I. The Great Depression

The Great Depression of the 1930s has affected the study of macroeconomics more than any other event in history. Indeed, the founding of macroeconomics as a separate discipline largely coincided with attempts to explain the Great Depression. It wasn't until the 1970s and 1980s that mainstream macroeconomics emerged from being dominated by theories of recession and depression.

The most common association that the general public has with the Great Depression is the crash of the stock market that occurred in October of 1929. Stock prices did fall dramatically on the day of the crash and continued in a general downward trend for several years. However, the Great Depression was much more than a crash in financial markets. Although the crash had an impact on the Depression, it was less a cause of the Depression than a co-symptom of a collection of underlying problems.

Both because of its magnitude as a social phenomenon and because of its impact on the development of macroeconomics, it is important to understand some basic facts about what happened during the Great Depression. In the words of Milton Friedman and Anna Schwartz, from their Monetary History of the United States, "The contraction from 1929 to 1933 was by far the most severe business-cycle contraction during the near-century of U.S. history we cover [1867-1960] and it may well have been the most severe in the whole of U.S. history. Though sharper and more prolonged in the United States than in most other countries, it was worldwide in scope and ranks as the most severe and widely diffused international contraction of modern times. U.S. net national product in current prices fell by more than one-half from 1929 to 1933; net national product in constant prices, by more than one-third; implicit prices [a broad index of prices across the economy], by more than one-quarter; and monthly wholesale prices, by more than one-third."

The most commonly cited indicator of business cycles, the unemployment rate, rose from 3.2% of the labor force in 1929 to 24.9% in 1933. Unemployment fell to 14.3% in 1937, but then increased again to 19.0% in 1938 and was still 9.9% in 1941 before the military boom associated with World War II brought it down to 1.9% in 1943. Real gross national product (output of goods and services) per person did not until 1940 recover to the level it had achieved in 1929. As the quote from Friedman and Schwartz indicates, prices were falling steadily through the 1930s as well. Table 1 summarizes some major macroeconomic statistics for the period 1925 to 1940.

Table 1 Per-capita real GNP (1958 GNP deflator |Interest rates prices) 1958 = 100) (% per year) Unemployment Rate Prime 4-6 3-month 30-year Level Growth Price Inflation month corporate Year (%) Rate level rate commercial Treasury bills bonds paper 1925 3.2 1,549 6.83% 51.9 1.37% 4.02% NA 4.50% 1926 1.8 1,619 4.52% 51.1 -1.54% 4.34% NA 4.40% 1927 3.3 1,594 1-1.54% 50.0 -2.15% 4.1 1% NA 4.30% 1928 4.2 1,584 -0.63% 50.8 1.60% 4.85% NA 4.05% 1929 3.2 1,671 15.49% 50.6 -0.39% 5.85% NA 4.42% 1930 18.7 1,490 |10.83% 149.3 -2.57% 3.59% NA 4.40% 1931 15.9 1,364 -8.46% 44.8 -9.13% 2.64% 1.40% 4.10%