Question

1. Cause

2. Dynamics

3.draw a figure

Ilallulul chsis that included debt deflation was the Great Depression, the worst et nomic contraction in U.S. history CATIO +The Mother of All Financial Crises: The Great Depressi In 28 and 192 prices doubled in the U.S stock market. Federal Reserve offcal vie market boom as excessive speculation. To curb it, they pursued a tigh monetary policy to raise interest rates; the Fed got more than it bargained for when th stock market crashed in October 1929, falling by 20%. Although the 1929 crash had a great impact on the minds of a whole generation most people forget that by the middle of 1930, more than half of the stock m decline had been reversed. Indeed, credit market conditions remained quite stable there was little evidence that a major financial crisis was underway. What might have been a normal recession turned into something far different, ho ever, when adverse shocks to the agricultural sector led to bank failures in agricultuni regions that then spread to the major banking centers. A sequence of bank panics fol lowed from October 1930 until March 1933. More than one-third of U.S. banks We out of business (events described in more detail in Chapter 17). The continuing decline in stock prices after mid-1930 (by mid-1932 stocks had declined to 10% of their value at the 1929 peak) and the increase in uncertainty from the unsettled business conditions created by the economic contraction worsened adverse selection and moral hazard problems in the credit markets. The los of ane hount of financial intermediation. Intensified adverse third of the banks reduce selection and moral hazard problems decreased the ability of financial markets to chand CHAPTER 9 Financial Crises and the Subprime Meltdown 201 funds to firms with productive investment opportunities. As our analysis predicts, the amount of outstanding commercial loans fell by half from 1929 to 1933, and invest- ment spending collapsed, declining by 90% from its 1929 level. The short-circuiting of the process that kept the economy from recovering quickly which it does in most recessions, occurred because of a fall in the price level by 25% in the 1930-1933 period. This huge decline in prices triggered a debt deflation in which net worth fell because of the increased burden of indebtedness borne by firms. The decline in net worth and the resulting increase in adverse selection and moral hazard problems in the credit markets led to a prolonged economic contraction in unemployment rose to 25% of the labor force. The financial crisis in the Great Depres- sion was the worst ever experienced in the United States, and it explains why this eco- omic contraction was also the most severe ever experienced by the nation.

Answer 1

1. Causes of Great Depression:

1. 1. The stock market crash: During 1920’s the U.S stock market is one of the lucrative way of earning. People of ordinary means put their disposable income in US stock market resulting in huge expansion but as prices began to decline millions of shareholders began to panic and rushed to liquidate which worsen the situation even more. During this period prices fell 33 percent resulting in loss of confidence in economy.
   2. Bank Failures: A large number of bank customers fearing their bank solvency attempted to withdraw their deposits in cash. By 1933 one fifth of the bank in existence failed. Surviving banks stop lending fearing their survival which exaggerate the situation towards worse.
   3. Reduction in purchases among common people: The stock market crash and decreasing confidence in the economy led the people from all walks of life to consume less. It resulted in less numbers of items produced and a decrease in work force. The unemployment rate rose to 25% which means even less spending didn’t help to alleviate the economic condition..
2. Dynamics:
   1. The Gold standard undoubtly played a significant role in spreading the great depression across countries. Under the gold standard there are imbalances in trade.
   2. Financial crisis and banking panics are witnessed in many countries besides United States.
   3. The enactment of Smoot-Hawley tariff in United States to protect trade policies was greatly retaliated by other countries exaggerating to balance of payments to many countries.
3. 
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