Great Depression vs. Current Recession: Causes Compared

Introduction

America and most of the world have been experiencing a severe recession. The causes of that recession are many, and the fallout has been severe. There are many similarities between the current recession and the Great Depression of 1929, and there are differences that set each event apart. When compared closely, the Great Depression was much worse than the more recent recession, and that may be due at least in part to governmental measures put in place since the 1930s. This paper traces the historical causation of the current recession and examines the causal factors that connect and distinguish these two major economic crises.

The Great Depression

The Great Depression, which began in 1929, was one of the worst worldwide economic downturns in history. Most people believe the Great Depression occurred as a direct result of the stock market crash of 1929, but it actually began before that. As one reporter notes, "The Great Depression of the 1930s began with falling demand for durable and investment goods in mid-1929, followed by a slowdown in business activity. The stock market crash of October 1929 reduced the assets held by many investors and consequently their willingness and ability to buy" ("Whatdunnit? The Great Depression Mystery").

Unemployment was rampant, and there were numerous bank failures that added to the country's misery. The same reporter continues, "Between 1929 and 1933 there were more than 9,000 bank failures in the United States. When Franklin Roosevelt took office, 38 states had already declared 'bank holidays' — suspending all banking activity to prevent bank failures" ("Whatdunnit? The Great Depression Mystery"). In addition, consumerism was rampant in the 1920s, just as it was in the years leading up to the current recession. The reporter continues, "U.S. prosperity in the 1920s had been based to a large extent on the sale of houses and automobiles. Consumers for the first time could buy houses and cars on the installment plan, and they were eager to do so" ("Whatdunnit? The Great Depression Mystery"). The Great Depression led to significant changes in many areas of finance, which may have helped ease at least some of the effects of the more recent recession.

One major difference between the current recession and the Great Depression is how long each lasted. The Federal Reserve believes the current recession eased in late 2009, and that the country was on the long road to recovery. The Great Depression, by contrast, did not really end until America entered World War II in 1941. Unemployment reached nearly 50% in some large cities like Chicago, and when the Dust Bowl struck in the 1930s, thousands more displaced agricultural workers left the Midwest in search of employment in the West. Poverty, unemployment, and homelessness were all profoundly affected during this period, and it was only the increased production and wartime economy of the early 1940s that helped put Americans back to work and set the country on the road to prosperity.

The Federal Reserve's Role

The Federal Reserve came into being in 1913 as a reaction to a deep recession in 1907. That recession caused a run on banks and led many banks to fail. The Federal Reserve Act created eight Federal Reserve banks across the country and a Board seated in Washington, D.C., to oversee them. Federal Reserve banks could issue certificates that were legal tender to banks when the occasion arose. The purpose of the Reserve was stated in the preamble to the Federal Reserve Act of 1913: "To provide for the establishment of Federal reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes" (Shull 49). The Federal Reserve sets interest rates, monitors banking, and helps guide the economy, but it has its detractors. As one reporter states, "The Fed's policy of intervening in the economy to push interest rates lower than the market would have set them was the single greatest contributor to the crisis that continues to unfold before us" (Adelmann).

As in the current recession, the Federal Reserve played a distinct role in the Great Depression — though a negative one, because it did not act to prevent banks from failing. The same reporter explains:

"The Federal Reserve System had been established in 1913, in part to prevent bank failures by lending reserves to banks that were experiencing unusually high cash withdrawals. On the eve of the Depression, the first concern of the 12 regional Federal Reserve Banks should have been the overall health of the financial system. But many of the regional presidents, formerly commercial bankers, hesitated to lend to banks in their districts that they considered unsound. Many banks thus were allowed to fail, and the failures caused fear among account holders in sound banks, prompting them to panic and withdraw their funds" ("Whatdunnit? The Great Depression Mystery").

After the Great Depression, the Federal Reserve gained power, and it has continued to gain power and control after every economic downturn the country has experienced since World War II. As one author notes, "The Federal Reserve System has grown and developed extensively over the past ninety years. The System's early aims and functions have been elaborated" (Shull 15). However, the Fed has also been heavily criticized for the way it has dealt with many financial crises, including its handling of the Great Depression itself.

Many critics charge that the Federal Reserve helped create the housing bubble that eventually burst by keeping interest rates too low for too long. Another writer notes, "By pushing very short-term interest rates down so dramatically between 2001 and 2004, the Fed lowered short-term rates relative to 30-year rates. Adjustable-rate mortgages (ARMs), typically based on a one-year interest rate, became increasingly cheap relative to 30-year fixed-rate mortgages" (White). Federal Reserve Chairman Ben Bernanke answered those charges by arguing that "monetary policy during that period — though certainly accommodative — does not appear to have been inappropriate, given the state of the economy and policymakers' medium-term objectives" (Adelmann). However, others believe the Federal Reserve could have predicted that the housing bubble would burst much sooner and should have raised interest rates to discourage subprime lending practices.

Just as throughout history, the Fed gained additional power following the federal bailout and near-failure of many financial institutions. Another author notes, "In addition to conducting monetary policy, the Fed took on the new role of selectively channeling credit in favored directions. It now makes loans to, and purchases assets from, an array of financial institutions that are not commercial banks and do not issue means of payment" (White). This occurred in 2008, and the policy continued in the years that followed. Many experts found this development deeply troubling, because the Fed was created to monitor banks and serve as the "lender of last resort," rather than a body that allocates credit to particular institutions. The Fed funded approximately $1.7 trillion to banks and credit institutions, compared with the Treasury Department's $700 billion (White).

It is important to note that the Federal Reserve undertook these procedures on its own initiative, without oversight. Author White continues, "The Federal Reserve's new interventions into financial markets over the past year have proceeded at its own initiative, without precedent, and without congressional oversight" (White). He and others imply that the Federal Reserve had accumulated far too much power and was acting more like a hedge fund than a regulatory body. If the Fed were to fail, the effect on the economy could be profound and long-lasting. This unprecedented expansion of power worried many economists who felt the Federal Reserve had gone too far in extending credit — an activity well outside its traditional role as overseer and manager of the banking system.

Conclusion

It will certainly take time for the country to recover from the current recession. Housing prices continued to fall in the years following 2009, and experts predicted another wave of home defaults as low-rate loans matured — echoing what occurred in 2006. This risk could lead to a deeper recession rather than recovery, and it could trigger further financial institution bailouts or failures. It seems that the appropriate moment to establish regulatory guidelines to help prevent a recurrence would be during the recovery period, and the Federal Reserve could play a meaningful role in those regulations. However, such reform did not appear to be a government priority at the time, which worried many who understood how another economic downturn could affect an already struggling country.