Question

In October 1929, the U.S. stock market suddenly crashed after a long period of growth. It was the beginning of the Great Depression era with falling incomes and prices that came to a definite end only right before Pearl Harbor, and the start of World War II.

In contrast, in 2001, the dotcom bubble burst, but the economy quickly got back on its feet a few quarters later. In 2007-2008 the US housing market crashed and set off a financial crisis that initially mirrored the great depression. After a few years, however, it became evident that the US economy had escaped such a threat with only a “great recession” rather than a “great depression”.

Discuss one or more of the following prompts:

• Why did the Great Depression last much longer than the Great Recession?
• What are the analogies and the differences in the policy responses to these similar shocks? (Distinguish monetary and fiscal policy).
• Japan in the 1990s and the Euro area in the 2010s were much less successful in responding to the crisis. What do you think explains the difference? Lack of reforms? Monetary policy? Fiscal policy? Explain.

Answer 1

The Great Depression period started in August 1929 and ending in March 1933 (which means 3 years 7 months); while the Great Recession was from December 2007 - June 2009 (which means 18 months). The Great Depression was far deeper and longer compared to the Recession. The main reason was that the Depression did not start as a garden variety Great Recession; however it was severe immediately as manufacturing output declined by 35% in just the first year of the Depression, before the huge declines in the money supply and the banking panics. Moreover between 1930 and 2008, huge changes occurred in economic policy and philosophy.

The Fed used contracting monetary policy during Great Depression which prolonged the depression, and also lead to the recession within the depression. When the government should have cut taxes and increased spending, it performed exact opposite and imposed new taxes and reduced the spending. The implemented policies during the Great Depression to restore the economy only made it worse and prolonged the period.