Financial collapse
The focus on deflation and financial collapse throughout the world also suggested ways through which the depression was channeled to other countries. Currently, economists agree that the gold standard played an important role in transmitting the economic decline in America to the rest of the world (Campa, 1990; Bernanke, 2002b) under the gold standard; trade imbalances gave rise to international gold flows.
In his analysis of international transmission of the American Depression, Kindleberger reasoned that that the stock market collapse and deflationary shocks triggered a liquidity squeeze, a reduction in bank lending and the international financial collapse of the 1930s i. e. the lack of access to credit forced less-developed countries to use up their gold and foreign exchange reserves; this forced them to sell old quantities of primary products at reduced prices (Kindleberger, 1973).
He also noted that the depression was more protracted in countries which stuck to the gold standard - The countries that abandoned gold pursued independent monetary policy and were able to rebound faster. International studies correlating adherence to the gold standard, deflation and continued economic decline have confirmed this argument (Bernanke and James, 1991; Eichengreen, 1992).
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Economists also believe that the enactment of The Smoot-Hawley Tariff which was supposed to protect American Farmers triggered a counterproductive wave of protectionist measures around the world, which worsened the depression (Draghi, 2009; Hamilton, 1987, Meltzer, 1963) Although most of these debates occurred after the Great Depression, scholars now agree that both inept fiscal and monetary policies transformed a normal business cycle into a depression.
Since monetary contraction was part of the problem during the Depression. Currency devaluation and monetary expansions had to play a leading role in the recovery process. A number of commentators have shown that the American money supply increased by 42% between 1933 and 1937 and worldwide monetary expansion led to a lowering of interest rates and easy access to credit (Mishkin, 1991). Economists argue that since fiscal expansion can reduce expectation of deflation, they can reduce the cost of borrowing (Romer, 2009).
Keynes theory that government spending, tax cuts, and monetary expansion are essential in countering recession can also be justified in light of historical evidence. Economists reason that the massive government spending, such as the New deal program {specifically Work Progress Administration (WPA) and Agricultural Adjustment Administration (AAA)} reignited the economy (Calomiris and Mason 2003, Romer 1989, Temin 1989). In fact, the general consensus among scholars is that the economy “American economy began to recover with a new monetary expansion and spending in preparation for war (White, 2009b).
” Concerning Banking sector reform, the view on the Bank Holiday is that it was a dramatic and effective remedy. The other reforms have also drawn support from Great Depression scholars (Blinder, 2008; Gapper, 2007; White, 2009b). These reforms saw the creation of a number of regulations and institutions, Banking Act of 1933 (commonly known as Glass Steagall Act) – the act prohibited commercial banks from underwriting of dealing in corporate securities.
Insurance of bank deposits by FDIC was designed to prevent depression type bank runs. SEC regulated investment and Federal Home Loan Bank (FHLB) guaranteed Residential mortgage loans. Collectively, scholars now believe that these regulations insulated America’s banking system from the booms and busts of the financial markets (Russell, 2008). Bernanke (1983 p2) “argues that only with the rehabilitation of the financial system in 1933-35 did the economy begin its slow emergence from the Great Depression. ”
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