Untying the “invisible hand”: A Keynesian view of the Great Depression
The Great Depression, the largest economic worldwide phenomenon that has yet to be repeated in as grand a fashion, continues to be a source of debate. Economists, historians, political scientists, and other academics strive to prove their theories on the events that led to the crash, the decisions made in the midst of the storm, and the reasons for its ultimate demise. Economist and former Chairman of the Federal Reserve Ben Bernanke called finding definitive answers to these questions akin to discovering the Holy Grail of economics.[1] This essay will seek to analyze the causes and ultimate end of the Great Depression through various sources and apply the lens of the Keynesian economic theory to the overall discussion.
In order to apply the economic theory of John Maynard Keynes to the overarching discussion, it is important to take a step back for the non-academic reader to display some of the causes of the Great Depression as explained by various academic writers in a short survey of the literature, including primary sources to give a sense of the insecurity of the period.[2] It is important to understand that the banking system in the United States from the interwar period (after the First World War) to the stock market crash in the late 1920’s consisted of many small, independent, financial institutions; the federal government established limits on “branch banking” and large banks for fear of competition between state and national banks.[3] At this point in time, the Federal Deposit Insurance Corporation (FDIC) did not exist, which meant deposits made in banks were not federally insured, so if a bank failed, the customers essentially lost their money. The FDIC would eventually be created in 1933 and insured in 1934.[4] So began the decline in consumer confidence in the banking industry.
Eugene N. White offered support for Galbraith’s study The Great Crash 1929 by asserting through his evidence that a bubble formed in the stock market in the 1920’s, putting the market in a volatile situation where the bubble would burst. He argued that immediately following the First World War was a time of stability and prosperity; investors did not have the necessary experience in managing stock buying which could have attributed to the bubble, but conditions remained favorable to invest.[5] To understand a market bubble, one can compare the situation to the recent Game Stop phenomena in which internet users banded together in great masses to purchase interests in a particular stock, in this case, Game Stop, which caused a quick mania and a giant boost to the overall worth of the company. It was so great, however, that the company could not realistically contend that it was worth the soaring price of the stock, which caused brokers to put a stop to allowing their customers to buy it, which led to accusations of firms such as Robinhood as unlawfully protecting their own interests instead of their customers. This is the very definition of what classical economists like Adam Smith would deem overtrading.[6] Erase the use of the internet, and these overtrading habits come full circle to the crash of the stock market in 1929.
Ben Bernanke added that monetary shocks played a significant role in the Great Depression. He noted that it is widely accepted that money supply dropped, prices fell, and demand for output dropped simultaneously. The domino effect was felt worldwide. Not only the American banking industry, but international banking were forced to make difficult decisions to either stay on the gold standard or revert to the silver standard. Countries made various decisions based on their own histories. He noted that their reasoning for doing so was not only economic but political and philosophical as well.[7] The countries that left the gold standard seemed to recover more quickly than those that stayed on it. The United States stayed on it longer than some countries but did eventually leave. In 1932, an article in the New York Times suggested that after having three years to ponder the significance of the stock market crash on the depression, the author suspected that the economy could not withstand the money losses after the crash, and that international confidence in the American market was completely destroyed.[8]
To give a sense of how people watched the market during the Great Depression, in early 1935, the New York Times published a chronology of financial events of the previous year. It gave a sense of the roller-coaster volatility of the economy in a year’s span. Early in the year 1934, the gold valuation of the dollar reduced, and market activity saw a slight boom. Industrial activity rose as well as stocks. By April, the increase in production (steel and agriculture) had risen, but a drought in May threatened the production of wheat which was a nerve-wracking time, but the business sustained. By July, the stock market took a hit as the drought increased. In August, it dropped further, and gold exports began. In September, stock trading remained slow, and by the elections of November, the victory of the Democratic party saw them gain more House seats and stocks began to slowly raise–putting hopes in the administration to end the crisis.[9] Bernanke claimed that the Federal Reserve played a part in extending the depression by not doing its part to ease restrictions to keep the economy stable. He also maintained that the economy did not fully recover until the country was plunged into World War II.[10] Christina Romer’s study added that aggregate demand stimulus (a combination of incentives or federal tax cuts or other means to change people’s spending habits) caused the recovery from the Great Depression.[11]
With the backstory of the Great Depression in tow, a Keynesian view of the event can be applied. Keynes economic theory is in many way reminiscent of the classical theory of the likes of Adam Smith and John Stuart Mill. Raised in the realm of laissez-faire economics, Keynes by and large agreed on the importance of free market capitalism and allowing the invisible hand to do its job—to a point. He argued that on occasion, government intervention is necessary for a broken economy to achieve equilibrium. Keynes’ ideas formed a new way of thinking about economic markets and his theory is widely influential, and debated, to this day.[12] In the case of the Great Depression, it hit fast, hard, and lingered on, and eventually rendered the invisible hand “tied.” The government intervened in several cases during this period to attempt to put out the fire and untie the invisible hand. First, the government chose to leave the gold standard in order to stabilize the ever-failing dollar. Next, Roosevelt established the FDIC to regenerate consumer confidence in banking. Third, Roosevelt called the Bank Holiday to put a halt to the mass run on the bank in 1933. In his address to the American people on March 12, 1933, he urged a new confidence in banks by stating:
“We had a bad banking situation. Some of our bankers had shown themselves either incompetent or dishonest in their handling of the people’s funds. They had used the money entrusted to them in speculations and unwise loans. This was of course not true in the vast majority of our banks but it was true in enough of them to shock the people for a time into a sense of insecurity and to put them into a frame of mind where they did not differentiate, but seemed to assume that the acts of a comparative few had tainted them all. It was the Government’s job to straighten out this situation and do it as quickly as possible — and the job is being performed…We shall be engaged not merely in reopening sound banks but in the creation of sound banks through reorganization. It has been wonderful to me to catch the note of confidence from all over the country. I can never be sufficiently grateful to the people for the loyal support they have given me in their acceptance of the judgment that has dictated our course, even though all of our processes may not have seemed clear to them.” [13]
Lastly, government intervened by applying New Deal programs to boost labor supply and demands and kick start he economy. According to Fishback, New Deal programs disbursed to four separate categories: relief funds (more than half), public works, veterans, and farmers. He noted that these programs generally increased employment, increased spending, and decreased crime.[14] During the Great Depression when unemployment rates hovered at an astounding twenty-five percent, the issue of “sticky wages” was yet another factor that the invisible hand could not fix. This reverts back to Romer’s study of aggregate demand stimulus—something had to give—and intervention needed to occur in order for people to be compelled to spend more.
The Great Depression saw a decade of hardship throughout the world that shook the confidence of citizens in their economies. Through another hardship-the Second World War-the United States witnessed a shift in the market. Labor demands and output would rise rapidly to pull the country out of the depression and into a prosperous era of the American dream. A Keynesian lens applied to the events leading to and closing out the Great Depression show that once government intervention had occurred, the invisible hand was untied and free to do its job once again.
[1] Ben S. Bernanke, “The Macroeconomics of the Great Depression: A Comparative Approach,” Journal of Money, Credit and Banking 27, no. 1 (February 1995): 1.
[2] To understand the basic tenets of Keynesian thought, see the classic study, John Maynard Keynes, The General Theory of Employment, Interest, and Money (New York: Harcourt Brace, 1936); for an in-depth overview of financial crises, see Robert Z. Aliber, Charles P. Kindleberger, and Tina Overton, Manias, Panics, and Crashes: A History of Financial Crises, Seventh Edition (London: Palgrave Macmillan, 2015).
[3] Ben S. Bernanke, “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression.” The American Economic Review 73, no. 3 (June 1983): 259.
[4] Federal Deposit Insurance Corporation, “History of the FDIC,” https://www.fdic.gov/about/history/
[5] Eugene N. White, “The Stock Market Boom and Crash of 1929 Revisited,” The Journal of Economic Perspectives 4, no. 2 (Spring 1990): 70.
[6] James MacIntosh, “GameStop Is a Bubble in its Purest Form,” Wall Street Journal, January 27, 2021.
[7] Bernanke, “The Macroeconomics of the Great Depression,” 3-4.
[8] “The 1929 Speculation and Today’s Troubles,” New York Times, January 1, 1932. Proquest Historical Newspapers.
[9] “Chronological Survey of the Outstanding Financial Events of the Past Year,” New York Times, January 2, 1935. Proquest Historical Newspapers.
[10] Ben S. Bernanke, “Segment 804: The Federal Reserve in the Great Depression,” April 3, 2017, video, https://www.youtube.com/watch?v=Bl3SXehHpR4&t=85s
[11] Christina Romer, “What Ended the Great Depression?” The Journal of Economic History 52, no. 4 (December 1992): 783.
[12] Clemente Ruiz Duran, “How Keynes Dialogues Can Help to Understand the New Global Economy,” Socio-Economic Review 7 (2009): 337.
[13] Federal Deposit Insurance Commission, “Transcript of the Speech by President Franklin D. Roosevelt Regarding the Banking Crisis” March 12, 1933. https://www.fdic.gov/about/history/3-12-33transcript.html
[14] Price Fishback, “The Newest on the New Deal,” Essays in Economic Business History 36 (2018), 2.