The Great Depression vs The Great Recession - Essay Example

Yu Chen Smith Econ 314 November 24, Comparing the Great Depression to the Great Recession Introduction The 2008-2009 recessions awakened a great debate on its relations to the 1930s great depression. The great depression that began 1929 and led to the stock market crash and, on the other hand, the great recession that lead to the global crisis of that began in 2007 were the biggest economic crises that the world has ever experienced (Navarro, 64). The breadth and depth of the both crises and in particular the suffering that resulted from the great depression is legendary. The global financial crises that lead to recession in 2007 had been predicted to lead to depression. Economists have often compared the two economic bad that have affected people throughout the world. This paper shall provide a comparative discussion on the two economic phenomena and draw parallels and differences on the two. To achieve this, the essay shall provide an outline understanding of the events that lead to the 1930s great depression, and the economic policy responses that were executed to handle the situation, and thereafter provide an understanding of the events that precipitated the 2008-2009 recession and the policy responses. Finally this paper shall provide a discussion of the major points raised by analysis of both phenomena. Causes of the Great Depression and Recession The exact cause of the market crash that lead to the great depression in the 1930s has been a subject of great debate, in as much as most economists contend that the 1929 New York market crash was just the smokescreen of the great depression; however, the crises are more complicated and multifaceted (Eichengreen et al., 53). The great depression affected every bit of the world economy: manufacturing, agricultural, financial, political and social, and it is deemed the longest crisis with grave consequences. Much like the global financial crisis that occurred in the late 2000s, the United States led the way, and soon spread to the rest of the world. After the First World War, the period in the 1920s was synonymous with a economic boom, and the world economy was enjoying a period of improved growths, and in a similar manner the United States experiencing high growths was being referred to as the roaring twenties. The economic boom created a situation in which stock prices rose in every sector of the United States, and was not only confined to real estate; in fact, Galbraith (16) insists that between May 1924 and December 1925, there was an average of eighty percent rise in stock prices. To maximize their income on investment that were escalating, investors borrowed heavily, but economic theory always predicts that a burst must be the end result of a price bubble and this was not different. Thereafter, investors after realizing that there was a burst, they began to panic sell their stock, and the end result was a depression that lasted the entire decade. The economic reality of the depression was apparent in the world economy and the US economy in particular, as the Gross National Product contracted from $104.4 billion to $56.6 billion in 1933 (Chirot, 88). The resulting social consequences was grave as a quarter of the US labor force became unemployed by 1933, and in fact, this was the worst situation during the great depression (Chirot, 88). The great recession during the 2008-2009 had its fair share of problems, and during this period, estimates of 8.7 million jobs were lost. Unemployment rate rose from 4.1% to 10% that is an aspect that left many young generations idle and thus could not be independent. The gross domestic product of America during this period shrunk by 5.1% that clearly indicate it is the worst economic crisis to occur in America after the great depression. The major cause of the great recession has been pointed out as the credit crunch, too much borrowing that hampered the economy. Fundamental Analysis The two economic crises have been analyzed in varying angles, and different professionals have come up with different opinions regarding the similarities and differences. Economists have provided varying accounts and analysis of the events. There are a new school of economists who argue that the great depression was far harsher than the great recession. On the other hand, there are other economists who point out that the latter could have been worse than the former. Egan (2014), quoting Ben Barmake a former head of the Federal Reserve remarked that the great recession could have been the greatest crisis, when compared to the great depression. The economist provides solid evidence that forms a crucial basis for any individuals trying to analyze the situation in the consideration of what happened before the great depression. After the World War 1, America experienced enormous economic growth that led to the improvement of the living standard of the Americans. The people who were working in farms shifted their areas of interest and moved to the cities in search of jobs and the priorities that come with living in the urban centers. The number of people in the middle-class level increased significantly (Essenburg 57). The increase in the level of people in the middle-class level led to a significant increase in the government expenditure. An example of such a situation is the acquisition of the cars by people. The citizens even in the rural areas asked the government to build for them roads. The action to which the government obliged led to extra expenditure in a venture that was not profitable in anyway, and economists think that such expenditure might have led to high magnitude of the great depression (Rothbard 19). In comparison to the great recession under the leadership of President Obama, the situation is rather different. The intensity of the recession is not that much because the government had safety measures to control the situation, and Watkins (81) in his work on the great depression mentions the case of unemployment. The government laid of an extension of the payment plan of those who had lost their jobs thus reducing the intensity of the situation on the economy. Comparison between the two can be analyzed from different perspectives. The first angle of comparison is the cause of the economic crisis. A closer look clearly shows that the main cause of the crisis of the two scenarios is the federal government. The federal government during the period of 1920s kept the interest rates low artificially and then all of a sudden raised the rates in 1929 (Rothbard 40). The reason for raising the rates was to bring to a halt the boom in borrowing of funds and thus maintain the liquidity ratio in the economy (Rothbard 40) It all did not go well as taking this step affected investment and reduced the rate at which people invested. Not only did it affect the upcoming of new ventures but also led to a limitation of the expansion of the already existing businesses. During this time is when president Hoover agreed to the Sky-High tariffs that led to a constraint on the American business especially the export and import business by many investors. Adding salt to the wound, the president Hoover signed to a law a bill that led to an increase in the amount of tax paid that led to a great discouragement of entrepreneurship. The cause of the great recession occurred during the 1990s. It took place when the American government was encouraging ownership of homes. It made the mortgage department consider people who were not credit worthy thus getting a loss (Sperry 220). The market for housing took an unexpected turn, and this led to the majority if the banks in America to collapse. The government after noticing this it tried to bail out certain banks and some corporations. According to Nicholson and Christopher (541), these actions by the government could have worsened off the situation and led to instability and uncertainties which economists think could have contributed to the widening of the recession. Roosevelt during the great depression raised the tax rates. The rates included both the income tax and the excise tax. During the year 1932, the federal government pushed to 79% the top level of marginal tax. A handful paid the tax with many Americans falling on the 50% bracket. Majority of the entrepreneurs had to give away more than 50% of the income that exceeded a certain level (Carbone 61). The failure to get incentives that guarantee many entrepreneurs to make capital investment was not available making the investors invest in tax-exempt bonds, foreign banks, and art collection. The amount of capital that was channeled towards investment that can create employment was minimal thus in fueling unemployment rate in the country was skyrocketing on a daily basis (Carbone 62) Further issue on tax is seen during the World War II when the concerned authority raised the tax rate of income above $200000 to 94%. It led to a further discouragement of not only investment in new ventures but also the expansion if the existing business to realize more profits by reaching out to a wider market is discouraged (Consumer Education 1968). Under the leadership of president Obama, taxes are raised with the future consumption of certain products being the target. The taxes are raised on products such as cigarettes, soft drinks, and plane tickets (Sperry 122). An increase in the amount of charged tax will mean hike of prices of the product, reduced consumption and thus less profit realized by the production companies. Matters get worse with the consideration of the chain of supply that is from the producer to the consumers through the chain of supply that also need to make profits from the sale of the product. Moreover, the increased tax causes an increase in the overall government spending, Though Braude (125) refutes this claim and asserts that taxes we not the proximate cause of the great economic recession. Scapegoat A series of spending of a large amount of money without recovery and increasing of tax rates is dangerous for any particular politician. Roosevelt is not an exemption in this case. The politician had an easy way out by placing blames on the Wall Street bankers and even gave them a name to symbolize they were the enemy to the economic stability of the country at that time. The blame game by Roosevelt was further extended to the top businessmen in America. Roosevelt blamed them for holding back capital and the refusal to invest which would lead to things such as improved employment rates in the country. Roosevelt was escaping the fact that increased tax rates and bank rates has made the investors afraid to venture into business as there is an increase in the level of risk in terms of making losses, and it can be argued that the large investors are also discouraged by the reduced labor supply and high tax that limit the profits to be realized. A similarity is this case is seen when president Obama also attacks not only the Wall Street bankers but also the corporate investors. The president is against the profits realized by some of these companies and also the interest charged by some the banks. The leader takes advantage of the fact that the majority of the citizens do not understand the role of the government and the central bank in controlling the amount of cash in circulation. The people do not understand the role of the government in controlling the overall economic status of a country. Further similarity in this aspect is seen between the two leaders as a political strategy is being applied to win the hearts of the people for re-election. Through the creation of resentment to a certain group people, the leaders aim at gaining the hearts of the public by acting good and showing the public where the current mistake lies. it can be argued that the promises to cover the potholes help the leaders gain public trust and therefore being elected again. Enormous spending by the federal government The responses of President Roosevelt and President Obama in these situations are similar. Unlike other presidents who had existed earlier, the two leaders only talked about balancing the expenditure to avoid a crisis in the points of noticing the economic status is at stake. The earlier presidents such as President Cleveland took charge and reduced the expenses of the federal government to great extend in order to save the economy from crashing (Folsom, 238). Roosevelt undertook a measure with the intention of saving the economy but instead did more harm than good. Roosevelt formulated the Agricultural Adjustment Act (AAA) which was aimed at making payments to the farmers in order for them not to produce. Hoover also came with the finance corporation that gave money to the banks and the existing large corporations. Undertaking this act leads to an increase in the amount of money in circulation and thus adversely affecting the economic status of a particular nation in a dangerous way. Furthermore, the effect was further felt after the Hoover increased the amount of money given to the Federal Farm Board, the Reconstruction Finance Corporation and public works (Folsom 122). A similarity to the preceded explanation is the current situation under the leadership of President Barrack. The president targets the interest groups in different places for the spending. The similarity of the situation is further seen in a scenario where the current American president signed into a law that allowed the disbursement of $787 billion. The money acted as a stimulus package which sent to various regions targeting different voting groups. Such amount of money if not properly managed leads to an economical imbalance. The president also agreed to a sign what is known as a job bill that would see large amounts of money sent to the congressional districts. Other many occurrences of such scenarios are seen where the leader signs in a bill known as the cap-and-trade bill which would see to it there is universal health coverage but in turn would increase the federal debt. Several factors in consideration one of the major similarities between the Obama leadership and Roosevelt is the significant increase in federal debt. During the reign of Roosevelt, the national debt doubled within the first two terms of leadership. According to a 2009 congressional debate, the national debt was expected to double within the next five years and triple in ten years (Gohmert 10544). Failure in expenditure Despite the increase in the level of spending by the two leaders being analyzed, the rate of unemployment still went up. During the 1930s, unemployment fluctuated but the nation did not recover from this national threat. A measure of how the situation was getting worse is in April of 1939. It was the period towards the end of Roosevelts second term in office, and the unemployment rate had dropped from 25 percent to 14.3 percent (Kazin 528). The aspect of comparison comes in when Obama took office with the unemployment rate being eight percent. After a short while in the office, the rate of unemployment went beyond ten percent, yet currently the rate of unemployment is reported at 5.8 percent (Schwartz 2014). It was a tough puzzle for the president and the advisors as they thought that an increase in expenditure would reduce the rate of unemployment. However, the president still made arguments that despite the scenario, the increased spending was still essential in an attempt to save the already existing jobs. Several economists made observations on the expenditure by the public works. It led to the realization that the jobs created by this increased spending led to a significant loss of jobs in other sectors such as the private sectors. Foundational Theories The situation in both the scenarios took place due to the interaction of the imbalances in the economy. The great depression happened after the world war which is what brought the imbalance. The awesome progression of the economy during the nineteenth century was brought to a halt by the war. During this period, he American economy was flourishing, and business and the manufacturing sector was setting standards on the international market of different types of products. Nevertheless, America was not ready to assume responsibility in the key control of the international economy. A clearer way to view the imbalance is the consideration of the capital movement. The Gold Standard well explains the imbalance, and it is an explanation given by economist known as David Hume (Pogány 57). The currency during the early nineteenth century was gold with some values attached to it. If the economy of one country fails or rather drops then one of the consequences becomes the drop in imports and an increase in the quantity of exports. Consequently, this will lead to more countries in the international market strive to conduct business with the country due to attractive value of the products. The increase in supply of the amount of money in the economy of a particular nation continuously makes the currency weaker and chances of survival in the international market weaker, and it can be argued that the effect is further felt on the other countries as the sold product is available in abundance reducing the trade even among the other economies. Response of Fiscal and Monetary Responses A comparison of the response of both the monetary policies and also the fiscal policies shows some differences. The response in the todays American economy is swifter and significantly vigorous compared to the time under the leadership of Roosevelt. Before president Roosevelt took over, the economy was much balanced compared to the state that the economy was in when the current American president took over. In 2007, the American budget was already on crisis. It posed pressure on the elected person as the president came into power (Temin 48). The pressure was not only on the president but also on the advisors as the political analysts, and the opposition had eyes on the strategy that was going to be used on establishing a solution to the situation. In other words, President Roosevelt and president Obama took charge of the country that was at totally different economic status. Roosevelt took charge a country that was in a better economic status compared to the status American economy was in when President Obama and he pressed for fiscal stimulus strategy meant to to tackle the negative effects such as a soaring unemployment rate and increasing foreclosure rates (Brezina 4). Difference in Monetary Policies Analysis by economists Friedman (1963) indicate that in the 1930s the period through which the great depression was taking place, the Fed had some degree of tolerance on the reduction or rather money supply shrinkage. It was achieved by the vice versa reaction to the problem of liquidity and insolvency. Instead of injecting more money into the economy, the responsible authorities did a sanction involving the getting of money from the banks facing difficulties and thus saving balance sheets of such banks from further losses. Undertaking this action saw to it that the economical imbalances are reduced to some extent. However, the action affected so many banks that were experiencing financial difficulties at that time and thus reducing the rate and supply of credit and money to the economy. The difference of the two situations is seen whereby the Fed learned the lessons from the early situation and in 2008. Instead of withdrawing money from the economy more money was being channeled, and the financial institutions facing difficulties are sorted out and one can argue that the policies that exist concerning the monetary supply and liquidation also indicate that the Fed learnt a good lesson. Difference in monetary institutions Before President Roosevelt took over, there were no policies regarding the banking deposit insurance. It was even after Roosevelt had taken over on the March of 1933 that the policy began. In the recent economy or rather under the leadership of President Obama, a policy that demands insurance policy up to 100 hundred thousand $ is in place. The policy has been part of the American financial structure for a long time even before the occurrences of the great recession of 2008 (Bordo 154). The increase of the amount of bank deposit insurance to up to 250 hundred thousand $ during the scenario of intensifying financial crisis that hit the American economy made the security measures even stronger. In comparison, if such policies of deposit insurance were being practiced during the earlier period before the great depression, the many banks could not have experienced failure. In relation to this point, during that time there was no capital need for the banks that is the scenario in not only American economy but also all over the globe. The other divergence between the great recession and the great depression is the fact that at the beginning of the great depression, America was still operating on gold standards. The attempt to ensure the gold parity on the international market is maintained collided with the application of monetary policy to counterbalance the issue of unemployment during the early periods of the great depression (Chacko 140). This implied that the monetary policies aligned to the gold standards were restrictive, yet expansive in principle, and through the intervention as proposed by the Keynesian theory, it led to a mere scratch of the surface, ignoring the deep underlying issues. Under the leadership of Roosevelt, America was forced to change from the use of gold standards. In the current situation, the dollar is valuable than other currencies and thus the constraint experienced in the great depression is a bit different from the one experienced in the great recession. The dollar being the uniformed standard for international trade, and according to (Domitrovic 2) enough evidence point to the weak dollar in the run up to 2008 that may have been a contributing factor to the great recession. Informational capital Information kept by banks about customers is very crucial in the business sector. During the 1930s where the great depression was hitting the economy, most of the banks especially the local banks disappeared thus disappearing with vital information on the credit worthiness of the potential customers. One of the major factors in consideration for the output of a bank is the credit worthiness information on a particular customer even if it is from a different bank that the customer used to operate. Imperativeness of such information is seen from the point where a bank has to analyze the customers and risks involved in the supply of credit to a certain group of customers. Furthermore, importance of such information is seen where large amounts of money is involved and borrowed by large organization and the determination of risk involved in the lending to such big institutions. The reduction of the supply of credit by the banks due to lack of the necessary information had an effect on the economy during the great depression under the leadership of Roosevelt (Graham 165). In comparison to the situation during the great depression, this was not the case during the great recession of 2008. The Fed avoided such a scenario by ensuring they take over the insolvent financial institutions or organized for the insolvent institutions to be taken over by worthy institutions. By the Fed doing this, the loss of vital information regarding the credit worthiness and organizations was maintained thus the credit supply by financial institutions was not a problem (Rothbard 54) Conclusion The two economic crises are the greatest to hit the American economy, and the world economy in general. It is crucial for the economists and the involved parties to understand great depression and depression well for the purpose of avoidance of such scenarios in the future. Economic planning and forecasting measures should be put in place to ensure that the danger on the economy of a particular nation can be seen. A good economic planning strategy is also vital in ensuring that the crisis affecting almost all the economic sectors making it hard to recover is avoided Works Cited Brezina, Corona. Americas Recession: The Effects of the Economic Downturn. New York: Rosen Pub, 2011. Print. Bordo, Michael D, and Harold James. The Great Depression Analogy. 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