Comparing and contrasting the economic conditions of the Great Depression and the 2007–2009 U.S. recession
Introduction
The Keynesian economic theory is among the most common theories in economics. This theory was first developed by Keynes who in response to the great depression argued that free market could not provide full employment during economic recessions. The theory postulates that aggregate demand is an important driving force in any economy (Tily et al., 2007). Accordingly, the theory justifies government’s intervention in providing full employment and price stability in an economy. The theory claims that when government provides credit to various entities or increases its spending in an economy, it adds to the sum credit or spending. The classical theories presumed that government’s spending came at the expense of private credit or spending. Based on this assumption, classical theories discouraged government’s intervention during recessions (Keynes, 2007).
The Keynesian theory argues that inadequate demand in an economy can lead to extended periods of high unemployment especially during the recession. In order to deal with this challenge, the theory argues that government should intervene to normalize demand (Keynes, 2007). This research paper compares and contrasts the economic conditions of the late 1920s and early 1930s referred to as Great Depression with the 2007-2009 recession. The purpose of this exercise will be to evaluate the way in which these recessions have contributed to corporate behaviors in the country as well as the changes in economic models. The first part of the paper starts by comparing and contrasting the two events by looking at various economic variables. The second part evaluates the measures that the government took to curb the outcomes of the two recessions. The third part evaluates the effects of government’s intervention whereas the other parts of the paper evaluate the effects of these interventions on business practices and public policies.
Events comparison
The US Great Depression started in the summer of 1929 and continued up to the early 1933. Although the aftermath of the recession continued to the late 1930s, the period between 1929 and 1933 was the most significant one for this recession. During this time, the real gross domestic product (GDP) for the U.S. economy declined by 46 percent. Prices fell sharply within this period to about 72 percent of 1929 levels. The unemployment rate in the country rose from 3.2 percent to 24.9 percent in 1933 (Snell, 2009). In the following year, it rose to 26.7 percent and remained in two-digit figure until 1941. Studies indicate that at one particular time 34 million people went without income (Rothbard, 2000). During the recession, most schools and universities in the country were shut due to bankruptcy whereas city revenues in most parts of the country collapsed. Industrial production in the country was also hit by the recession. In percentage, industrial production reduced by 47 percent because majority of the people did not have adequate income (Temin, 2016). In contrast to the great recession, the main cause of the great depression is attributed towards strict monetary policies that were aimed at limiting speculation in the stock market.
The great recession started towards the end of 2007 and carried on towards the end of 2009. Its root causes were the soaring housing prices as well as increasing food and energy prices that caused panic in the finance sector (Hetzel, 2009). In contrast to great depression, unemployment rate during the great recession rose from 4.7 percent to 10 percent (Goodwin, et al., 2015). This means that the rate of unemployment during the great recession was not as severe as it was during the great depression. However, the effects of the recession were far-reaching as they were in the great depression. It is estimated that the economy lost about 9 million jobs during the recession. It is also estimated that average households in the country lost about $100,000 from retirement and property portfolios (Goodwin, et al., 2015). This means that majority of the people in the country became poorer if not poor.
Although the 2008 economic hardships hit almost every family in the U.S., some groups of people were affected more than others. The young people in particular especially those graduating from colleges and universities were affected by the recession more than those already in employment. Most of them did not secure jobs as soon as they graduated and the few that were fortunate enough to secure jobs earned low incomes because most businesses were in the process of minimizing costs of doing business (Goodwin et al., 2015). Experts predicted that the trend would carry on for a period of one decade, but the government’s intervention changed the trend. This notwithstanding, some sectors such as manufacturing and construction had higher rates of unemployment during the recession than other sectors. In 2009, the manufacturing sector had an unemployment rate of 12.1 percent which rose from a low of 4.3 percent in 2007 (Mian, & Sufi, 2015). While this was the case, the unemployment rate in the construction sector nearly tripled during the same period. To make the matter worse, many employers were forced by economic hardships to fire some of their workers. Others were forced to stop hiring until the recession was over. The banking sector was the worst hit because there was little or no money for lending (Riumallo-Herl et al., 2014).
Government’s reaction
During the Great Depression, the government was unwilling to spend money for direct relief. In response, the then president urged the congress to save major banks, lands, railroads and insurance companies. The Congress in response responded by setting up the reconstruction finance corporation (Rothbard, 2000). The president believed that there was nothing wrong with the economy and that all that needed to be done was to restore public confidence in the economy. The assumption was that once public confidence was restored, everything in the economy would normalize. Based on this assumption, the president spent most of his time assuring the members of the public that the recession would soon be over (Snell, 2009).
In contrast, during the 2007 – 2009 recession, the government reacted by formulating measures that could stabilize the financial system and mitigate the recession. First, it spearheaded the formulation of federal laws that could protect small businesses from collapsing. Therefore, it provided a method of saving small businesses from collapsing (Bartels, 2013). Second, it provided financial support to industries such as auto industry that were on the verge of collapsing. By so doing, it saved majority of companies from collapsing. At the same time, it reduced the rate of unemployment that would otherwise be higher than 10 percent (Labonte, 2016). Third, it provided financial support to families that were experiencing financial difficulties. It also provided student loans to students that were on the verge of dropping from schools.
On the other hand, the federal government reacted by instituting measures that were aimed at quelling financial panic. Such measures included lowering interest rates and adopting zero interest rate policy. This was the first time the federal government lowered interest rates to the zero lower bound. The interest rates remained in this range until December 2015 after which they were raised. The aim of raising interest rates after this period was aimed at tightening monetary policies. By the time the federal government raised interest rates, the U.S. economy had recovered almost fully from the recession (Labonte, 2016). From an economic viewpoint, lower interest rates enable financial institutions to access funds from central bank and in so doing provide financial institutions with fund for lending. Consequently, this move was aimed at providing financial institutions in the country with funds for lending to customers. Apart from lowering interest rates, the Fed also purchased treasury bonds that had initially been sold to private investors. The aim of this move was to enable depository institutions to have access to more money for lending.
The federal government in conjunction with the Treasury ordered the nineteen largest banks in the country to conduct comprehensive stress tests to establish whether they had sufficient capital to withstand the effects of the recession. Once the exercise was over, it raised confidence in the banking industry. The Congress on its part reacted by establishing the troubled asset relief program (TARP). Initially, this program was aimed at purchasing troubled assets from financial institutions struggling from financial viability. However, because of the urgency of the issue, the $700 billion fund for this program was used for direct equity infusion among other purposes. Although unprecedented, the program minimized the collapse of financial system as experienced during the great depression. The federal government also benefitted from this program in its PPIP and TALF programs (Byun, 2010). At the same time, the program was also extended to auto industry to save Chrysler and GM from disorderly liquidation and massive layoffs. This saved the two auto companies from collapsing. As a result, the rate of unemployment in the country did not increase unreasonably. The federal deposit insurance corporation (FDIC) was not left out in this fight. On its part, it increased deposit insurance limits to ensure that financial institutions did not collapse.
The measures that were taken by different policy makers during the 2007 – 2009 recession especially those in the Federal Reserve could be challenged. However, if the Federal Reserve did not react in the manner it reacted, may be the U.S. economy could still be struggling from the effects the recession. Blinder and Zandi feel that even if these measures could be challenged, they were in total effective in curbing the recession (Blinder & Zandi, 2010).
Effects on business decision-making
The government’s effort during the great recession maintained mortgage rates at low rates by availing funds to financial institutions. Following this move, majority of the U.S. citizens did not lose their homes as they did before the move was instituted. Indeed, most of the U.S. citizens that had bought homes before the crisis were able to retain their homes because they were able to refinance their mortgage loans at low rates (Aklin & Kern, 2015). At the same time, the government’s move to save the auto industry from collapsing enabled the major auto companies in the country to continue with business rather than liquidating their properties disorderly and firing employees. Independent estimates indicate that the government’s move to save auto industry saved over one million jobs. This means that over one million people in this industry were able to retain their jobs because of the government’s intervention. More importantly, the move added about 230,000 jobs in auto industry because most companies in auto industry that were on the verge of collapsing did not collapse. Instead, they continued with business because the government financed their activities.
Studies indicate that if the government did not stop auto industry from collapsing by investing $22 billion, the effects would have been higher (Grusky, Western, & Wimer, 2011). The government’s intervention during the 2007 – 2009 recession was very instrumental in saving the U.S. economy from collapsing or experiencing more shocks than it experienced. With regard to this issue, studies have shown that the rate of unemployment in the country normalized faster in the great recession than they did during the great depression.
Effects on economic models
During the 2007 – 2009 recession, economic models were changed slightly to help mitigate the effects of recession. During and after the great recession, the Federal Reserve reacted to the crisis by lowering interest rates to zero lower bound. Economic experts and analysts argued that this was the first time such a move was implemented in the U.S. economy (Grusky, Western & Wimer, 2011). Doing this provided funds to financial institutions in the country because they were able to access funds from the central bank at almost no interest rate. In return, financial institutions offered mortgages at low rates as though there was no recession. Although this move was not intended to increase the number of borrowers because of the prevailing market conditions, it enabled those with mortgage loans to finance them at low rates. It also restored confidence in the finance sector (Roberts, 2010). At the same time, the congress passed some regulations that although looked controversial at the outset, they saved the economy. One of these regulations involved establishing the TARP program that among other things aimed at purchasing troubled assets from financial institutions as well as financing industries that were on the verge of collapsing. The program as discussed earlier on reduced the rate of unemployment in the country. It also prevented auto industry from collapsing (Rosenblum et al., 2008).
Effects on forecasting
During the great recession, majority of the people predicted that house prices in U.S.A. would remain relatively high whereas mortgage rates would remain considerably low. In line with this prediction, majority of the people resulted to acquiring mortgage loans. This in return enabled majority of the people to own homes. Whereas this was a good move, there were those that were not interested in owning homes, but selling those homes in the future when prices were high. However, this was never the case because housing prices did not increase as projected. As a result of the decline of housing prices, majority of the people were unable to finance their mortgage loans. This together with increasing energy and food prices caught majority of the people unprepared for unprecedented eventualities (Bellofiore, & Vertova, 2014).
During the Great Depression, there was a similar practice in the stock market in USA. This practice was attributed to economic growth experienced in the early 1920s that dramatically came to an end towards the end of 1920s. During this period, Federal Reserve was based on the gold (Snell, 2009).
Quantitative analysis
(Byun, 2010)
The above historic housing price in U.S. indicates that before the Great Recession, housing prices increased at a relative low rate. However, before the 2007 – 2008 recession, they increased considerably. Majority of the people projected that this increase would continue even in the future, but in contrast to their expectations, housing prices surged. This resulted to the great recession (Byun, 2010).
Quantitative analysis is an important tool in the analysis of Keynesian theory because of the following reasons. First, it provides a visual picture of what happens when changes occur in aggregate demand. Second, it highlights a number of factors that influence economic decisions in an economy. Third, it depicts the manner in which various factors in an economy respond to changes in prices and wages that result to unemployment.
The role of economic thinking
Analysis of how President Hoover responded to the Great Depression and President Obama’s response to the 2007 – 2009 recession shows that economic thinking plays a major role in dealing with recession. During the Great Depression, the problem was the failure of the government to address an economic problem from an economic viewpoint. This problem was exacerbated by President Hoover who instead of admitting the fact that the problem was an economic one believed that it was a psychological one. Accordingly, he did not develop economic viable measures to deal with the problem. Conversely, during the 2007 – 2009 recession, the problem was addressed as an economic one. In so doing, the government acknowledged its role in curbing the rate of unemployment.
Impact of my analysis to business practices and public policy
Analysis of how these two economic crises were handled shows that government with the help of Federal Reserve among other players plays a critical role during and after recession. It also establishes what the Fed should do to curb unemployment, spur economic growth and restore confidence in an economy that is on the verge of collapsing. It further highlights what the government needs to do to develop short term measures for curbing recession (Weller, 2013). Based on this understanding, this analysis can be used by policy makers to inform public policies and business practices. With regard to formulation of public policies, the analysis can be used to inform policy developers what they need to do to curb recession. It can also be used to inform policy developers what might happen if government does not intervene during recession. With regard to business practices, it can be used to inform businesspeople how they can partner with government during recession to curb unemployment rates in an economy.
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