The Great Depression of 1929

The Depression caused many farmers to lose their farms. At the same time, years of erosion and a drought created the “Dust Bowl” in the Midwest, where no crops could grow. Thousands of these farmers and other unemployed workers traveled to California to find work. Many ended up living as homeless “hobos” or in shantytowns called “Hoovervilles," named after then-President Herbert Hoover.

Bernanke highlighted several key Fed mistakes:

• The Fed began raising the Fed Funds rate in the spring of 1928, and kept raising it through a recession that began in August 1929. This led to the stock market crash in October 1929.
• When the stock market crashed, investors turned to the currency markets. At that time, dollars were backed by gold held by the U.S. Government. Speculators began selling dollars for gold in September 1931, which caused a run on the dollar.
• The Fed raised interest rates again to preserve the value of the dollar. This further restricted the availability of money for businesses, causing more bankruptcies.

• The Fed did not increase the supply of money to combat deflation.
• As investors withdrew all their dollars from banks, the banks failed, causing more panic. The Fed ignored the banks' plight, thus destroying any remaining consumers’ confidence in banks. Most people withdrew their cash and put it under the mattress, which further decreased the money supply.

Bottom line...thanks to the Fed, there was just not enough money in circulation to get the economy going again. Instead of pumping money into the economy, and increasing the money supply, the Fed allowed the money supply to fall 30%.

However, the extent of the Great Depression was so great that government programs alone could not end it. Unemployment remained in the double-digits until 1941, when the U.S. entry into World War II created defense-related jobs.

However, there is only so much monetary policy can do to offset fiscal policy. The incredible size of the U.S. current account deficit, and the national debt, could possibly trigger an economic panic that would be difficult for monetary policy to affect. No one really knows, since the current U.S. debt level is unprecedented.

The current thinking is that a Great Depression could not happen again because the global economy is much more integrated, and all central banks are working together to make sure it doesn’t. (Source: The Federal Reserve Board web site, “Remarks by Governor Ben Bernanke at the H. Parket Willis Lecture in Economic Policy”, March 2, 2004, FDR Library Web Site.)

(Article updated December 17, 2010)