Looking back on the Great Depression today, many people think they know the direct cause to why it happened and the reason it lasted so long. Everybody likes to point to Black Thursday, October 24, 1929 when the stock market seemed to go into free fall and on Tuesday, October 29, 1929 the New York Stock Exchange saw over sixteen-million shares traded. People who had heavily invested or borrowed found themselves in bleak situations as the banks had no money to give. Businesses closed and work was hard to find. Since there were few ways to make money, people were not spending money and there was no way for the economy to recover on its own. Another accepted belief is that the Great Depression ended once the United States geared up to enter World War II. However, those are just simplified understandings that most high school and even early college level students have been provided. The situation is more complicated and various economic theories are involved.
The Great
Depression did not suddenly happen in late October 1929 for no reason. There
had been mounting problems in the United States’ economy for years. During the
1920’s the United States was still riding high from the Progressive Era with
its innovation and the economic growth stemming from the rebuilding efforts in
Europe after World War I. As the economy kept going strong, more people started
investing in the stock market, but often only buying on margin (only paying a
percentage of the stock’s value and borrowing the rest). But a big issue came
from overproduction and supply in the agricultural industry. As the excess of
product flooded the market the prices began to fall and farmers were
struggling. Mirror situations were occurring in the industrial industry as
demand for production increased but wages did not match, which caused a
decrease in consumerism followed by a decrease in production. When the stock
market crashed, the run on banks showed the lack of faith as banks began to
fold under and people lost everything.
Recessions
and depressions are not unusual in an economic cycle after a financial crisis;
this is strongly believed in the Austrian School of Economics. The issue with
the Great Depression was why was it so severe? How can it be prevented from
happening again? If a depression hits, how does an economy get out of it and
recover?
An economic theory, known as the
Keynesian Theory, was created by a British economist, John Maynard Keynes
during the Great Depression. He believed that an economy is driven by the
demand for goods and services. His theory about the Great Depression focused on
there not being enough aggregate demand, which led to less spending, which
spiraled to the need for less production and fewer jobs; a cycle where there
was even less money available for spending to be injected into the economy.
Aggregate demand is a term to describe how much somebody is willing to spend or
consume in a year – but the ‘somebody’ encompasses all people, businesses, and
governments of a country. As the depression continued on, the negative outlook about
the situation would prevent businesses from investing in their company and that
dominoed into lower employment and less output – perpetuating a depressed
economy. Aggregate demand is too low for the economy to recover. Without an
outward control, economies can not stabilize.
Keynes saw free markets as lacking the ability to provide full employment, so as a solution, he thought governments needed to be involved and have policies in place to stabilize employment and pricing. During depressions, governments should lower taxes and spend money to create jobs – even if it creates a government budget deficit. These jobs could be for infrastructure projects (which President FDR implements with programs like the Works Progress Administration and the Civilian Conservation Corps). By creating jobs there is income provided, which allows the spending of money, which helps the economy to keep moving. Aggregate demand increases and the economy is boosted. On the flip side, Keynes thought that during higher demand periods with a hot economy, the government should raise taxes to prevent inflation. Generally, Keynesian theory is a strong supporter of government involvement in order to control the economy.
The Keynesian
Theory does not provide the whole solution, however. Some economists stick to a
classical economic theory where intervention should be left out and allow for free
market supply and demand to eventually balance the economy again. Later, an economic
theory brought forward by Milton Friedman and Anna Schwartz (mainly viewed as
the Monetarist theory) posits that the Great Depression was not about the
economy, but instead caused by limited money supply and mismanagement by the
Federal Reserve. This theory began to win out over the Keynesian Theory when it
could not explain why, in the 1970s, there was slow economic growth but
inflation was high. Only after implementing solutions of the Monetarist theory
(restricting money supply) did inflation decrease, though a recession followed.
Monetarist actions were utilized again by the Fed during the 2007 recession
when interest rates were lowered in order to stimulate the economy.
There will
continue to be theories and debates about the causes of the Great Depression in
the 1930s. It remains a complicated issue. Economists keep studying the period
and look for trends or similarities in the market that might reveal new ideas
about it so they can hopefully prevent it from happening again. The Keynesian
Theory seemed to fit the situation at the time of the Great Depression; however,
it does not work for other economic disruptions. As time progresses, economics seems
like a wild science that is still being understood and more theories will be
developed in the future.
Sources
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Accessed July 23, 2025.
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Accessed July 23, 2025.
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