Great Depression

Definition

The Great Depression was a severe worldwide economic downturn that lasted from 1929 to the late 1930s, marked by a dramatic decline in industrial production, widespread unemployment, and deflation. It highlighted the importance of central banking functions, particularly the role of a lender of last resort in stabilizing financial systems during crises, and raised significant concerns about moral hazard where institutions might take excessive risks knowing they could be bailed out.

5 Must Know Facts For Your Next Test

1. The Great Depression began with the stock market crash on October 29, 1929, known as Black Tuesday, which wiped out millions of investors.
2. Unemployment rates soared during this period, peaking at around 25% in the United States, leading to widespread poverty and social upheaval.
3. Many banks failed due to insolvency during the Great Depression, exacerbating the economic crisis and leading to a loss of savings for millions of people.
4. In response to the Great Depression, governments implemented various policies, including fiscal stimulus and monetary easing, to stimulate economic recovery.
5. The lessons learned from the Great Depression led to significant changes in banking regulations and the establishment of safety nets like deposit insurance and social security systems.

Review Questions

• How did the concept of a lender of last resort evolve as a response to the banking crises experienced during the Great Depression?
  • During the Great Depression, many banks faced insolvency due to massive withdrawals from depositors fearing bank failures. This crisis highlighted the need for a lender of last resort, typically a central bank, to provide liquidity to troubled financial institutions. The Federal Reserve took on this role more seriously after observing how failing banks led to a broader economic collapse, emphasizing the importance of stabilizing financial systems during crises.
• Evaluate how moral hazard was influenced by the actions taken during the Great Depression to stabilize financial institutions.
  • The actions taken during the Great Depression, such as bailouts for struggling banks and industries, raised concerns about moral hazard. Institutions may engage in riskier behavior if they believe they will be rescued by government intervention in times of crisis. The balance between providing necessary support during economic downturns and ensuring that institutions do not act irresponsibly became a key consideration in financial regulation moving forward.
• Assess the long-term impacts of the Great Depression on modern monetary policy and financial regulation.
  • The Great Depression had profound long-term impacts on modern monetary policy and financial regulation. It prompted significant changes like the establishment of the Federal Reserve's dual mandate and led to new regulations aimed at preventing systemic failures. Policies like deposit insurance were introduced to protect consumers and maintain confidence in the banking system, while ongoing debates about government intervention in economies continue to reflect lessons learned from that era.

Related terms

Bank Runs: A situation where a large number of customers withdraw their deposits simultaneously due to fears that the bank will fail.

Federal Reserve:

The central banking system of the United States, established to provide a safer and more flexible monetary system.

Moral Hazard: The risk that a party insulated from risk may behave differently than if they bore the full consequences of that risk.