Said Bonakdar
The current financial crisis compared with
the world crisis 1929
How did different central banks and governments in Europe and
the USA act?
Economics
Bachelor's Thesis
Spring 2012
Supervisor: Karl-Markus Modén
Karlstads universitet 651 88 Karlstad
Tfn 054-700 10 00 Fax 054-700 14 60
1 www.kau.se
[email protected]
Abstract
The financial crisis nowadays is an important event in the economic history. It
is conspicuous, that the current crisis has a lot of similarities with the world
crisis in 1929. These facts can be seen from the failure in the banking system,
shown in easy-given credits, to the reactions of central banks and governments
and to the bankruptcy of several institutions. The analysis showed, however,
that the impacts today on different parameters, for instance, the industrial
production and the unemployment rate, were not as bad as they were during the
Great Depression. Interesting to see is that in both crises countries had to
handle a parameter for simpler monetary transactions: the gold standard and
the Euro. However, the economic situation nowadays is more complex, because
the Euro-area cannot just abandon the Euro like governments did earlier with
the gold standard. Nevertheless economists recently consider of giving the
bankrupt country Greece its own currency, the Drachma, back to regulate itself
with own decision making in fiscal and monetary policy like the United States
did after the Great Depression.
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“There is no means of avoiding the final collapse of a boom brought on by
credit and fiat monetary expansion. The only question is whether the crisis
should come sooner in the form of a recession or later as a final and total
catastrophe of depression as the currency systems crumble.”
Ludwig Heinrich Edler von Mises,
Economist and Social Philosopher (1881 – 1973)
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Table of Contents
1. Introduction ............................................................................................................ 5
1.1. Introduction .....................................................................................................5
1.2. Purpose............................................................................................................ 6
1.3. Methods ..........................................................................................................6
1.4. Limitations ......................................................................................................6
1.5. Disposition ......................................................................................................7
2. How could the crises occur? .................................................................................. 7
2.1. Economic and political reasons of the world crisis 1929 ............................... 7
2.2. The gold standard in the inter war period ..................................................... 10
2.3. Economic and political reasons for the current financial crisis .................... 11
2.3.1. The dotcom-bubble ................................................................................ 12
2.3.2. Banking failure which led to the crisis in the USA ............................... 13
2.3.3. USA and the European Monetary Union ............................................... 15
3. Influences and Impacts of the crises ....................................................................18
3.1. Impacts of the world crisis 1929 graphically ................................................ 18
3.2. Impacts of the world crisis 1929 analytically ............................................... 23
3.3. Impacts of the current world crisis graphically ............................................ 25
3.4. Impacts of the current world crisis analytically ............................................ 30
4. Interest rates of the Central Banks in Europe and the USA.................................32
5. Political conditions during the Great Depression ................................................ 36
5.1. The failure of president Herbert Hoover ....................................................... 36
5.2. Franklin Delano Roosevelt and the New Deal in 1933-1935 ....................... 38
6. Direct comparison between the crises 1929 and 2008 ......................................... 40
7. Conclusion ........................................................................................................... 42
8. Acknowledgement ............................................................................................... 44
9. Reference list .......................................................................................................45
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1. Introduction
1.1. Introduction
The current financial crisis is a serious issue in the world economy. The
subsequent consequences are shown in a crush in the stock market in 2009,
losses in companies' revenues, bankruptcy and – on a macroeconomic level –
debt problems among Europe, due to the same currency used in several
countries: The Euro. This currency is used by the European Monetary Union
(EMU), which contains 17 countries1 since the 1st of January 2011. Therefore
the Euro is an important variable for Europe's economy and has influence on
other world currencies like the Dollar or the Renminbi and affects therefore the
economies of the USA and China, too.
A similar event occurred already earlier, which was responsible for a
recession in several nations. The world crisis in 1929 was one of the biggest
events in the economic history and is the reason why macroeconomics as a
distinct field of study was established.2 During the Inter-War period, the gold
standard was an important feature and it was a constraint on monetary policy,
in a similar way as the Euro is today. The “Great Depression,” as it is called,
described as “virtually universal among market economies” (Bernanke 1995)
and affected the world economy strongly.
Both crises show a lot of similarities on the way they occurred and their
effects on the economies, which leads to the actual topic of this paper, the
comparison between the world crisis 1929 and the current financial crisis.
Despite these similarities, which are explained later in the paper, there are some
differences as well. These are given, for instance, in the political situation of
Europe. The European Union did not exist during the Great Depression, which
means, that the world crisis 1929 had different effects among the countries in
Europe than today. Therefore a distinction between certain areas has to be
made to be able to make clear statements about the impacts and the solution
approaches in different countries.
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2
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http://www.ecb.int/ecb/history/emu/html/index.en.html visited: 20 of March, 21:28.
Bernanke, B.S. 1995 The macroeconomics of the Great Depression: a comparative approach;
Journal of Money, Credit and Banking. Volume: 27. Issue 1.
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1.2. Purpose
The purpose of this paper is to make a comparison between “The Great
Depression” in the 1930ies and “The Great Recession” which started in 2008.
First of all it is important to see how both crises could occur due to mistakes
made by politics and economies. Crucial facts are the gold-standard and the
Euro, which led to economic unions in several regions of the world.
Additionally I will explain the impacts of the crises on mainly the USA in both
crises. However, I will add the influence of the European Union nowadays, too.
The last part will be a comparison between different actions of governments
and central banks to be able to make a proper statement, which policy was the
most effective and, which is even more important, if current central banks and
governments are able to take over some approaches from previous times,
despite the different circumstances, the countries are in.
1.3. Methods
At the beginning, demographic and macroeconomic data is used to
describe the impacts of the crises on the American economy. Additionally, the
subsequent graphs are used to describe the Dow Jones, unemployment rate,
inflation rate, Consumer-Price Index and the industrial production in these time
periods. The last method used is the “Trilemma of Monetary Policy” to be able
to make a proper statement about the current European situation and its effects
on the United States.
1.4. Limitations
Due to the fact, that this topic can be analysed in many different ways,
there are some limitations for this paper. First of all, it would go beyond the
scope, if the analysis would contain impacts of the crises on other important
countries in the regions of Asia or South America.
Secondly, it has to be mentioned, that the focus will just be mainly on
the USA in both crises, but the influences of the European Union or rather the
European Monetary Union for the current crisis are shown as well.
Another fact is that connections from the world crisis 1929 and the
current crisis to other financial crises are not made, but might be mentioned for
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reasons of comparison. The focus lies on the comparison between the crisis
1929 and the crisis nowadays.
The final limitation of the paper is the fact, that mostly the reasoning of
Friedman&Schwartz (1963, A Monetary History of the United States) is used for
the causation in the USA. A comparison to Temin's theory (1976, Did Monetary
Forces Cause the Great Depression?), how the world crisis in 1929 occurred would
go beyond the scope.
1.5. Disposition
The paper follows a certain structure. In Chapter 2, I will describe how
the both crises could occur due to mistakes of politics and economies in certain
countries and areas. Chapter 3 talks about the impacts and the influences on
several regions which is followed by Chapter 4, which shows the determination
of the interest rates in the USA and the European Monetary Union. Chapter 5
deals with the political conditions during the crisis in 1929. Afterwards, there is
Chapter 6 containing the comparisons between several facts and solution
approaches. Finally Chapter 7 gives a conclusion, if current governments and
central banks are able to take over some ideas from previous times.
2. How could the crises occur?
2.1. Economic and political reasons of the world crisis 1929
The Great Depression was one of the biggest events in economic
history. The stock market crash on the “Black Thursday”, October 24th 1929,
and the ensuing long decline in industrial production and employment around
the world.
There are different kinds of theories how the world crisis in 1929
occurred. On the one hand there is the theory of Friedman&Schwartz (1963),
who talk about the failure in the banking sector and imply an economic bubble.
On the other hand there is the theory of Peter Temin(1976), who says, that the
war itself initiated the Great Depression, due to facts like enormous reparation
costs, new political borders without economic adoption and other factors,
which came out of World War I. This thesis focuses more on the point of view
of Friedman&Schwartz, because a bigger comparison would go beyond the
scope.
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After World War I, the United States started the “roaring twenties” with
the conversion from a wartime to a peacetime economy, because weapons and
their production were no longer necessary. Although one branch of the
economy was not used any more, the USA managed to become the richest
country in the World in the 1920s, which led to a high level of consumption
during this decade3. The industry even used advertising methods of World War
I to make people buy new products like cars or radios. This great consumerism
was due to higher consumer goods production, which was due to the rise of
capacity in the industry. However, this kind of welfare required that the demand
of goods was growing as fast as their supply. The problem was that this
requirement could not be guaranteed over time, because the markets will be
saturated at a certain point and individuals followed traditional values like, for
instance, saving or postponing pleasures and purchases. Basically, the
population had to be persuaded to abandon these traditions to be able to
continue the production and to maintain the welfare of the country, which was,
as expected, just doable till a certain point.
Another fact was that the income of the Americans was distributed very
unevenly. This is caused by two factors: On the one hand there were huge cuts
in the top income-tax rates and on the other hand that although the industry
had remarkable improvements of productivity, the workers earned a relatively
small amount. This can be seen between 1923 and 1929, where the
manufacturing output per person-hour rose by 32%, but the growth-rate of the
worker's wage was increased by only 8%4.
Finally, a lot of people were not able to buy the advertised new products
due to a lack of money. Because the industry still wanted the consumers to buy
more products, the banks came out with a new innovation: the consumer credit.
Therefore individuals had the opportunity to “buy now, pay later”. Due to this
fact, the used capital by individuals increased strongly which led to a rise in the
stock market as well. Thus, the problem was that customers accumulated debts
until they reached the point of insolvency where they were not able to purchase
new products any more. That occurred in 1929.
USA's economy was weakened by international problems, too, due to the
fact, that the United States became the world's chief creditor. After the first
world war a lot of European countries needed financial support to be able to
pay back the high debts and to cover the reparation costs. Due to the
3
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inexperience of American bankers, they gave several big credits to European
borrowers, especially to Germany, caused by the problems of loan repayments.
The given credits from American financial institutes to the own population and
to institutions of the European countries made the banking structure very
unstable in the late 1920s.
Another factor that had influence of the American economy was the
behaviour of international trade. While the USA maintained high tariffs on
imported goods, the industry tried to export products and to make foreign
loans in the same time. This behaviour implies several problems: If other
countries were not able to sell goods to the US, they were not gaining enough
money to purchase products from the American industry or to repay American
loans. Additionally all industrial nations followed the same kind of policies to
maximize their own utility, but without considering the consequences on the
international market.
As mentioned before, the used capital of individuals rose strongly, which
led to an increase in the stock market. Investors bought millions of shares with
most of the money given as credits from the banks. Due to the simple relation
between demand and supply, it is obvious, that the stock prices in the 1920s
grew rapidly. Individuals were even willing to pay inflated prices, because they
thought, that the stock prices will continue rising to gain huge profits later in
time to be able to pay back the credits easily. In fact, this is not realistic, because
such strong movements in stock prices are hypothetically followed immediately
by a comparable movement in the other direction (DeBondt, Thaler 1985). This
is shown in the crush on the stock market on the Black Thursday 1929.
As a conclusion, it is possible to talk about an economic “bubble”
regarding to the theory of Friedman&Schwartz. Regarding to the 1920s the
industrial production increased strongly and the stock market boomed. But
because of the high debts of the people and the high amounts of credits banks
gave to individuals and other nations, it was just a matter of time until the
bubble burst after expanding the whole decade. This point was reached on the
24th of October 1929: the Black Thursday, which was the beginning of the
Great Depression.
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2.2. The gold standard in the inter war period
The gold standard was an important variable during the interwar period.
This is due to the fact, that it caused additional money supply for the countries
using it. This worked the following way: basically, if the amount of notes and
coins are backed by a certain quantity of gold and one unit of a currency is
expressed in terms of grams of gold, the base money supply equals the supply
of gold. A country which gains gold by current account surpluses will have
subsequently a higher money supply. By restricting the amount of domestic
credit created by the banking system, such a surplus country could avoid
inflationary pressures. Alternatively, if the reason for the current account
surplus is a rapid increase in productivity, the increase in money supply can be
accommodated without inflationary pressures. Deficit countries will face the
reverse problem, with a gold outflow and deflationary pressures.
After the gold suspension due to World War I, many countries
anticipated the return to the gold standard in the early 1920s. In the end of
1925, 28 nations had been pegged to the gold standard again. This is caused by
two factors: the first one was the chaotic financial and monetary conditions and
the subsequent unhappiness in some nations, which can be seen especially in
countries in central Europe which had to face hyperinflation (Bernanke with
James in “essays on the great depression”). The second reason is the fact, that
although open capital markets were present, the different currencies were
successfully attached to each other. Consequently, there were unrestricted
financial transactions on international level and a strong increase in lending and
borrowing globally (Eichengreen and Flandreau 1997 in The gold standard in theory
and history). Despite the high level of anticipation, Bernanke pointed out, that it
was not easy to realize the return of the gold standard without the consequence
of deflation, because gold was not sufficiently available to cover the world's
demand. Due to that fact, the Economic and Monetary Conference in 1922
recommended the adoption of a gold exchange standard. It should be used to
back national money supplies in form of gold and convertible foreign exchange
reserves, mainly pounds and dollars.
According to Bernanke, the inter war gold standard, which was mainly
established between 1925 and 1928, crushed by 1931 and disappeared fully by
1936. This is due to several problems, the gold standard brought with it. One
of the reasons was “The asymmetry between surplus and deficit countries in the required
monetary response to gold flows” (Bernanke B.S., 2000). The central banks of the
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nations which got gold inflows had to help to control the price-specie flow
mechanism. For countries with deficits, the central banks were supposed to
reduce money supplies and deflate, while in nations with surplus they were
supposed to expand domestic money supply and inflate. The problem was that
surplus countries were not being prevented from accumulating reserves, which
led to a potential deflationary bias. The big problem of deflation leads to the
second important reason: Pyramiding of reserves.
Several countries hold convertible foreign exchange reserves as partial or
fully substitute for gold. However, gold usually backed these convertible
reserves just insignificantly. Thus, the gold exchange system showed the
possibility of lowering the world money supply by shifting foreign exchange
reserves to gold. Consequently, central banks abandoned the foreign exchange
reserves generally at the beginning of the 1930s. This is due to the strong
increase in risk for foreign exchange assets, which faced the threat of
devaluation.
The third problem was that central banks had insufficient powers, which
is due to several restrictions or prohibitions of open market operations. This
means, that politicians made it more difficult for central banks to have influence
on the monetization of deficits by prohibiting dealing with higher amounts of
government securities. This political decision was made, to prevent the
economy of getting future inflation. This led to the fact, that central banks were
quite weak in their control over money supply.
As a conclusion, you can say, that the gold standard was an important
variable in the inter war period. Besides the actual currencies of the nations, the
gold gave them the opportunity to do international transactions easier than
without the gold investments. Unfortunately, the gold standard could not
maintain in the world economy, due to several problems, which are described
earlier in the paper. However, the gold standard led to a kind of “monetary
union” for all these countries which anticipated the gold standard.
2.3. Economic and political reasons for the current financial crisis
The World Crisis 1929 was mainly due to World War I and banking
failure in the United States. The current crisis did not occur after a crucial event
like a World War, but was caused by several reasons in different regions of the
world. For instance, the USA had again problems in the banking sector, which
were partly different than in the 1920s, though. Europe has to face several
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problems with its monetary union, which uses the Euro as a common currency.
Chapter 2.3.1 will explain the dotcom-bubble, Chapter 2.3.2. the causes in the
banking sector in the USA and chapter 2.3.3. shows why the USA had to face
problems with the Euro as well.
2.3.1. The dotcom-bubble
The financial crisis in the USA has its origin already between 1995 and
2000 with the increase of the dotcom bubble, which led to a crush of the
NASDAQ index in March 2000. Generally, you can define a bubble as strong
increase in assets prices and a burst, when the assets reach the point of being
“over-priced” (Aburjanidze, N., et.al.) In this case, it occurred, because of the
invention of the internet, which was seen by the majority as “new era” of
technology. Experts were sure, that internet-enabled technologies could rapidly
change the structure of several ways how to run an economy, for instance, the
stock market, corporate landscape and the way how business was done. The
authors mention, that many investors started investing in internet-based
companies. Thus, the value in equity markets grew exponentially. In the early
2000s, the equity prices were grown on uncontrolled levels due to the high
demand of investors for shares and assets of internet-based companies. Even
firms, which never earned profits were selling assets to investors, despite a lack
of valuation data. The growth of the companies could not sustain for a long
time, because these companies could not account high profitability. Thus, the
markets capitulated, which was followed by a wave of selling assets. This can be
seen in Graph 15, which shows the loss in the NASDAQ index from 1994 to
2005.
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Graph 1: NASDAQ index from 1994 to 2005
Graph 1 shows that the NASDAQ index was booming between 1994
and 2000. It had a total increase of approximately 4000 index points. From
spring 2000, a similar movement is noticeable, but in the other direction. Here,
the theory of DeBondt and Thaler, which is already mentioned before, shows
again its validity.
2.3.2. Banking failure which led to the crisis in the USA
The crisis itself began in 2007 and went stronger in 2008, although
governments and central banks tried to keep the financial gap small (M.
Jickling, 2009 causes of the financial crisis). After August 2007, the Federal Reserve
tried to flood financial markets with liquidity, which led to huge expansion in
the balance sheets, which never existed before (B.Eichengreen 2008 The global
credit crisis as History). This leads again to Jickling, who argues, that the Federal
Reserve did not focus on inflation any more, but just on financial stability. This
is caused by the relaxed credit standard and mortgage lending in the 2000s.
Credits and mortgages were given out to everybody with low interest rates,
although banks did not have any securities. Regarding to Jickling, securitization
anticipated the policy of “originate-to-distribute” instead of transfering the
credit risk to other investors (V. Acharya and M.Richardson, 2009 causes of the
financial crisis). This means, that lenders became less cautious, because the
demand of investors for subprime loans – which were marked as AAA-bonds
and therefore as the lowest risky ones – was enormous. Generally, subprime
loans are defined as following:
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“General term for borrowings of subprime debt, or loans made to people with
less-than-perfect credit or short credit histories. Subprime credit includes the
original borrowing itself, as well as any derivative products such as
securitizations that are based on subprime loans and then sold to investors in
the secondary markets.”6
Unfortunately, there were several rating agencies, who gave the AAAstatus to numerous bonds, which were actually already downgraded to a very
risky level. Jickling mentions several reasons why rating agencies acted in that
way and why they were the reasons for that failure. It is said, that the causes
were conflicts of interests, poor economic models, the market's excessive
reliance on ratings – due to several laws, which say, that the agencies are in
charge of giving proper statements about investments and required capital –
and finally the critic of a lack of effective regulation. Due to these facts,
financial institutions suffered under the mistakes of rating agencies, for
instance, because borrowers were not able to pay back the loans at the maturitydate, due to the losses they experienced out of the investments in “wrong”
AAA-bonds.
Another point is, that this abundance of credits led to a strong increase
in housing prices, because the demand of the home ownership was booming.
This relaxed behaviour of giving credits and the housing boom ended, when
people started purchasing houses they could not afford at all. This led to a
housing bubble, which was increasing with the amount of credits given out.
Thus, the great credit boom and the housing bubble were positively correlated.
When the bubble burst, the prices crushed and the loans were not able to be
paid back. This led to a strong shock in the financial system. Graph 27 shows
the Case-Shiller home price indices from 1988 till 2010, which represents the
price development on the real estate market in the USA.
The non-dashed line represents ten different cities in the United States,
which prices indices were accumulated. This curve goes from 1988 until 2010.
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Definition from http://www.investopedia.com/terms/s/subprime_credit.asp#axzz1sy4cVyNG
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2012, 13:22.
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For this paper, the development of the prices indices between 2001 and
2010 is more interesting and is shown as the dashed line, which gives the
accumulation of 20 cities in the USA. In Graph 1, it can be seen, that housing
prices from 2001 until 2002 are falling slightly, which might be due to the terror
attacks at the 11th of September 2001. Afterwards the price-indices increased
between 2002 and 2006, which is, as already mentioned, due to the relaxed
mortgage and credit behaviour of the banks and the subsequent high demand
of housing purchases. The crush in the price-indices is seen between 2007 and
2009 and amounts to 36 percentage points in decrease. The start of the fall in
the prices was the point, where the housing bubble burst.
2.3.3. USA and the European Monetary Union
The crisis, which occurred in the USA was not only due to the domestic
markets. The United States had to struggle with international problems, too.
Because the economic relation to all important regions in the world would go
beyond the scope, the paper just focuses on the problem with the Euro-area.
In 1992, some countries of Europe signed the Treaty of Maastricht to
establish the European Union and later on a common currency, the Euro. The
reason was to pursuit an economic stable region, which has open borders in the
area and can compete better on the international level. On the 1st of January
2011, the European Monetary Union contained 17 members, which shows the
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anticipation of this program of European countries. To be able to describe
Europe's new economic structure, it is important to mention the “Trilemma of
Monetary Policy”, which explains Europe's problems very well. is shown in
Graph 38.
Graph 3: The Trilemma of Monetary Policy
The Trilemma of Monetary Policy says, that only one corner can be
reached, due to the anticipation of two variables shown in the graph. This
means, that a country cannot have a fixed exchange rate, if monetary
independence and financial integration are the main goals of the government’s
economic policy. If a country wants to have monetary independence and
exchange rate stability, it most forego the benefit of financial integration.
Regarding to the economic situation in Europe, nowadays, the financial markets
are almost fully integrated and exchange rate stability is complete inside the
EMU. Thus, countries, which are involved in the EMU have to sacrifice their
monetary policy to be part of the Euro-system, which means, that the own
central bank is not in charge of the domestic money supply any more, but
instead next higher institution: the European Central Bank (ECB).
The problem for the USA was and still is that the Euro represents a very
strong currency due to the European Monetary Union. The different influences
8 http://web.pdx.edu/~ito/trilemma_indexes.htm visited the 24th of April 2012, 17:57.
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on the Euro of several member-states increase the value of the Euro
enormously. Graph 49 shows the development of the exchange rate of the
Euro with the Dollar from 1999 until today.
Graph 4: Development of the exchange rate € to $
Graph 4 shows that the exchange rate of the Euro decreased from 1999
until 2002. That means that the Euro became cheaper compared with the
Dollar. This changed immediately after this period due to a strong increase in
the exchange rate, which has persisted till today, despite some fluctuation
between 2008 and nowadays, which is due to the crisis itself. This raising
appreciation of the Euro and the subsequent decrease of the Dollar led to
additional incentives for excessive domestic creation of credits in the United
States, due to availability of “cheap” funds for foreign investors (Angkinand,
A., Willett, T., 2006). This fact worsened the liquidity position in the USA and
led to an increase of loans, which – as already mentioned – turned out badly.
As a conclusion you can say, that the alliance of the European Monetary
Union represents another factor, which the USA had to fight against
economically. The continuous loss against the Euro over time shows, that the
Dollar is strongly affected by the Euro. Thus, the Euro nowadays and the gold
standard in the time of the Great Depression are important variables in the
economies in these periods.
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3. Influences and Impacts of the crises
3.1. Impacts of the world crisis 1929 graphically
The financial crisis in the early 20's century had several consequences for
the American economy. After the credit boom and the high consumerism, the
nation had to face four years of the Great Depression (Friedman,M., Schwartz,
A. 1963, A Monetary History of the United States). As described already earlier, the
stock market and the industrial production were booming in the 1920s. But due
to the problems of deflation, caused by the scarcity of gold and high
consumerism, the economic bubble burst on the Black Thursday. The Great
Depression had several consequences, for instance, a strong fall in the stock
market, industrial production and consumerism and an enormous increase in
the unemployment rate with a dependency on inflation. All these facts are
connected to each other, which means, that there exists a positive correlation
between the stock market, the industrial production, the inflation and the
consumption. Thus, the focus of the impacts lies on these variables, because
they are representative and have direct influence on the markets in an economy.
Graph 510 shows the development of the stock market in the United
States between 1928 and 1942.
Graph 5: Dow Jones from 1925 until 1942
In Graph 5, you see the rise in the Dow Jones from 1925 until the late
1929, where the Dow Jones reached its peak with nearly 300 index points. From
that point on, a strong decrease in this stock market is noticeable, which
10 Concludes out of Table 1 on page 23
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lastened until 1933. The total loss from the peak in 1929 until the minimum in
1933 equals approximately 250 index points (almost 80%). Thus, individuals
wealth decreased, since the value of assets declined, but the value of debt
remained (or even increased due to debt deflation) The crush in the Dow Jones
had of course consequences on the industrial production as well, because
millions of assets were sold, which were partly offered by companies. This
means, that companies suffered losses due to the lack of non-working capitalflow. Graph 611 shows the development over time from 1925 until 1942 in
industrial production.
Graph 6: Average Annual industrial production over time
Regarding to Graph 6, it is important to mention, that the y-axis
represents the annual average of the industrial production. Anyways, Graph 6
shows clearly that in the end of 1929 there is a huge decrease in industrial
production. The fall equals to approximately 3,5 index points (which is
relatively a fall of 36,39%) in the four-year-period between 1929 and 1933. This
deficit got cleared after 1933, where the percentage-change increased strongly
again and reached more than 12 index points in 1942. The subsequent effect of
the recession on the labour market is obvious. The labour demand decreased
enormously (industrial production fell by 36,39%), which led to huge increase
in the unemployment rate. Graph 712 shows the unemployment rate over time
from 1925 to 1942.
11 Concludes out of Table 1 on page 23
12 Concludes out of Table 1 on page 23
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Graph 7: Development of the unemployment rate from 1925 to 1942
0.3
0.25
0.2
Unemployment rate
0.15
0.1
0.05
0
1926 1928 1930 1932 1934 1936 1938 1940 1942
1925 1927 1929 1931 1933 1935 1937 1939 1941
In the period from 1925 until 1929, the unemployment rate is constant
at 3,3%, which is due to an estimation of the annual rate between 1923 and
192913. Anyways, with the beginning of the Great Depression in 1929, an
enormous increase in the unemployment rate is noticeable. From 1929 to the
peak in 1933, the change contains 21,6 percentage points. After the Great
Recession, there is a decrease over time until 1942, where the percentage of
unemployed people almost equals the amount of the early 1920s.
Another effect of the Great Recession is shown in the decrease of the
Consumer Price Index (CPI), which seems obvious, because industrial
production and stock market index are decreasing and the unemployment rate
is increasing. The subsequent consequence for the consumption is a decrease
over time, which is due to less capital per person and less people, who earn
money in the industry. In the early 1920s, there had not been any
unemployment insurance, which made people more saving than spending. The
mechanism of the unemployment insurance shows a transmission time, until
the unemployed individuals get a new working place. During this time, insured
people can still consume goods. This was not the case in these days. Graph 814
shows the CPI between 1925 and 1942 with base year 2007=100.
13 http://www.bls.gov/opub/cwc/cm20030124ar03p1.htm visited the 03.05.2012, 15:04
14 Concludes out of Table 1 on page 23
20
Graph 8: CPI between 1925 and 1942
The CPI decreases between 1929 and 1933 and has a recovery phase
over time. In 1942, the original level of 1926 is still not reached. Interesting to
see is that the CPI already decreases from 1926 to 1929, which can be due to
the fact that the market was slightly saturated after the great consumerism in
the early 1920s or to deflationary pressures due to the gold standard. The fall
from 1929 to 1933 equals to 24% over these four years.
Due to the fact, that the Consumer-Price-Index is dependent on
fluctuating prices over time, it is important to consider the inflation rate over
time as well. Besides, several economies were strongly affected by inflation, for
instance central Europe, which suffered hyperinflation during the Great
Depression (Bernanke,B. with James, H., 2000). Graph 915 therefore shows the
inflation rate over time from 1925 until 1942.
15 The inflation rates conclude out of Table 1 on page 23, where the inflation rate is calculated as the
growth rate among the years: (CPIt+1 – CPIt)/CPIt
21
Graph 9: Development of the inflation rate over time
Due to Graph 9, it is obvious, that the inflation rate was slightly negative
until 1929, where it reaches almost 0% again. With the occurrence of the world
crisis, you see a strong fall until 1932 and afterwards a strong increase again.
Exactly during the interval of the world crisis, the USA suffered deflation,
instead of inflation like other regions in the world, which is due to the scarcity
of gold and the subsequent gold exchange reserves, which was mentioned and
explained already in Chapter 2.2. Thus, the central banks (USA and Great
Britain) engaged in a scramble for gold and a competitive deflation by giving
several discount rates, which led automatically to more deflation during the
crisis (Bernanke, B. 2000).
Regarding to Graph 5-9, the positive correlation between consumerism,
industrial production, inflation and the stock market seems obvious. Moreover
the negative correlation between the four variables and the unemployment rate
seems to be correct. This can be seen in Graph 10, where all variables are
included with a base year 1942=100, to see how these variables acted over time.
The data used concludes out of Table 1. The exact behaviour of the variables is
explained already earlier in this paper, but Graph 10 gives a good overview, how
these variables differed over time in direct comparison with the other ones.
22
Graph 10: Indices from 1925 until 1942
3.2. Impacts of the world crisis 1929 analytically
To prove the statement of correlation analytically, the following indices
have been looked up additionally: Dow Jones (open for year), which represents
the stock market, Industrial Production Index, Unemployment rate and the
Consumer Price Index (CPI), which shows the consumerism in the USA during
the time interval 1925 till 1942. . Table 116 shows these indices over time. It has
to be mentioned, that the data for industrial production and the consumer price
index were modified in certain ways. The industrial production data was
originally given in monthly data, which means, that I determined the average of
these data to get annual data (AAIP). On the other hand, the CPI had to be
changed to the same base year. At the beginning the base years was 198284=100, which was changed to base year 1929=100.
16 Data from the following websites:
st
ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt visited 1 of May 2012, 14:26;
nd
http://forecasts.org/data/data/INDPRO.htm visited 2 of May 2012 ,19:12
nd
http://www.bls.gov/opub/cwc/cm20030124ar03p1.htm visited 2 of May 2012 ,19:27
nd
http://www.econstats.com/eqty/eqea_mi_3.htm visited 2 of May 2012, 21:12
23
Table 1: Several indices between 1925 and 1942
Year
1925
1926
1927
1928
1929
1930
1931
1932
1933
1934
1935
1936
1937
1938
1939
1940
1941
1942
AAIP Index
1929=100
81,8389
86,5858
86,5268
90,0942
100
83,0777
68,8084
53,7145
63,6199
68,9561
79,8642
94,2509
103,2426
81,6331
100,1765
115,7131
146,1374
167,6880
CPI 1929=100
102,3392
103,5088
101,7544
100,0000
100
97,6608
88,8889
80,1170
76,0234
78,3626
80,1170
81,2865
84,2105
82,4561
81,2865
81,8713
85,9649
95,3216
Unemployment Dow Jones Open for
rate
year
0,033
121,25
0,033
158,54
0,033
155,16
0,033
203,35
0,033
300,31
0,089
248,48
0,159
164,58
0,236
74,62
0,249
59,93
0,217
99,9
0,201
104,04
0,17
144,13
0,143
178,52
0,19
120,85
0,172
154,76
0,146
150,45
0,099
131,13
0,047
110,96
Inflation
rate
0,011
-0,017
-0,017
0
-0,023
-0,09
-0,099
-0,051
0,031
0,022
0,015
0,036
-0,021
-0,014
0,007
0,05
0,109
To be able to make a proper statement about the correlation and
subsequently the behaviour of the variables to each other, I used Microsoft
Excel to generate a correlation table out of Table 1, which is shown in Table 2.
To interpret it correctly, it is important to know, that correlation moves between
-1 and 0 for negative correlation or between 0 and 1 for positive correlation.
Negative correlation means, that one variable moves in one direction and the
second variable in the other one. Moreover, positive correlation shows the same
movement for both variables. If the correlation is equal to 0, then there is no
correlation between the variables, which means, that the movements of the
variables are independent from each other.
Table 2: Correlation table for the crisis 1929
AAIP Index
2007=100
AAIP Index 2007=100
CPI Index =2007
Unemployment rate
Dow Jones o. f.y.
Inflation rate
1
0,184452903
-0,452669438
0,142032092
0,803338313
CPI Index =2007
1
-0,947128034
0,575812508
0,132207453
24
Unemployment rate
1
-0,593276857
-0,376391519
Dow Jones Open for
year
1
0,026592227
Inflation
rate
1
Table 2 shows, that there are indeed positive correlations between
consumerism, industrial production, inflation and stock market. The lower
correlations lie between Consumer Price Index and Average Annual Industrial
Production, Dow Jones and AAIP, CPI and inflation and with almost no
correlation the Dow Jones and the inflation. Despite this fact, the variables still
show some kind of dependency to each other, although it is not as strong as
the relation to other variables. Conspicuously are the higher correlations, which
are mainly linked to the unemployment rate. This variable seems to be
significant for the whole economy, because the high unemployment led to
higher losses in industrial production and the stock market. Almost perfectly
negatively correlated are unemployment rate and consumer price index with a
value of ~-0,9471. Another conspicuousness of Table 2 can be seen in the
relation between inflation rate and AAIP. These variables are strongly positive
correlated with a value of ~0,8033. It is well known, that a negative relation
between unemployment rate and inflation rate exists. This is seen in the
equation of the Philips-curve and the subsequent sacrifice ratio17 (deeper
explanations go beyond the scope of this thesis).
3.3. Impacts of the current world crisis graphically
The current financial crisis is a crucial event nowadays. The American
economy suffers in different ways after the credit and housing boom in the first
decade of the 21st century. Unfortunately, there have been several problems, for
instance, the easy-given credits and mortgages without securities, which led to
the bankruptcy of the investment bank “Lehman Brothers”, which was
followed by more cases of bankruptcy. Due to these facts, the economic bubble
in the first decade of the 2000s burst. It is conspicuous, that the current crisis
has similar effects on the American economy. Compared with the world crisis in
1929, the economy had to face a crush in the stock market and the industrial
production and of course again a strong increase in the unemployment rate. An
exception is the Consumer Price Index, which seems to be almost unaffected
by the financial crisis.18 Anyway, this part is going to analyse the effects on stock
market, industrial production, unemployment rate, consumer price index and
17 In case the sacrifice ratio is 3:1, it means, that it needs an increase of 3% in inflation to reduce the
unemployment rate by 1%.
18 This fact is shown later on with the graph of the CPI and Table 3
25
inflation nowadays. Graph 1119 shows the development of the Dow Jones
between 1995 and 2011.
Graph 11: Dow Jones development between 1995 and 2011
Regarding to Graph 11, it is obvious, that the index of the Dow Jones is
increasing constantly between 1995 and 2000. Here the first crush can be seen,
which is due to the dotcom-bubble in 2000/2001. After the recovery phase till
2006, the Dow Jones index could increase again and reached its peak in 2008
with approximately 13000 index points. The second crush is the bubble burst
of the credit and the housing boom. The Dow Jones fell almost on the level of
the 2002, where the local minimum with nearly 8500 index points and shows
therefore a decrease of ~33,85%. This means, that the Dow Jones decreased by
almost 4500 index points. The Dow Jones recovers already, though, which
means, that the recession is almost done. This decline had of course influence
on the industrial production as well. Graph 1220 shows the annual average
industrial production from 1995 until 2011.
19 Concludes out of Table 3 on page 29/30
20 Concludes out of Table 3 on page 29/30
26
Graph 12: Development of Average Annual Industrial Production over time
The average annual industrial production behaves in a similar way like
the Dow Jones index nowadays. Graph 12 shows a strong increase from 1995
until 2000 and a subsequent slight fall, which is due to the dotcom-bubble.
Afterwards the industrial production increases strongly again until it reaches its
peak in 2007, which is the base year for this graph. After 2007, the effects of
the financial crisis can be seen in the decrease in productivity by 10% from
2007 until today. Like the Dow Jones, the industrial production index recovers
already since 2010. Nevertheless, the effects on the industrial production affect
the unemployment rate as well. Graph 1321 shows the unemployment rate from
1995 until 2011.
Graph 13: Development of the unemployment rate from 1995 until 2011
21 Concludes out of Table 3 on page 29/30
27
Regarding to Graph 13, it is conspicuous, that the unemployment rate
fluctuates between 4% and 6% in the time interval of 1995 and 2007. When the
financial crisis occurred, the unemployment rate increased strongly to more
than 9%. In 2009, it reached its peak with ~ 9,6%. Since 2009, the recovery
phase started slowly and the USA managed to push the amount of
unemployment people under 9% again, which is still very high though.
Compared with Graph 7, it is obvious, that the unemployment rate did not as
boom nowadays as in the Great Depression, because the peak in 1933 reached
25% of unemployment rate which is more than twice as big as the highest
number nowadays. The hypothesis, that people in the 1920s/30s did not have
any unemployment insurance, like today, seems correct regarding to Graph 7
and Graph 12, but this will be proven in Chapter 3.4.
In the recent crisis, this seems to be not the case, because the CPI with
base year 2007 shows a continuous increase from 1995 until 2011, which is seen
in Graph 14.22 During the crisis, the CPI was just slightly affected by holding
the level of consumption almost on the level of 2008. However, an immediate
increase is followed after this one-year period. Consequently, the CPI is not
affected by the financial crisis, which might be due to the fact, that consumers
do not buy only domestic products anymore, but import cheap goods from
foreign nations, which is easier since outsourcing and other trade factors came
into account. Another point might be the reason of the power of the Euro.
Due to Graph 4, the Euro got more expensive than the Dollar over time. This
means, that either investors or consumers from the Euro-area consume in the
United States, because the prices in the USA are cheaper for Euro-users than
for American inhabitants.
Graph 14: CPI over time
22
Concludes out of Table 3 on page 29/30
28
Due to the fact, that the change in the CPI is a measure of inflation, it is
interesting now, how the inflation behaves over the time from 1995 until 2011.
Graph 15 shows the development of the inflation rate over time.
Graph 15: Inflation rate from 1995 until 2011
Regarding to Graph 1523, it is conspicuous, that the inflation rate is
fluctuating from 1996 until 2007 between 1,5% and almost 4%. However, a
decline in the inflation rate can be seen during the current world crisis. This fact
is due to the relation of inflation rate and CPI. As already mentioned, the CPI
did stay almost constantly during the crisis, which leads to a non-change in the
CPI and therefore a decline in the inflation rate and a slight deflation.
The last Graph in this section shows the development of all variables
over time as indices with base year 2011 = 100 to see how the variables behaved
in the past years to each other, but all of them with the same ending point
2011. The exact behaviour is already explained earlier, but this graph seems
useful to have the direct comparison between the observed variables. Here, all
the data are transformed into an index. The transformed data concludes out of
Table 3.
23
Concludes out of Table 3 on page 29/30
29
Graph 15: All variables with base year 2011=100
3.4. Impacts of the current world crisis analytically
To be able to make a proper statement about the variables above to each
other, Table 324 shows the data between 1995 and 2011. You must add that the
data-sets have been modified in the same way like the ones for Table 1. Right
here, the base year for the average annual industrial production and the CPI is
conspicuous and is set on 2007 = 100.
Table 3: Several indices between 1995 and 2011
Year
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
24
AAIP Index
2007=100
71,6266
74,8106
80,2032
84,8636
88,5006
92,0530
88,9173
89,1007
90,2304
92,3288
95,3183
97,4062
CPI Index
=2007
73,50
75,67
77,41
78,61
80,35
83,05
85,41
86,76
88,74
91,11
94,19
97,23
Unemployment
rate
0,056
0,054
0,049
0,045
0,042
0,040
0,047
0,058
0,060
0,055
0,051
0,046
Dow Jones Open for
year
3834,44
5117,12
6448,27
7908,25
9212,84
11501,9
10790,9
10021,7
8342,38
10452,7
10783,8
10718,3
Inflation
rate
0,030
0,023
0,016
0,022
0,034
0,028
0,016
0,023
0,027
0,034
0,032
Data sources identical with the ones from Table 1, except for the data set of the unemployment
rate nowadays: http://www.bls.gov/lau/#tables visited the 08th of May 2012, 16:43.
30
2007
2008
2009
2010
2011
100
96,2907
95,5452
90,0658
93,7994
100
103,84
103,47
105,17
108,49
0,046
0,058
0,093
0,096
0,090
12459,5
13261,8
8772,25
10430,7
11577,4
0,028
0,038
-0,004
0,016
0,032
Regarding to Table 3, it is important to create a correlation matrix as
well, to see how these variables interact and behave between each other,
because the Graphs 10 till 14 show already a certain direction of behaviour by
comparison. Anyways, Table 4 shows the correlations between the variables
above in the time interval of 1995 until 2011.
Table 4: Correlation between the observed variables nowadays
AAIP Index
2007=100
AAIP Index 2007=100
CPI Index =2007
Unemployment rate
Dow Jones Open for year
Inflation rate
CPI Index
=2007
1
0,796497508
1
0,141918062 0,646698295
0,906526239 0,727682162
0,12007676 -0,013588525
Unemployment
rate
1
0,059050872
-0,481688869
Dow Jones Open for
year
1
0,40469195
Table 4 shows higher correlations between the different variables than
Table 2 does during the Great Depression. This shows, that all the variables are
more pegged to each other than at the time of the Great Depression. For
instance, a high positive correlation is conspicuous between CPI and average
annual industrial production with ~0,7965, which makes sense, because the
relation of consumption and price is dependent on the quantity, which is
produced, due to the simple rules of demand and supply. Regarding to Table 4,
it is obvious as well, that the Dow Jones is almost perfectly correlated with the
average annual industrial production with a value of ~0,9065. This fits, because
a lot of bigger producers give out shares on the stock market. Subsequently,
you might expect, that the Dow Jones and the CPI are highly positively
correlated, too, which is true and shown in the correlation value of ~0,7277.
On the other hand, you can observe the high negative correlation
between inflation rate and unemployment rate. As already explained earlier, this
is completely normal and is used to predict the sacrifice-ratio between these
two. Another point is the positive correlation between inflation rate and Dow
Jones, which contains a value of ~0,4047. This fact seems to be fine as well,
because a high inflation rate decreases the actual value of the shares, traded on
the stock market. The last, but maybe most important correlation here is the
31
Inflation
rate
1
one between unemployment rate and CPI, which shows a value of ~06467.
During the Great Depression, these two variables were almost perfectly
negatively correlated and are nowadays highly positively correlated. This means
basically, that the connection of CPI and unemployment rate has switched over
time. Subsequently, an increase in unemployment rate leads to an increase in the
relation of price and consumption as well. The statement itself is, of course,
not representative and distorted, because it is crucial to take into account, that
people nowadays have the opportunity to purchase unemployment insurance,
which gives people a subsistence minimum to bridge the time, they are
unemployed. This means, that people can still consume goods, although they do
not gain labour income. This fact leads to the conclusion that Americans do not
need to save money and can still afford goods, which is shown in the
continuous increase of the CPI from 1995 until today. During the Great
Depression, it was not the case, because people had to save money and
consume less, which led to a decrease in goods prices. Due to these facts, the
hypothesis of Chapter 3.2 seems to be correct. The American economy did not
crush that hardly than during the world crisis in 1929, due to the opportunity
of purchasing unemployment insurance.
4. Interest rates of the Central Banks in Europe and the USA
After explaining the reasons and the impacts of the financial crises in
the USA, it is important to take the monetary policy into account. Regarding to
that instrument, the control of the interest rate is the most important tool a
central bank can use to regulate the money supply and the inflation of an
economy. The Federal Reserve uses the Federal funds rate, which represents the
interest rate for other monetary institutions, which trade balances at the FED.
To be able to make a proper statement about the reaction of the Federal
Reserve during and after the Great Depression, Graph 1625 is shown below. It
shows the real Fed funds rate from November 1915 until November 2008.
25
http://greshams-law.com/wp-content/uploads/2011/04/Long-term-Real-Fed-Funds-Interest-RateGraph.png visited the 14th of May 2012, 17:11
32
Graph 16: Development of the real Fed funds rate between 1915 and 2008
Conspicuously is the decrease of the real Fed funds rate in several crises.
First of all, you notice it during the Great Depression, where the Federal
Reserve the interest rate lowers from almost 15% to nearly –3% in a short time
period after 1930. After the fluctuation between 1930 and 1936 a slight increase
is given again, which crushes in 1939 again with the start of World War II. The
next active decrease in the interest rate happened in the 1970s, where the oil
price shock occurred. These two crises are recording to the graph “overvalued
deposits and undervalued Federal Reserve Notes”, which led to an unwinding of
Fractional reserve banking, which includes financial bubbles.
Due to these facts, central banks seem to lower the interest rates during
a crisis to increase the competition in the economy to increase the prices again.
For the importance of this paper, the interest rates of the Federal Reserve and
European Central Bank for the current crisis are looked up to see, if the central
banks act in a similar way like the Fed did already in the world crisis 1929. The
interest rates are given in monthly data from January 1999 until March 2012.
Table 526 shows the Federal Funds Rate from the FED and short run interest
rate from the ECB in the given time interval.
26
Real Federal Funds Rate – data from: http://www.federalreserve.gov/releases/h15/data.htm visited
the 15th of May 2012, 15:36.
Short Run interest Rates from the ECB from:
http://epp.eurostat.ec.europa.eu/portal/page/portal/interest_rates/data/database visited the 15th of
May 2012, 15:46.
33
Table 5: Federal Funds Rate and short run interest rate set by FED & ECB
%
1999M01
1999M02
1999M03
1999M04
1999M05
1999M06
1999M07
1999M08
1999M09
1999M10
1999M11
1999M12
2000M01
2000M02
2000M03
2000M04
2000M05
2000M06
2000M07
2000M08
2000M09
2000M10
2000M11
2000M12
2001M01
2001M02
2001M03
2001M04
2001M05
2001M06
2001M07
2001M08
2001M09
2001M10
2001M11
2001M12
2002M01
2002M02
2002M03
2002M04
Euro
Area
3,14
3,12
2,93
2,71
2,55
2,56
2,52
2,44
2,43
2,50
2,94
3,04
3,04
3,28
3,51
3,69
3,92
4,29
4,31
4,42
4,59
4,76
4,83
4,83
4,76
4,99
4,78
5,06
4,65
4,54
4,51
4,49
3,99
3,97
3,51
3,34
3,29
3,28
3,26
3,32
USA
4,63
4,76
4,81
4,74
4,74
4,76
4,99
5,07
5,22
5,20
5,42
5,30
5,45
5,73
5,85
6,02
6,27
6,53
6,54
6,50
6,52
6,51
6,51
6,40
5,98
5,49
5,31
4,80
4,21
3,97
3,77
3,65
3,07
2,49
2,09
1,82
1,73
1,74
1,73
1,75
%
2002M05
2002M06
2002M07
2002M08
2002M09
2002M10
2002M11
2002M12
2003M01
2003M02
2003M03
2003M04
2003M05
2003M06
2003M07
2003M08
2003M09
2003M10
2003M11
2003M12
2004M01
2004M02
2004M03
2004M04
2004M05
2004M06
2004M07
2004M08
2004M09
2004M10
2004M11
2004M12
2005M01
2005M02
2005M03
2005M04
2005M05
2005M06
2005M07
2005M08
Euro
Area
3,31
3,35
3,30
3,29
3,32
3,30
3,30
3,09
2,79
2,76
2,75
2,56
2,56
2,21
2,08
2,10
2,02
2,01
1,97
2,06
2,02
2,03
2,01
2,08
2,02
2,03
2,07
2,04
2,05
2,11
2,09
2,05
2,08
2,06
2,06
2,08
2,07
2,06
2,07
2,06
USA
1,75
1,75
1,73
1,74
1,75
1,75
1,34
1,24
1,24
1,26
1,25
1,26
1,26
1,22
1,01
1,03
1,01
1,01
1,00
0,98
1,00
1,01
1,00
1,00
1,00
1,03
1,26
1,43
1,61
1,76
1,93
2,16
2,28
2,50
2,63
2,79
3,00
3,04
3,26
3,50
%
2005M09
2005M10
2005M11
2005M12
2006M01
2006M02
2006M03
2006M04
2006M05
2006M06
2006M07
2006M08
2006M09
2006M10
2006M11
2006M12
2007M01
2007M02
2007M03
2007M04
2007M05
2007M06
2007M07
2007M08
2007M09
2007M10
2007M11
2007M12
2008M01
2008M02
2008M03
2008M04
2008M05
2008M06
2008M07
2008M08
2008M09
2008M10
2008M11
2008M12
Euro
Area
2,09
2,07
2,09
2,28
2,33
2,35
2,52
2,63
2,58
2,70
2,81
2,97
3,04
3,28
3,33
3,50
3,56
3,57
3,69
3,82
3,79
3,96
4,06
4,05
4,03
3,94
4,02
3,88
4,02
4,03
4,09
3,99
4,01
4,01
4,19
4,30
4,27
3,82
3,15
2,49
USA
3,62
3,78
4,00
4,16
4,29
4,49
4,59
4,79
4,94
4,99
5,24
5,25
5,25
5,25
5,25
5,24
5,25
5,26
5,26
5,25
5,25
5,25
5,26
5,02
4,94
4,76
4,49
4,24
3,94
2,98
2,61
2,28
1,98
2,00
2,01
2,00
1,81
0,97
0,39
0,16
%
2009M01
2009M02
2009M03
2009M04
2009M05
2009M06
2009M07
2009M08
2009M09
2009M10
2009M11
2009M12
2010M01
2010M02
2010M03
2010M04
2010M05
2010M06
2010M07
2010M08
2010M09
2010M10
2010M11
2010M12
2011M01
2011M02
2011M03
2011M04
2011M05
2011M06
2011M07
2011M08
2011M09
2011M10
2011M11
2011M12
2012M01
2012M02
2012M03
Euro
Area
1,81
1,26
1,06
0,84
0,78
0,70
0,36
0,35
0,36
0,36
0,36
0,35
0,34
0,34
0,35
0,35
0,34
0,35
0,48
0,43
0,45
0,70
0,59
0,50
0,66
0,71
0,66
0,97
1,03
1,12
1,01
0,91
1,01
0,96
0,79
0,63
0,38
0,37
0,36
Regarding to Table 5, it is conspicuous, that the interest rates are
lowered, when an economic event occurs. This decrease can be seen in the
interest rate of the FED and the ECB after 2000 with the burst of the dotcombubble and the terrorist attacks in 2001. The local minimums of the interest
34
USA
0,15
0,22
0,18
0,15
0,18
0,21
0,16
0,16
0,15
0,12
0,12
0,12
0,11
0,13
0,16
0,20
0,20
0,18
0,18
0,19
0,19
0,19
0,19
0,18
0,17
0,16
0,14
0,10
0,09
0,09
0,07
0,10
0,08
0,07
0,08
0,07
0,08
0,10
0,13
rates are reached March 2004 with 1% for the Federal Funds Rate and 2,01%
for the short run interest rates of the European Central Bank. After this time,
an increase in the interest rates is noticeable again, which lastened for the USA
until July 2007 and for the Euro Area until August 2008. After July 2007, the
Federal Reserve lowered the interest rates continuously and rapidly. The global
minimum is reached in the last three months of 2011 with 0,07%. Of course
this rapid decrease is due to the financial crisis. The reason, why the European
interest rate was lowered one year later than the American one, is that the
financial crisis showed its effects in Europe later. With the bankruptcy of
Greece and other financial endangered southern European countries, the crisis
started to roll through Europe. You can even talk about a second crisis, which
occurred in Europe, due to several balance manipulations etc., but these
explanations go beyond the scope of this thesis.
To visualize the behaviour of the interest rates in the Euro-Area and the
USA, Graph 1727 is shown.
Graph 17: Development of interest rates set by the FED and the ECB in %
It is obvious, that the Federal Funds Rate fluctuates more than the short
run interest run of the ECB, although a similar movement of both central
banks can be seen. The amplitude of the FED’s curve is higher than the ECB’s
ones. Between July 2000 and January 2004, the interest rate of the Federal
Reserve fell from 6,54% to 1%, which gives a difference of 5,54%-points in 3
and a half years. In contrary, you see the European interest rate, which
27
Concludes out of Table 5.
35
decreased its interest rates just from 5,06% in April 2001 to 2,01% in March
2004. This is just a change of 3,05%-points. Almost the same happened in the
USA from July 2007 until today. The interest rate crushed from 5,26% to 0,13%
in March 2012. The USA suffered again a loss in the interest rate of 5,13%points, where Europe does not have that high decreases in the interest rate.
From August 2008 with 4,30% interest rate, the ECB lowered the value to
0,34% in January 2010. Although the interest rate changed by 3,96%-points, the
ECB managed to increase the interest rates again, which the USA is still not
able to. This might explain why the financial sector in the USA suffered higher
shocks than the financial sector of the Euro-Zone during the crises.
5. Political conditions during the Great Depression
After explaining how central banks themselves acted during the Great
Depression and nowadays, it is important as well, to have a look on the political
decisions and conditions, the USA and Europe were facing during the world
crisis 1929. As mentioned already, the gold standard and the subsequent
“monetary union” led to deflation due to the scarcity of gold and the holding
of gold exchange funds. Eichengreen and Sachs (1985) presented evidence that
countries, which abandoned the gold standard completely, recovered faster
from the Great Depression, than countries, which were still pegged to it. This is
due to the fact, that countries faced higher inflation expectations by abandoning
gold, which reduced automatically the money demand (Bernanke, B., James, H.,
2000). The authors point out, due to the evidence of Eichengreen and Sachs,
that countries were able to expand their money supply by abandoning the gold
standard and were subsequently able to escape the deflation. This fact is
important, due to a change in the American government, because exactly that
happened in the USA with the presidency of F.D. Roosevelt and his new deal,
which is explained later on in this chapter.
5.1. The failure of president Herbert Hoover
Herbert Hoover was a dominant member of the Republican Party and
became president of the United States during the world crisis (1929-1932).
Hoover’s policy was, recording to historians, typical for a conservative, because
36
he relied on the principles of budget control, low taxes and minimal
government regulation (Himmelberg, R., The great depression and the new deal,
2001). In his opinion, it was important, that the national government should
take over an active role in improving the social and economic welfare. However,
Himmelberg argues, that Hoover’s policy was proclaimed as “do-nothingism”
by the “progressives”, because it was an insignificant change for people who
already had wealth did just slightly help individuals who wanted to achieve it.
When Hoover candidate for the presidency, he was known as the great
“problem-solver”, due to his good position in the Republican party in the
1920s. Due to Himmelberg, Hoover left his activity as president remembered
for his failure to struggle the Great Depression instead of his efforts against it.
Due to the Black Thursday, Hoover’s first attempt to struggle the crisis
was the try to prevent the crash from affecting wages, spending and business
activity negatively. First of all, he recommended business leaders to continue
the industrial production, the planned industrial spending and to keep the
wages and the number of employees on the same level. Additionally Hoover
wanted the state governments and the Congress to enlarge their expenditures to
maintain overall national spending. Although, these attempts had positive
effects, the downward swing of the American economy was not stopped.
Moreover, Himmelberg argues, that Hoover failed in giving an effective
leadership for the Republicans, which held the majority in both houses. This
was shown in an enlarged fight over tariff revision, which gave the Democratic
Party more reason to criticize the Republican Congress and Hoover himself.
Hoover could not handle the criticism, which led to the loss of the House to
the Democrats at the congressional elections in 1930.
Another fact, which Himmelberg mentions, is that Hoover’s hopes of
the economic recovery in 1931 were evaporated, because the financial crisis
affected European countries as well. Major banks and several of their monetary
systems suffered under the threat of destruction, which was the reason, why
Hoover intervened with a proposal of a year-long deferment of payment on all
intergovernmental debts. Nevertheless, the moratorium failed to control the
European financial crisis.
Due to a rapid increase in the unemployment rate and banking system,
which was on the edge of a collapse, Hoover came out with a new strategy.
Recording to Himmelberg, Hoover attempted to save the American financial
system and the American banking by establishing a new federal agency, which
was authorized to lend money to American banks. This new institution was the
37
Reconstruction Finance Corporation (RFC). The Democrats criticized Hoover,
because his intention, apparently, was just to improve the banking sector by
lending millions of dollars to banks through the RFC. However, he did not
provide anything to unemployed people and their families, which led to a
permanent damage in Hoover’s reputation. His aim was to economic recovery,
which was, recording to him, just achieved by borrowing and spending by
businessmen. The erosion of business confidence would have been furthered,
if federal spending would have opened up on relief, due to heavy taxation and
heavy government borrowing. Subsequently, Hoover faced critics, which said,
that his actions were cruel and misguided.
5.2. Franklin Delano Roosevelt and the New Deal in 1933-1935
After the failure of president Herbert Hoover, the American population
voted in the presidential election in 1932 for the Democratic Party and
subsequently for Franklin Delano Roosevelt, who was nominated as candidate
for the Democrats. Himmelberg (2001) argues that the banking system was
standing still, when Roosevelt was sworn in. This fact is due to the fact, that
one governor after another, declared bank holidays in the last days of Hoover’s
presidency, which almost led to complete halt of the economy. In the
meanwhile, farmers were struggling desperately to increase the prices by
destroying crops and keep them away from the market supply. This behaviour
was called “farm holiday”.
Immediately after Roosevelt’s inauguration, he declared a national bank
holiday and broke the previous regulations through an appreciating Congress.
This change gave the government the possibility to close banks, which were
facing the threat of failure and reopen the ones, which seemed to be stable
again. Consequently, investors and depositors started again to trust in the
banking system. The previous hoarding in cash diminished and returned to
savings and checking accounts, which led to the stabilization of the banking
system. To strengthen the banks, the Federal Deposit Insurance Corporation
(FDIC) was established. This period was declared as “One Hundred Days”.
One of Roosevelt’s main aims was the importance of “reflating” the
American economy. Recording to Himmelberg, the Democrats and
subsequently Roosevelt thought, that the prices of raw materials and agriculture
had to increase again. A few weeks after Roosevelt’s inauguration, he accepted
38
the Thomas Amendment to the Farm Relief Bill. This instrument, which
Roosevelt used carefully during the subsequent years, gave him the opportunity
to inflate the dollar. The reflation included the creation of the two premier
initiatives, too, which were set as the Agricultural Adjustment Administration
(AAA) and the National Recovery Administration (NRA). The NRA
represented an institution, which permitted members limited regulated
competition between the different businesses of broad array industries.
Recording to Himmelberg, the increase in farm prices due to federal regulation,
or in other words subsidies from the government, of the market concluded
successfully.
The question here is how Roosevelt managed to reflate the economy,
although the United States were pegged to the gold standard and other states.
Additionally, the US had to face the problem of the limited power of the
Federal Reserve. Almost immediately after Roosevelt’s inauguration, he referred
again to the wartime and the “Trading with the Enemy Act” (Himmelberg, R.,
2001). Roosevelt decided to prohibit exporting gold from the USA and basically
took the US off the gold standard. The reaction in Europe was, obviously,
really bad, because Roosevelt took the USA out of European’s business, which
consequently means, that the United States did not support European countries
with credits and loans anymore.
Germany’s economy boomed again, after the election of Adolf Hitler.
Although his backgrounds and reasons were very badly-intended, he improved
the German economic situation by hiring people for the war-machineproduction and the construction of the “Autobahn”.
Anyhow, Roosevelt’s decisions and policy increased the economic
situation of the United States again. Together with the Federal Reserve, he
managed to get the USA out of the deflation and out of the crisis. This kind of
policy might give some suggestions for the financial crisis nowadays.
39
6. Direct comparison between the crises 1929 and 2008
This section is meant for a direct comparison of the crises. Due to the
fact, that causes, impacts, reactions and policies show similarities, it is important
to compare every phase of the crises with each other. This will occur in Table
6, which summarizes the thesis in a comparative way.
Table 6: Direct comparison of the crises
The world crisis 1929
The financial crisis
today
Causes
- Stock market
- Stock market
crash
crash
- High amount of
- High amount of
out given credits
out given credits
- People had high
and mortgages
debts, due to
- People had high
maintain high
debts, due to the
consumption
housing-market
- Financial bubble
- Financial bubble
- High loans to
- Agencies marked
other countries
lower rated
bonds with
AAA-status
Prior event
World War I
Dotcom Bubble
Variable of TradeGold Standard (USA
Euro (USA indirectly
Simplification
directly affected)
affected by exchange
rate)
Influences and
Losses in
Losses in
Impacts
Dow Jones: -80%
Dow Jones: -33,85%
AAIP: -36,39%
AAIP: -10%
CPI: -24%
CPI: 0%
Increase of
Increase of
Unempl. Rate: 757% Unempl. Rate: 209%
(from 3,3% to 24,9%)
(from 4,6% to 9,6%)
Deflation
Deflation
40
Bankruptcy of banks
Central Banks’
behaviour
Government’s
behaviour
Bankruptcy
of
the
investment
bank
“Lehman Brothers”
High state debts in State bankruptcy in
European countries
European countries
Determining a low
Determining a low
interest rate which is
interest rate which is
close to 0%
close to 0%
Abandoning the gold
(follows in conclusion)
standard to give own
central bank more rights
and to reflate
Table 6 shows several similarities nowadays and in the crisis 1929. For
example are the causes of the crises due to problems in the financial sector by
giving out to many unsafe credits and mortgages, although the backgrounds
were different. Additionally, both crises are pegged to a stock market crash and
created a financial bubble in previous times. Moreover, both events had/have a
monetary variable to simplify international transactions: The gold standard and
the Euro. However, it is conspicuous, that the influences on industrial
production, Dow Jones and the Consumer-Price-Index are nowadays way lower
than the USA had to face during the Great Depression. Another point is that
the unemployment rate today did not increase as high as the one in the interwar
period. Other similarities are the factor of deflation in both periods and the
high state debts in European countries, which led nowadays even to state
bankruptcy cases like Greece. Moreover, the Central Bank’s behaviour in the
USA and the Euro area is identical, which means, that Central Banks lowered
the interest rates immensely to almost 0%, to boost the market competition
again to increase goods prices to get out of the deflation. The last point, which
is for today still unsure, is the fact, that Franklin Delano Roosevelt abandoned
the gold standard immediately after his inauguration to give the Federal Reserve
the full power of money supply and to regulate the deflation again. Due to the
fact that current Central Banks took already over the methods of the crisis
1929, the only open question here is, if current governments can learn from the
previous event as well?
41
7. Conclusion
As a conclusion, you can say, that both crises show a lot of similarities
but, as well, some differences in the way they occurred. Due to the analysis and
the comparison, it is already clear, that the Central Banks lowered the interest
rates recently, like they did during the Great Depression. The current American
government and president Barack Obama cannot take over the methods of the
Franklin Delano Roosevelt, because the United States are not pegged (but
indirectly affected by the exchange rate of the Euro) to a monetary “union” like
they were in 1929 with the gold standard. In my opinion, however, the
American economy will recover by itself due to the fact, that the Federal
Reserve already lowered the interest rates and that the impacts of the crisis on
the analysed parameters were not as dramatic as in 1929. The unemployment
insurance led to the point that the relation between consumption and prices did
not fall, because it helped the unemployed people to bridge the time of nonemployment, which means that individuals did not need to sacrifice their
normal consumption.
Looking closer at the conditions of the current crisis in Europe and the
world crisis in 1929, you notice, that Germany, France and the Netherlands
(GFN) have the same position as the United States had in the interwar period.
GFN supports mostly Greece with monetary aid packages to keep the economy
working, although Greece suffers under state bankruptcy. The USA was main
creditor for European countries after World War I, because they had large
reparation costs and loans. Economically, Germany was able to increase its
situation although the US decided to be independent and abandoned the gold
standard. The backgrounds of the monetary support are different, but the
methods themselves are the same. In my opinion, you can take over the idea of
abandoning the monetary variable, to increase the economic situations for
several European countries. Of course, European countries cannot abandon
the Euro completely, because, I think, this would imply an increase in prices to
maintain the current GDP, which would lead to the problem of inflation in the
Euro-countries. Additionally the problem with the exchange rates would appear
again, which would affect the net exports of the economies.
Anyways, the governments just could give Greece its own currency
(Greek drachma) back to give Greece the opportunity to regulate its economy
by itself with a certain monetary and fiscal policy. If Greece could solve its
bankruptcy problem by own decision making, GFN won’t be supposed to
42
support Greece financially anymore, which leads automatically to a higher
amount of domestic savings, which GFN can use in other sectors like repaying
the loans from World War II etc.
In my opinion, the question, if current Central Banks and governments
can learn from the world crisis in 1929, can be answered with yes, although
economies are not supposed to act in the exact same way, like central banks and
governments did in the interwar crisis, but similarly.
43
8. Acknowledgement
I am grateful, that Karl-Markus Modén (Economic Department at
Karlstads Universitetet) was my supervisor for this Thesis. I thank him for his
help, support, good advices and good proposals for useful literature, which I
included into my thesis. Additionally I would like to thank my home university,
the Albert-Ludwigs-Universität Freiburg in Germany, and my host university,
Karlstad’s Universitetet in Sweden, which gave me the opportunity to write this
thesis here in Karlstad to get a second Bachelor’s Degree.
44
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Acharya, V. V. (2009). Causes of the Financial Crisis.
Angkinand, A., & Willett, T. D. (n.d.). Moral Hazard, Financial Crisis, and the
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Bernanke, B. S. (1995). The Macroeconomics of the Great Depression: A
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Bernanke, B. S. (2000). Essays on the Great Depression.
Bernanke, B. S., & James, H. (2000). The Gold Standard, Deflation, and Financial
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