However, a stock market crash could cause people to increase their liquidity preference which might lead them to hoard money.In the August 1990 issue of The Quarterly Journal of Economics, Christine D. Romer writes that "the negative effect of stock market variability is more than strong enough to account for the entire decline in real consumer spending on durables that occurred in late 1929 and 1930."
If a country has a gold standard, then hoarding money can make the money supply drop dramatically since a gold standard makes the quantity of money difficult for the government to control.
The existence of the gold standard linked economic conditions across countries to a much greater extent than is currently the case, and it is because of this linkage that the Depression was a worldwide event.and:
Except for minor adjustments, and the temporary suspensions of gold payments during wartimes, the price of gold was held standard from the establishment of the new United States of America in 1791 until gold was revalued in 1933.In "Gold Standards and the Real Bills Doctrine in U.S. Monetary Policy" (PDF), professor Richard Timberlake argues that the gold standard was not responsible for the Great Depression, since the Federal Reserve had not been following a strict gold standard prior to the onset of the Depression.
The Federal Reserve began expressing concern in early 1928 and at that time began a policy of monetary restriction in an effort to stem the stock market advance. This policy continued through May 1929. The monetary restriction was carried out by selling $405 million in government securities and raising the discount rate in three stages from 3.5 percent to 5 percent at all Federal Reserve banks.and:
the monetary expansion of 1927 is considered by many economists to be an important factor in setting off the U.S. stock market advances of the lates 1920s.
Hall and Ferguson also write that:
But a further irony is the fact that the very existence of the Federal Reserve caused banks to wait for the central bank to act and not turn to the solutions they had devised in the face of the banking crises of the nineteenth century.But even with all that bungling, it is not clear that we can lay responsibility for the Great Depression at the feet of the Fed.
Wages grew more slowly than output per worker, which suggests that corporate profits were rising. This change shows up as rising dividends, which constituted 4.3 percent of national income in 1920 and rose to 7.2 percent of national income by 1929 (Soule 1947, 284). Since 82 percent of all dividends were paid to the top 5 percent of income earners, this clearly helped contribute to the change in income inequality (Potter 1974).and:
But critics of that view contend that increase inequality of income and wealth is an unlikely candidate to cause an economic decline on the order of the Great Depression. Their criticism of the underconsumptionist view is that it ignores an obvious adjustment mechanism; if deficient demand for goods and services is caused by unequal distribution of income, then the price level would fall to cause the quantity of goods and services demanded to rise. Underconsumptionists respond that prices could not fall because of various rigidities built into the economic system (see, for example, Strikcer 1983-84).However, as economist Arnold Kling explains while reviewing Randall E. Parker's Reflections on the Great Depression, a collection of interviews of economists who lived through the Great Depression:
A number of myths that are popular in conventional histories of the Depression are punctured in Parker's book. For example, the Wikipedia echoes many textbooks in saying, "A fundamental misdistribution of purchasing power, the greatly unequal distribution of wealth throughout the 1920s, was a factor contributing to the depression." None of the economists interviewed by Parker cites this so-called causal factor.
In "Did France Cause the Great Depression?", economist Douglas Irwin argues:
This paper revisits the origins of the Great Depression to highlight the key role played by France. After describing France’s monetary policy in the late 1920s, particularly its gold accumulation and sterilization policy, the paper addresses two counterfactual questions. First, how much gold would have been freed up if the United States and France had kept enough only to cover their actual liabilities at their 1928 cover ratios? Second, to what extent can this “gold hoarding” explain the worldwide price deflation of the early 1930s?
The end of the Great Depression is often marked as December 1941, the same time that America became officially involved in World War II. Did World War II really end the Great Depression, though? It's useful to note that the economy had been in expansion since June of 1938, two and a half years before U.S. entry into the second World War and that the economy stopped expanding in February 1945, prior to the end of the war. In "Wartime Prosperity? A Reassessment of the U.S. Economy in the 1940s", Robert Higgs argues:
Relying on standard measures of macroeconomic performance, historians and economists believe that “war prosperity” prevailed in the United States during World War II. This belief is ill-founded, because it does not recognize that the United States had a command economy during the war. From 1942 to 1946 some macroeconomic performance measures are statistically inaccurate; others are conceptually inappropriate. A better grounded interpretation is that during the war the economy was a huge arsenal in which the well-being of consumers deteriorated. After the war genuine prosperity returned for the first time since 1929.It's easy to see that a war is simply a special case of deficit spending. Whatever the case is for deficit spending as a cure, war spending is clearly much weaker because the spending is not for productive purposes, but for destructive ones, no matter how justified the war might be.
Amazingly, doing nothing often
seems to be the correct response. The Depressions of 1907 and 1920
were both over within a year, even though the Federal government did virtually
nothing in response.