What Caused the Recovery from the Great Depression?
How did the economy recover from the Great Depression? In this video, expert David Wheelock of the St. Louis Fed describes the role rapid money supply growth and the New Deal played in the economic recovery from the Great Depression. “So, what caused the recovery? It's when the price level started to recover. From deflation, we turned the corner and prices started rising. When prices came up, the real interest rate went down, making it cheaper for firms to invest in plant and equipment, putting people back to work ... and you get increased spending in the economy.”
David Wheelock: What caused the recovery? So, when the price level started to recover from deflation, we turn the corner and prices started rising. When prices came up, the real interest rate went down, making it cheaper for firms to invest in plant and equipment. Putting people back to work like these ladies in a sock factory. And you get increased spending in the economy.
So here’s business investment plunging to very low levels as a result of rising real interest rates, but when real interest rates came down, business investment recovered. And then we had the recovery here being associated with the increase in the money supply. Now, it wasn’t the Fed that caused the increase in the money supply or the end of deflation, it was... I’ll thank our friend Franklin Roosevelt.
What did he do? He took office, he declared a bank holiday. He said we’re not going to reopen the banks unless we go in and make sure that they’re able to stay in business, that they have to be solvent. Against his own judgment, he allowed a temporary system of deposit insurance. He was against deposit insurance, but his advisors talked him into it. And with deposit insurance, no longer was the need to run on your banks. After the bank holiday in 1933, money poured back into the banking system.
Now in addition, there was a huge gold inflow from Europe because Europe was in, by then, worse shape than we were, both economically and politically. With the rise of Hitler in Germany, the growing specter of political uncertainty and war possibilities going on in Europe, there was this... anybody with wealth in Germany, who had the ability to get their money out of Europe sent it to the U.S., and that expanded the U.S. money supply as the gold poured in from abroad. It’s known as the golden avalanche. And that was really what caused the U.S. money supply to expand and ultimately caused the price level to rise and brought about the end of the Depression.
There’s a whole other lecture on the New Deal, but you know the New Deal is... in a nutshell, a mixed bag. A lot of the early programs, the alphabet programs, many of them had very laudable objectives and were helpful for individuals, but the consensus is now that they were a real mixed bag. Some were helpful, some hurt.
The National Recovery Act, which encouraged firms to collude to fix prices, probably slowed the recovery from the Great Depression. The Agricultural Adjustment Act, “Triple-A” up there, is another one which is often blamed for slowing the recovery because it essentially paid farmers to keep crops out of... to stop planting things. It also resulted in the end of the southern tenancy system and released a lot of largely African-American sharecroppers, you know, because they were no longer demanded in agriculture. So it was a real mixed bag. So I’m not going to — again the New Deal, it’s a whole different lecture. It really wasn't until World War II began that the U.S. unemployment rate fell below 10%. So again, 10 years of 10%-plus unemployment.