Unraveling the Causes of the Great Depression (2024)

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• While the October 1929 stock market crash triggered the Great Depression, multiple factors turned it into a decade-long economic catastrophe.
• Overproduction, executive inaction, ill-timed tariffs, and an inexperienced Federal Reserve all contributed to the Great Depression.
• The Great Depression’s legacy includes social programs, regulatory agencies, and government efforts to influence the economy and money supply.

Periods of economic downturn are a normal part of the business cycle, with the average US recession lasting around 10 months. But the Great Depression was a catastrophe, lasting nearly a decade and ushering in a new era of government regulations still seen today.

Following the exorbitant economic growth of the 1920s, poor policy decisions based on stock market speculation and overproduction by businesses resulted in a large-scale economic crisis known as the Great Depression. Its causes aren't entirely dissimilar to those of recession, though compounded on a grander scale.

Yet, if the causes of the Great Depression can be seen in other recessions, can the economy fall into another depression?

Let's explore the economic policies leading to the Great Depression, the impact of the 1929 stock market crash, and the impact of the crisis on global economies.

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What is the Great Depression?

The Great Depression was the worst economic period in US history. Starting in 1929, when the stock market crashed, it lasted until 1939 when the US began mobilizing for World War II. Industrial production fell by nearly 47%, and gross domestic production (GDP) declined by 30%. Almost half of US banks collapsed, stock shares traded at a third of their previous value, and nearly one-quarter of the population was jobless.

Despite popular belief, the stock market crash of 1929 was only the start of the crisis, not the sole perpetrator. The Great Depression resulted from a multitude of different complex policy and economic factors, including ill-timed tariffs and misguided moves by the young Federal Reserve.

"The crash was not a cause, but a triggering event," says Barry M. Mitnick, a professor of business administration and public and international affairs at the University of Pittsburgh's Katz Graduate School of Business.

The average US recession between WWII and today is 10 months, according to data from the National Bureau of Economic Research. However, the Great Depression ravaged the economy for roughly a decade.

Economic landscape preceding the Depression

The lavish economy of the "Roaring Twenties" preceded the crash of the Great Depression. Between 1922 and 1929 was a time of exorbitant economic growth.

The gross national product grew at an average annual rate of 4.7%, while the unemployment rate dropped from 6.7% to 3.2%. Total wealth in the US more than doubled, though most of that growth was experienced by the wealthiest Americans. Individual Americans also started investing in the market in a big way.

But all was not as roaring as it seemed. Consumers were spending more than they could afford, and companies over-produced to keep up with the demand. Financial institutions became heavily involved in stock market speculation. In some cases, they created subsidiaries that offered their own securities. Brokers secretly sold their own stocks — what would be a clear conflict of interest today.

Still, the stock market stubbornly kept on climbing. That is, until October 1929, when it all came tumbling down.

Key factors that caused the Great Depression

The stock market crash of 1929

The stock market crash of 1929 wasn't a one-day event but rather a week of escalating panic. On October 24 — a day now known as Black Thursday — the markets opened a staggering 11% lower than the previous day. Investors who had caught on to the market's overheated situation had begun rapidly selling their shares, sending a shockwave through Wall Street.

The market rallied briefly, but share prices plunged another 13% the following Monday (aka Black Monday). Many investors couldn't make their margin calls. Panic caused more investors to sell, further accelerating the crash.

"The system fell back on itself like a house of cards," says Mitnick.

The stock market lost more than 85% of its value from 1929 to July 1932. The Dow Jones Industrial Average sank from a 381.17 high in 1929 to a 41.22 low in 1932.

Oversupply and overproduction problems

Mass production sparked the consumption boom of the 1920s, leading businesses to overproduce products. Even before the crash, businesses had to start selling goods at a loss.

A similar crisis was occurring in agriculture. Farmers were in debt during World War I after buying more machinery to boost production. However, in the post-war economy, they produced more supply than consumer needs. Land and crop values plummeted.

In turn, the price of agricultural and industrial products dropped, which decimated profits and hurt already over-extended enterprises.

Low demand, high unemployment

During periods of economic recession, consumers stop spending, which forces companies to cut production. With less output, companies start laying people off, raising unemployment.

A healthy unemployment rate in the US hovers between 3% to 5%. During the peak of the Great Depression, the unemployment rate peaked at 24.9% in 1933 — 12.8 million Americans out of a population of 125.6 million — and it was still as high as 17.2% in 1939.

Banking failures and financial panic

Weak regulations had opened the way for wild speculation on stock exchanges. Being "in the market" was the "in" thing, but many investors weren't making choices based on research or fundamentals. Rather, they were just gambling that the stock would keep going up.

Even worse, many people bought shares on margin not realizing they'd be on the hook for the whole amount if the price fell. The result was inflated prices, with shares selling for more money than justified by their companies' actual earnings.

Moreover, the Fed followed the "liquidationist" policy of then-Treasury Secretary Andrew Mellon, in which the central bank stands aside and lets troubled banks collapse. Theoretically, a stronger, sounder banking system would emerge. The policy ended up taking out smaller banks, not necessarily bad banks. By 1933, 11,000 of them had failed, wiping out the savings of millions.

Ultimately, the decrease in the money supply led to deflation. That, in turn, caused sky-high increases in real interest rates, which choked off any chances of companies investing or expanding.

International trade and tariff policies

As demand declined, big business and agriculture, feeling the effect of cheap goods from abroad, lobbied for protection. The role of trade tariffs in the Great Depression negatively impacted the interconnectedness of global financial systems. Congress obliged with the United States Tariff Act of 1930, aka the Smoot-Hawley bill, which raised tariffs on foreign products by about 20%.

Multiple countries retaliated with their own tariffs on US goods. The inevitable result was a trade meltdown. In the next two years, US imports fell 40%.

No markets abroad. No demand at home. Small wonder that economic activity ground to a standstill.

Government response and policy failures

The role of monetary policy

During the Great Depression and years after, blame initially fell on the private sector, with accusations that banks had recklessly depleted their reserves. However, a groundbreaking 1963 study by economists Milton Friedman and Anna Schwartz revealed that the Fed's monetary policy was largely to blame.

In 2002, Ben Bernanke, a Board of Governors of the Federal Reserve member, said as much. "I would like to say to Milton and Anna: Regarding the Great Depression. You're right; we did it. We're very sorry. But thanks to you, we won't do it again," Bernanke said in an address during Friedman's 90th birthday.

Federal Reserve's mistakes during the Great Depression contributed to the heady expansion. Interest rates were kept low in the early to mid-1920s, then increased after the crash, doubling in 1931 from their pre-crash levels. The idea was to discourage lending and borrowing by stopping the "wild speculating" that encouraged the market to bubble and burst.

Fiscal policies and unemployment

President Herbert Hoover's response to the economic crisis was tardy. A believer in minimal government intervention, which he called "rugged individualism," Hoover considered direct public relief character-weakening. He did eventually start spending and launched lending and public works projects. Still, according to many economists, it was too little, too late.

The severity of the Depression forced the government to take a more hands-on relief effort. Increased government spending through direct relief programs and infrastructure projects provided more jobs, while simultaneously helping struggling families access unemployment benefits and welfare. However, these programs were funded by controversial budget deficits aimed at re-stimulating the economy.

Banking reforms were also enacted to regulate financial institutions and prevent further reckless practices. Prior to the crash, bank deposits lacked protection and led to folks withdrawal ing their savings in a panic. Thus, policymakers created the Federal Deposit Insurance Corporation (FDIC) to reduce bank runs and restore trust in the banking system.

Concluding analysis: Lessons learned from the Great Depression

The New Deal

When Franklin D. Roosevelt became president in 1933, he quickly began pushing through Congress a series of programs and projects called the New Deal. How much the New Deal actually alleviated the depression is a matter of some debate, as production remained low and unemployment high throughout the decade.

But the New Deal did more than attempt to stabilize the economy, relieve jobless Americans, create previously unheard of safety net programs, and regulate the private sector. It also reshaped the role of government with programs that are now part of the fabric of American society.

Among the New Deal's accomplishments:

• Worker protections, like the National Labor Relations Act, which legitimized unions, collective bargaining, and other employee rights
• Public works programs, aimed at providing employment via construction projects — a win-win for society and individuals
• Individual safety nets, such as the Social Security Act of 1935, which created the pension system still with us today, and unemployment insurance

A legacy of government regulation

New Deal legislation ushered in a new era of government regulations — and the underlying concept that even a free-enterprise system can use some federal oversight. Milestone measures include:

• The Glass-Steagall Act of 1933, which separated investment banking from commercial banking to prevent conflicts of interest and the sort of speculation that led to the 1929 crash (it was repealed in 1999, though some of its regulations remain in the Dodd-Frank Act of 2010)
• The Federal Deposit Insurance Corporation (FDIC) oversees banks and protects consumer accounts, via FDIC deposit insurance
• The establishment of the Securities and Exchange Commission(SEC) to oversee the stock market, create securities legislation, and protect investors from fraudulent practices

"The biggest legacy is a change in the view of government's responsibilities — that it should take an active part in addressing economic and social problems," says Aleksandar Tomic, program director of Master of Science in Applied Economics at Boston College.

The Great Depression — Frequently asked questions (FAQs)

Could the Great Depression happen again?

"The highest unemployment rate since the Great Depression" screamed headlines in April 2020, when the jobless level hit 14.7% of the US population. Since the initial spike, unemployment rates have dropped back to healthy rates, sitting at 3.9% as of February 2024.

January 2024, the S&P 500 reached its first record high in two years and officially became a bull market after its low point in October 2022. Amidst the AI boom, mega-cap tech stocks like Nvidia have surged more than 264% and are expected to keep growing.

The Feds raised interest rates back in 2022 to stem rising inflation. But with inflation receding and after its December 2023 meeting, the US Federal Reserve will likely be cutting interest multiple times by the end of 2024.

Though there's by no means a consensus, many economists argue that another such catastrophe, at least one caused by internal factors, is unlikely. That's largely because the contemporary federal government can draw on many more policy and monetary tools, ranging from unemployment compensation to easing the money supply.

As, indeed, it has done. Take the Great Recession of 2007 to 2009, for example. It, too was kicked into high gear by a financial-market crisis, the subprime loan meltdown. But the Fed quickly slashed interest rates. And thanks largely to a massive government bailout of the banking, insurance, and automobile industries and an $800 billion-plus stimulus package, the downturn officially lasted less than two years. The economy recovered — albeit sluggishly — and eventually sparked a record-breaking bull market.

Though economic downturns may trigger memories of the Great Depression, nowadays, says Brad Cornell, managing director of Berkeley Research Group, "we know enough and can respond quickly enough so that these sorts of endogenous downward spirals are not going to happen again."