7/26/2019 Topic 7: The Great Depression

1/2

EC104 Starting Questions

1

Topic 7: The Great Depression

1. In what ways was the international economy less integrated in the interwar period?

In the post WWI era, there was a collapse in trade. One of the contributing factors was the UKs de-cision to go back to the Gold Standard (with high parity relative to the USD). This action adverselyaffected the exports of the UK. And during the Great Depression, the UK formed a trade bloc withother British Commonwealth nations, whilst it implemented the General Tariff of 1932 in retaliationto the increasing worldwide protectionism.

Germany was burdened with harsh reparations payments after the War. Its economy was not in aposition to demand a high quantity of imports. Similarly, its previous trade partners were in the same

situation. There was also a hyperinflation during the early 1920s. Thereafter, Germany halted repa-rations payments, and then it pursued autarkic policies, which led to rapid recovery and a boost inemployment.

There was an increase in trade during the Roaring Twentiesmainly led by the boom in the US,which quite generously lent money to the peripheral countries. However, the investors lost confi-dence after the 1929 Crash and started tightening credits elsewherei.e. Europe and Latin America.This, of course, resulted in a sharp drop in trade, and the world economy become less integrated. Thecrisis also spread to the peripheral countries as a result of the collapse in the commodity prices. TheLatin American countries, whose economy depended mostly on exporting primary commodities, wereparticularly hit hard by the crisis as the demand for the commodities fell and overproduction exacer-bated the situation. The fall in exports and the reverse in capital flows from the US encouraged theLatin American countries to abandon the Gold Standard and default on loans. These countries aban-doned trade and credit, and they began Import Substitution Industrialization (ISI).

2. What were the main causes of the Great Depression?

The three important causes of the Depression are banking crisis, deflation, and trade collapse.Between 1929 and 1933, 10,763 of the 24,970 commercial banks in the US failed. The public in-

creasingly held more currency and fewer deposits. There was a credit crunch as more banks failed;and as businesses and individuals were unable to obtain credits, there was a sharp fall in consumption

and investment. Partly because of this, households demanded less imported goods, leading to a tradecollapse (which was also caused by a currency crisis).

Deflation during the Depression was partly due to the enormous contraction of credit. The largenumber of bankruptcies also fostered a situation in which there was a frantic demand for money. TheFed notably did nothing to help alleviate the situation. Instead it chose to contract the money supplyby 30%. This led to further plunges in price.

7/26/2019 Topic 7: The Great Depression

2/2

EC104 Starting Questions

2

3. Why was international co-ordination of monetary policy desirable but unattainable in 1931?

A good co-ordination of monetary policy would require the central banks to intervene during a bank-ing crisis. This is easier to achieve if a country pursues easy money policy. But since most of thecountries were trying to stay on the Gold Standard, as a matter of international cooperation andcredibility, the co-ordination was somehow unattainable. We know that the Gold Standard inhibitedthe kind of monetary policy intervention that the economic situation required. By 1936 the majoreconomies abandoned the Gold Standard, and then we started seeing recovery.

4. Why did economic policies become more protectionist in the 1930s?

It is commonly believed that the US led the movement towards greater protectionism when theSmoot-Hawley tariff act was introduced in 1930. This action provoked intense bitterness abroad.

However, the main contributing factor was the failure of Creditanstalt in June 1931. This failurecaused a financial panic that spread to neighboring countries and around the world. The financial cri-sis in Germany, in which there were massive withdrawals of funds and demand of gold in exchangefor the Mark, prompted Germany to impose strict capital controls; trade and capital flows were im-peded as a result. Many other countries followed these steps in order to prevent the loss of gold andforeign exchange reserves. In addition, when the UK allowed its currency to depreciate against gold,other countries that were on the Gold Standard responded as they sought to offset the competitiveadvantage gained by the UK. This, needless to say, led to the breakdown of international trade rela-tions.