Try it now!

USD
10

Calculate your price

Number of pages:

Order Now
Table of Contents

A Look Into the Monetary Policies During the Great Recession and the Great Depression - Part 14

1004

6 Comparison Between the Great Recession and the Great Depression

There are many fundamental differences that existed between the two economic downturns, namely, the Great Depression and the Great Recession. Other than the degree of severity, there are two important differences that separate the two events. The first aspect is that Great Recession saw milder declines in real income and milder increases in the rates of unemployment when compared to the Great Depression. The second and the more important aspect, is the variation in monetary conditions, especially the money supply situation within the economy.

Are you up to writing a critical book review but don't have enough skills? Learn about it from our informative article at Pro-Papers, it should help you to write a top-notch review.

6.1 Money Supply

The money supply in the US economy plummeted during the Great Depression, however, during the Great Recession, it increased. In fact, towards the end of the recession, the levels of money supply within the economy accelerated.  These phenomena of money supply are explained in the charts below.

Money supply is plotted for the two economic downturns on a graph. It represents the business cycle peaks that were witnessed in August 1929 and December 2007. The period for the Great Depression is 21 months, from November 1927 to August 1929, and 43 months from then till March 1933. As for the Great Recession, the period represented on the graph is for a period of 17 months. From the above graph, it is obvious that money supply increased during the Great Recession while in the Great Depression, it fell.

The primary reasons for the fall in money supply is that the fear of a possible collase of the  banking idustry  made people to choose liquidity over bank deposits relative to the currency and the bank's preferences for deposits relative to the currency. In other words, people preferred to have cash on hand instead of putting it in a deposit with any bank. This preference caused a major liquidity crunch in the financial industry, and it eventually led to the decline of monetary deposits within the economy. To compound this problem, the Fed failed to instill confidence back into the economy with the right monetary policies, and all these factors made the depression “Great.” On the other hand, the Great Recession saw higher liquidity levels in the ecoomy because the Fed started many programs to build liquidity within the economy. These two actions were what caused money supply to fall during the Great Depression and increase during the Great Recession.

Bernanke is believed to have agreed that the Fed did make mistakes during the Great Depression, and he promised that it will not happen again (Lothian, 2009). He was true to his words, but, he misjudged the 2007 crisis. To avoid a repeat of the Great Depression, the Fed saw the problem as one of liquidity, so they took all possible steps to provide liquidity within the market. These actions by Fed ensured that the money supply within the economy did not falter. This action explains why money supply increased during the recession when compared to 1930s.

Due to these actions, the monetary policy has expanded since December 2007. When the recession began, M1 was $1369.2 million and in July 2014, it had almost doubled to $2858.1.  As for M2, it was $7455 in December 2007 and in July 2014, $11415.1 million (St.Louis Fed, 2014). , when it . Around the same time during the Great Depression, money supply fell by five percent, and later, during the banking crisis of 1931, the money supply fell by a whopping 33 percent. Therefore, in this sense of money supply, the Fed ensured that the recession did not end up to be a repeat of the Great Depression. This increase in money supply has also been one of the high points of the recession because there was no rude monetary shock for the economy.

A related factor that needs to be taken into account is the movement of the money multiplier during both the times. A graph is presented below to show the movement and velocity of money multiplier during both the cycles.

There was a surprising trend because the money multiplier during the Great Depression increased initially, and then fell hard, while during the Great Recession, it fell gradually over the entire period. Also, both the curves declined at almost identical rates, and this trend raises many questions.  During the Great Depression, this multiplier fell which meant that banks did not create more money against the Fed's money, so the amount of money available for lending was low. The same was the case during the Great Recession, however, the difference is that during the latter downturn the fall was not sharp because the Fed brought in more liquidity  into the economy with its programs.

The key purpose of writing an admission essay is to provide quite a broad overview of an applicant. If there are some problems with writing high school personal statement, Pro-Papers is always ready to help you out.

An analysis of both the curves show that though the fall is identical, it is not for the same reasons. In other words, the underlying cause for the fall of both the curves is very different. The fall during the Great Depression came as a result of banking failures. Individuals and businesses changed their mix of holdings and currency because of their lack of trust in the banking industry.     Therefore, banks were faced with a loss of deposits. However, in this recession, the rate of bank deposits and loans have been on the rise for banks. This rise goes to show that the reason for the fall of money multiplier during the great recession is not the same as the Great Depression. In fact, the reason for the fall is the initial reaction of money supply to the base funds pumped in by the Fed into the economy.

Other possible explanations for the fall of money multiplier in the economy is that it could be a short-run phenomenon that is likely to exist before the base fund turn into increased spending. This idea of a decline in money multiplier is based on the theory called the buffer stock models of money demand (Carroll, 1992).

The basic principle of the buffer stock model is that the transactions money balances act as shock absorbers during a transitional period, and these balances would even itself out in the long-run when the demand for money gets adjusted to the supply level. These balances, according to the theory, would happen in the event of unanticipated economic shocks or monetary influxes. Since the base multiplier trends follows a similar pattern, the application of this buffer stock model gives much sense to the falling trend.

Other theories have also emerged that explain the falling money multiplier during the Great Recession.

A notable opinion is that of Paul Krugman (2008) who has argued that had this situation been in the 1930s, could that have meant that the US would have face a recession instead of a deep depression? The answer to this question depends on two factors. The first factor is an empirical one because the demand for money function did not change during the Great Depression or the years ensuing it, as the short-term interest rates continued to remain low.

The second reason is a more theoretical one than the first. “Underlying the notion of the liquidity trap is a narrow view of the transmission mechanism for monetary policy in which short-term credit instruments are the only substitute for money. That, however, is completely unrealistic – the range of substitutes is much broader, including other types of securities, real estates, non durable goods and services. Incipient excess supplies of money will result in a portfolio adjustment process involving increases in nominal spending on this entire range of substitutes” (Federal Reserve Bank of Atlanta, 2009, p. 4). This explanation goes to show the decline was slower than expected because people had more avenues to invest their money such as real estate and ETFs, so during the natural process of adjustment, people tend to look beyond bank deposits and invest in other investments to equalize their return. Such a diversification opportunity was not available during the Great Depression.

6.2 Fed's Policies

The biggest difference between the Great Recession and the Great Depression was the way in which the Fed handled both, including their swiftness and pragmatism. During the Great Depression, the Fed's missteps hastened the economic decline. When the stock markets were on a speculative boom, the Fed increased interest rates to curtail inflation. Such a measure was a short sighted one because in dampened the borrowing ability of banks, and led to a steep decline in the liquidity position of the economy. Capital spending slowed dramatically, and the economy came to a complete halt after the infamous stock market crash of 1929.

In these measures, the Fed specifically failed to stop the massive banking panics that plagued the US economy from 1930-33. It even failed in its role as the lender of last resort, as it allowed only banks with enough collateral to borrow. As a result, many banks failed, and investors lost much money during this time. This panic and loss of confidence among investors led to deflation.

In 1933, FDR and the new government brought about measures that helped to stabilize the economy to some extent. However, unemployment levels that were present before the Great Depression were achieved only in 1941, after the US entered the Second World War. This prolonged downturn was due to the Fed's wrong policies. It had no control over the situation, and did not anticipate any of these events. In fact, the Fed had completely read the economy wrong, and as a result, it came up with the wrong policies that further harmed the economy.

By contrast, the policies implemented by the Fed during the Great Recession were drastically different. Firstly, when the recession began, the Fed acted swiftly to prevent the collapse of the financial sector. The Fed believed that a sound banking system was the key to a fast recovery, so it took measures right away to protect that sector. It implemented policies such as reducing the federal funds rate to near zero percent to boost liquidity within the economy.

Another important step that the Fed took was to lend money to distressed banks for a short period of time. This move to lend money was especially beneficial to prevent further chaos within the economy. Its funding to the insurance company American International Group (AIG) was the key to halt the free fall of the financial sector. Furthermore, it expanded its balance sheet to help banks such as Bear Sterns get merged with other institutions such as JP Morgan Chase. On top of these measures, the Fed ensured that money supply was available in plenty within the economy. It also made large-scale purchases of Treasury bonds to prevent the risk of deflation that plagued the US economy during the Great Depression.

From the above comparison, it is clear that the Fed learned the mistakes made during the Great Depression, and was careful to avoid the same during the Great Recession. Therefore, with better insight and policies, it was able to curtail the collapse of the financial sector during the Great Recession.

6.3 Changes in Wealth and Income Distribution

The Great Recession also had a profound impact on the society in terms of its wealth and income distribution. These changes provided more opportunities to some sections of the society to study and to excel in their careers. Furthermore, it also provided more business opportunities to some over others, and in this sense, these changes in wealth and income distribution caused by the recession impacted the future of the American society.

Another big question is whether the Great Recession caused substantial shifts in the distribution of income and wealth in the society. While it may be too early to answer this question, the preliminary data does not reveal such major shifts, as the ones witnessed after the Great Depression because of the introduction of the New Deal. This difference in income distribution between the Great Recession and the Great Depression is because the stimulus program introduced during the Great Recession was only a temporary initiative that worked to buttress the existing programs as opposed to the New Deal that created new institutions for economic recovery. These institutions redistributed the wealth among the society, which was unfair to some segments while another segment made the most of it.

If you are an outcome driven student, who has a lot of tasks and very tight deadlines, you can try Pro-Papers services and get your papers for effective academic writing as soon as possible.

Since the Great Recession did not create such institutions, the reform measures tended to be more transitory in nature when compared to the Great Depression. For example, the stock market decline caused reductions in wealth and consumption, and to offset this decline, the government acted to extend unemployment benefits and other temporary programs to improve income and spending. Now that the stock markets have recovered, the programs are tapering out slowly. The bottom line is that these stimulus programs did create changes in income distribution, But it was temporary because of the way the different unemployment programs were setup.

This argument extends to the social and cultural impact of the Great Recession too. The fundamental changes that were caused due to programs introduced Great Depression had a more cultural and social impact, and the same scenario is not seen during the Great Recession, since the programs are temporary in nature, and are not aimed at making any fundamental changes to the society.

Leave a Reply

Your email address will not be published / Required fields are marked *

USD
10

Calculate your price

Number of pages: