According to economist Ben Bernanke, to "understand the Great Depression is the Holy Grail of macroeconomics."
Macroeconomics, which didn't exist before the Great Depression, studies the overall functioning of an economy, focusing on aggregate measures like Gross Domestic Product (GDP), unemployment, and inflation. It examines how policies, such as government spending and monetary control, influence economic performance and stability.
With this approach in mind, the causes and resolution of the Great Depression can be achieved by combining John Maynard Keynesian economics with Ben Bernanke's (1953- ) focus on financial stability. This combined perspective provides a detailed insight into the economic downturn and the diverse policy actions that facilitated the recovery, emphasizing the significance of maintaining both financial and macroeconomic stability during times of economic crisis.
John Maynard Keyes
Familiar to us today in 2024, a Keynesian view of economic strategy to combat a fiscal crisis promotes active government intervention, including increasing government spending on infrastructure to create jobs, lowering interest rates to encourage borrowing, and accepting temporary deficits to finance these measures. In theory this supports providing financial aid to sustain consumption and investment. These actions aim to mitigate downturns and stimulate economic recovery by boosting aggregate demand.
The U.S. initially stayed on the gold standard during the early years of the Great Depression, which worsened the economic situation. The gold standard restricted the Federal Reserve's ability to expand the money supply, leading to deflation and deepening the economic downturn. It wasn't until 1933, with President Franklin D. Roosevelt, that the U.S. abandoned the gold standard domestically, allowing for monetary expansion and economic recovery. Staying on the gold standard delayed the recovery process and contributed to further deflation and economic hardship.
However, the end of the Great Depression cannot be solely attributed to this intervention. Economist Ben Bernanke in his writings, suggests that in tandem with a combination of historical, political, and philosophical factors, it was when certain governments chose to depart from the gold standard in the early 1930s crises that relief from the depression began. The countries that departed early on include the United Kingdom, Japan, Sweden and Denmark (all in 1931). Meanwhile, other nations opted to stick with the gold standard despite deteriorating circumstances (France, Belgium, and the Netherlands). The former countries that abandoned the gold standard were able to boost their money supplies and prices, resulting in swifter economic rebounds. Nations that opted out of the gold standard sooner tended to have faster economic recoveries.
Ben Bernanke was the Chairman of the Federal Reserve, the central banking system of the United States, from 2006 to 2014 and notably was at the helm of the U.S. economy at the time of the 2007-2008 financial crisis.
Bernanke also brought attention to the debt-deflation theory, initially proposed by Irving Fisher (1867-1947). As deflation took hold, the actual value of debt rose, resulting in increased default rates and added financial strain for households and businesses alike. This cycle of deflation and escalating debt burdens exacerbated the economic downturn, a phenomenon well-documented in contemporaneous accounts and economic studies from the era.
Returning back to government intervention, President Franklin D. Roosevelt led the New Deal, which marked a large shift towards Keynesian economic policies. The administration launched extensive public works initiatives like the Works Progress Administration (WPA) and the Civilian Conservation Corps (CCC) to create jobs and spur the economy. These projects, documented in official records and personal testimonies, provided instant relief and helped increase overall demand, in line with Keynesian concepts of stabilizing the economy through government involvement.
Nevertheless, the recovery began, as per Bernanke, with the move away from the gold standard. This shift permitted more flexibility in monetary policy. By departing from the gold standard, the United States and other nations could enact expansionary monetary measures, stabilizing prices and fostering economic growth.
Let's look at some details:
Historical records found at the Federal Reserve provide approximate values for gold per ounce during the 1930s to 1940s. Could we have broken out of the Great Depression with this limited value of gold?
1930-1933: The price of gold was fixed at $20.67 per ounce due to the Gold Standard.
1934: Following the U.S. Gold Reserve Act, the price was revalued to $35 per ounce.
1934-1940: The price remained at $35 per ounce as the gold standard was redefined.
Today, the current market price of gold per ounce stands at around $2,299.58. (Cloud Resource Group).
If the U.S. economy were still on the gold standard, the price of gold per ounce would be determined by the amount of gold backing the total money supply in circulation. To estimate this, we would need to calculate the ratio of the current money supply to the gold reserves.
Steps to Estimate the Gold Price Under the Gold Standard
Determine the Money Supply:
According to the Federal Reserve, as of 2024, the M2 money supply (which includes cash, checking deposits, and easily convertible near money) is approximately $21.5 trillion source: Federal Reserve Economic Data (FRED).
Determine U.S. Gold Reserves:
The U.S. gold reserves are reported to be about 261.5 million ounces source: U.S. Department of the Treasury
Using the formula below, this rough estimate indicates that if the U.S. were to return to the gold standard, the price of gold would need to be around $82,252 (!!) per ounce to back the current money supply. This figure underscores the significant disparity between the actual price of gold and what it would need to be under a gold standard, illustrating the impracticality of returning to such a system given today's economic scale.
This calculation is theoretical and simplified. The actual transition to a gold standard would involve numerous economic and political challenges.
What this data suggests is that a gold-backed dollar would be impractical for regulating the economy and preventing further depressions because it severely limits the government's ability to adjust the money supply in response to economic conditions. Under a gold standard, the money supply is constrained by the amount of gold reserves, restricting the flexibility needed for monetary policy to stabilize the economy, combat deflation, or address financial crises. This lack of flexibility could exacerbate economic downturns and hinder recovery efforts, as seen during the Great Depression when countries adhering to the gold standard experienced prolonged deflation and deeper economic distress.
Despite being a generation apart, the joint perspectives of Keynes and Bernanke highlight the complex nature of the Great Depression. There is value in Bernanke's global lens on the Great Depression and focus on the gold standard (it was Bernanke's job to know for all our sakes in 2007-2008!).
The ultimate recovery that coincided with the start of World War II was also aided by Keynesian fiscal policies that boosted overall demand. The mysteries surrounding the duration and end of the Great Depression have become the modern economist's Holy Grail. Despite extensive research and analysis, definitive explanations remain elusive, akin to the legendary search for the Holy Grail. The complex interplay of economic factors, policy decisions, and global events continues to fuel debate and investigation, as economists strive to fully understand the mechanisms that ultimately led to recovery.
Bernanke, B. S. (1995). The Macroeconomics of the Great Depression: A Comparative Approach. Journal of Money, Credit and Banking, 27(1), 1–28.
Bernanke, B. S. (1983). Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression. The American Economic Review, 73(3), 257–276.
Cloud Resource Group, St. Simon's Island, GA. Tom Cloud, President.
Keynes, J. M. (1989). The General Theory of Employment, Interest and Money. Düsseldorf: Verl. Wirtschaft u. Finanzen.
Nasdaq Data Link. (n.d.). Retrieved from https://data.nasdaq.com/data/FRED-federal-reserve-economic-data.
Skidelsky, R. (2010). Keynes: The Return of the Master. New York: PublicAffairs.
U.S. Department of the Treasury. (n.d.). Retrieved from https://www.usa.gov/agencies/u-s-department-of-the-treasury.
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