. Keynesians argue that Roosevelt's government-centric recovery plans lacked adequate federal spending to drive recovery effectively.
  2. Some contend that Roosevelt's efforts to accelerate immediate improvement, rather than allowing the natural economic/business cycle to follow its typical two-year course of hitting bottom before rebounding, may have prolonged the depression, akin to Hoover's approach.
  3. Research by economists at the University of California, Los Angeles, estimated that the New Deal extended the Great Depression by at least seven years. However, it's worth considering that the rapid recovery, characteristic of post-depression periods, might not have occurred as swiftly post-1929, as it marked the first time the general public, not just the Wall Street elite, suffered substantial losses in the stock market.

American economic historian Robert Higgs proposed that Roosevelt's swift and revolutionary introduction of new rules and regulations made businesses apprehensive about hiring or investing. Meanwhile, Philip Harvey, a professor of law and economics at Rutgers University, suggested that Roosevelt prioritized addressing social welfare concerns over creating a Keynesian-style macroeconomic stimulus package. The New Deal also ushered in social welfare policies, leading to the establishment of programs encompassing unemployment, disability insurance, old-age benefits, and widows' benefits through Social Security.

World War II's Economic Impact

The Great Depression seemed to abate abruptly around 1941-1942, as indicated by employment and GDP statistics. This coincided with the United States' entry into World War II, leading to a significant decline in the unemployment rate, plummeting from eight million in 1940 to just over one million in 1943. However, more than 16 million Americans were conscripted for military service, contributing to a growth in the real unemployment rate in the private sector.

The wartime period witnessed a decline in the standard of living due to shortages brought about by rationing, coupled with substantial tax increases to fund the war effort. Private investment dwindled from $17.9 billion in 1940 to $5.7 billion in 1943, and total private-sector production contracted by nearly 50%.

While the idea that the war conclusively ended the Great Depression reflects a fallacious perspective, the conflict set the United States on a path to recovery. It facilitated the reopening of international trade routes and the removal of price and wage controls. Government demand surged for affordable products, generating a substantial fiscal stimulus. Within the first year after the war's conclusion, private investments surged from $10.6 billion to $30.6 billion, with the stock market embarking on a bullish trajectory in just a few short years.


The Great Depression stemmed from an unfortunate amalgamation of variables, including the Federal Reserve's inconsistent policies, protective tariffs, and erratic government interventions. A shift in any one of these factors could have potentially shortened or averted this period of economic turmoil.

Debates persist regarding the appropriateness of these interventions. Nevertheless, enduring reforms from the New Deal, such as Social Security, unemployment insurance, and agricultural subsidies, remain integral to contemporary American society. The belief in the federal government's role during national economic crises has gained widespread support, contributing to the enduring significance of the Great Depression as a pivotal event in modern American history.

The Great Depression
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