Table of Contents

A Look Into the Monetary Policies During the Great Recession and the Great Depression - Part 5


3 Perspectives of Different Economists and Their Analysis

Different economists have expressed their opinions on both Great Depression and the Great Recession. Below is a detailed explanation of the opinions expressed by different economists on both the economic downturns. An analysis of these perspectives is expected to give readers a new direction on both the events.

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3.1 Smiley

According to Smiley (2013), the Great Depression was the most damaging crisis in the history of the world. The economic recession of 2007 is similar to the Great Depression, but these two crises differ in many respect. The causes of crises, their development, and the consequences of economic decline were different. On one hand, the Great Depression was more complex because of the interplay of many factors that were taking place within and outside the US. The recession of 2007, on the other hand, was caused by the instability of the financial system of the US and other countries worldwide. Besides, the Great Depression was longer than the financial crisis of 2007. In addition, the consequences of the Great depression including poverty, famine, unemployment, and civil disorder were severe than the consequences of the recession.

Smiley (2013) offered new insight on the causes and consequences of the Great Depression. He challenged popular beliefs related to the Great Depression, and mainly emphasized that one of the primary causes of the Great Depression was wrong governmental policies such as its deflationary measures. The Fed's deflationary policy limited economic activity and contributed to the reduction of price levels. He even argued that it was the deflationary policy, and not the stock market crash that led to the depression in the first place. He believed that the Fed made a mistake by focusing on reducing inflation, rather than boosting economic growth, and this costly mistake caused the entire country to suffer. Smiley also strongly contended that the stock market collapse was a consequence of the depression, and not its cause as is popularly believed.

Another area Smiley emphasized is his thoughts on the recovery. He opined that the New Deal Program did not help restore the United States economy. Increased taxes and tariffs, wage price and market control caused more harm than good for the economy. In this sense, it is not only the Fed, but the US government as a whole that failed to give the economy the much-needed impetus to recover. To add to this failure, the policies of the Fed and the New Deal Program that was implemented during the Great Depression transformed the role of the government within the US economy. Smiley (2013) contends that this increased role for the US government does not augur well for the future of the country because the government should simply remain as the authority for law and order, and it should not enter into the economics of the market. Unfortunately. after the Great Depression, the U.S. government expanded its role in economic activities, exercised more control over businesses, created unemployment compensation schemes, and took over other social security measures. Furthermore, Keynesian view on the economy started to prevail in the United States.

Though these points of view are insightful, one major drawback is that Smiley failed to explain the methodology he used to arrive at these conclusions. Furthermore, many of his assumptions are not backed by tables and charts, thereby making it difficult for readers to understand the basis of his arguments.

3.2 Bernanke

Bernanke is the former chairman of the Fed, and he has been appreciated by many segments of the society for his role in handling the Great Recession. Therefore, his opinions carry much clout, and are examined in detail below.

Bernanke (2000) examined two types of evidence using aggregates and dis-aggregated indicators across countries during the Great Depression. The central claim of Bernanke is that the Great Depression originated from the countries that followed the Gold Standard. This claim means the Great Depression originated mostly in the US and Europe, and later spread to the rest of the world. This is an interesting point compared to that of Smiley, who as explained earlier, believed that the Great Depression did not originate within the US, but came from countries that were already having an economic downturn. This contrasting opinions again go to prove that it is hard to get a consensus on the causes and nature of the Great Depression, even after 85 years.

However, there is some measure of unanimity in the theory that the monetary policies of the Fed contributed to the depression, as it was agreed by both Smiley and Bernanke. In fact, Bernanke (2000) used extensive statistics collected across the country to prove his arguments. He opined that the economic decline was accompanied by the decline in money stock, and inadequate nominal wages resulted from improper monetary policy that was implemented to kick start the economy. He further argued that the financial crisis that took place in the early 1930’s had negatively affected the real economy by driving up cost of credit intermediation. The basic arguments for this increase is that the fall of the financial sector and the debt crisis that followed increased this cost because the banks were unable to channel funds from the savings of people to the needs of credible borrowers.

During normal times, banks make the lending process easy by gathering information about customers and evaluating their financial position. When banks fail, this crucial information is lost or is not accurately available. Therefore, the new lenders which could be banks or non-banks have to incur additional costs to gather this information about customers. This additional cost incurred to know about customers decreases the availability of credit available for lending and at the same time, increases the cost of intermediation. Another related cause of rise in the cost of credit intermediation is the credit perception of the bank manager. If a bank manager has a tendency to be risk averse, then he or she is likely to tighten lending standards or amounts, that would eventually reduce credit availability. Therefore, when the banks failed in 1930s, it increased the cost of credit intermediation. This increase is corroborated by the time series data collected and analyzed by Bernanke (2000).

The aggregate time series data analyzed by Bernanke (2000) included bank deposits and liabilities of businesses predicting output growth. The effect of deflation and monetary policy was based on the analysis of simple ratios using simpler methods. Thus, the linkage between price levels and nominal money supply that prevailed within the economy at that time, international reserves, the monetary base, price and the quantity of gold reserves were used to decompose the factors influencing the global deflation before and after the crisis. He reported that nominal money supply was zero from the fourth quarter of 1928 to the fourth quarter of 1929 with 1930 being the worst as it fell six log points.

He concluded that the monetary collapse resulted from poorly managed international monetary system, and this included the gold standard as well. The main contribution of the research presented by Bernanke (2000) is a provision of quantitative details that helped to substantiate the situation, and to throw more light into the causes of the Great Depression. His argument centered mainly on deflation and its reasons as this was one of the major causes for the continued decline and the slow recovery of the economy.

However, Bernanke is sometimes criticized by economists such as Charles Kindelberger and Hyman Minsky (Norris, 2013), for using outdated statistical methods and wrong assumptions made during the research that influenced the outcomes of the research. For example, PANIC variable is not statistically significant, though it was used as a measure of banking instability by Bernanke. Rather, this was a dummy variable that he defined as “the number of months during each year that countries in the sample suffered from banking crisis” (Bernanke, 2009, p.27). This variable was coined as a measure of banking stability because Bernanke did not have information on the indebtedness and financial distress that impacted the banking sector during the period that he included in his research. Therefore, the use of such a dummy variable distorted the research to some extent, thereby making it inconclusive.

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Besides, the assumption related to the adjustment of perfect wage, the minimum wage that is acceptable for every worker to produce a single unit of a product, to the cost of living did not make an effect on the ability to track employment and working hours. For example, the data and simulations used by Bernanke did not anticipate the move by steel and automobile industries to preserve their workforce through work sharing strategies such as cutting back hours. While it can be argued that the above example is due to the oligopoly nature of the industries, the underlying point is that the simulations done by Bernanke linked the sensitivity of wages to cost of living changes instead of linking it with the price behavior. Due to this reason, Bernanke's argument did not bring out the true picture of the situation that existed then. Other than these drawbacks, Bernanke's opinions on the Great Depression's causes is well-received, and it also underlined the fact that the Fed's monetary policy worsened the situation.

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