Not on My Watch – Keeping a Great Depression at Bay
Could interest rates in the U.S. go negative? If they do, the rationale may be the memory of the Great Depression.
The Great Depression began 90 years ago in the United States as an ordinary recession in the summer of 1929. Today it is remembered primarily in old photographs and movies, and the pain has faded from public memory. The impact of the Great Depression still lingers, however, in the minds of economists, and particularly the minds of the economists who manage the Federal Reserve Bank system. If there is one thing they do not want, it is a rerun of the Great Depression under their watch.
Trying to pin down the cause of the Great Depression has spawned countless books, but at its most basic, people stopped spending. To limit stock market speculation, the Federal Reserve had increased interest rates, which reduced interest sensitive spending. Then the stock market crash reduced wealth and consumer spending substantially. Banking panics in the early 1930s resulted in cash hoarding that wasn’t helped when the Federal Reserve also deliberately contracted the money supply and further raised interest rates. The Revenue Act of 1932 increased American tax rates greatly in an attempt to balance the federal budget, and by doing so it dealt another blow to the economy by further discouraging spending.
How bad was the resulting contraction in spending? Between the peak and the trough of the downturn, industrial production in the United States declined 47% percent and real gross domestic product (GDP) fell 30%. (In contrast, during the next worst U.S. recession, 1981-1982, GDP fell 2%.) The U.S. experienced the near-total breakdown of a previously affluent economy for ten hard years. There was nothing romantic about the breadlines, peddlers on street corners, shuttered factories, rural poverty, and so-called Hoovervilles where homeless families sought refuge in shelters of salvaged wood, cardboard, and tin. 2.5 million people fled the Plains states as the Dust Bowl stripped topsoil from the land. Unemployment exceeded 20% in a society where 21% of the workforce was employed in agriculture.
To prevent a second Great Depression, the most common prescription is to keep people spending and limit saving. To keep people spending, the Federal Reserve has two basic strategies – (1) Promote inflation, which feeds the benefit of buying now to avoid paying more in the future. This means avoiding deflation, which would make goods cheaper the longer one waits, and potentially reduce wages. (2) Make saving unattractive. Removing the incentive to save by dropping interest to zero or below is one tool to do so. The catch is the low interest rates have to offset consumer concerns about the direction of the economy. The slow U.S. recovery is one sign that interest rates have limited utility as consumers stubbornly continue to save and spend judiciously.
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