We’re All Keynesians Now: The Economic Effects of the Great Depression

The Great Depression forced Western governments to shift from laissez-faire economics, where government intervention was minimal, to active fiscal policy.

Oct 4, 2021By Owen Rust, MA Economics in progress w/ MPA
public works administration map pwa united states
A map of Public Works Administration (PWA) projects across the United States during the New Deal era, via Penn State University

 

The Great Depression (1929-39) was an era of severe economic depression that permanently altered how governments view economic policy, social welfare, and unemployment. Prior to the Great Depression, there was minimal government intervention in the economy. This pre-Depression era, often described as laissez-faire economics, saw strong suspicion toward government intervention and regulation of social welfare, banking, and employment policies. However, the overextended banking system, unexpectedly dire and long-lasting economic effects of the 1929 stock market crash, and resulting economic depression, soon rallied most policymakers around a radical new concept championed by British economist John Maynard Keynes: using government funds to stimulate spending and reduce unemployment, even if it requires running a deficit.

 

Before the Great Depression

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President Herbert Hoover (1929-1933) with a radio, via Biography Online

 

Prior to the Great Depression, most of the West was enjoying an economic boom known today as the Roaring Twenties.  After a brief post-World War I recession, the Prohibition-era 1920s saw strong economic growth coupled with popular new consumer goods like automobiles, radios, and movies. With the economy booming and money flowing easily, many people saw little need for government intervention in areas like unemployment, social welfare, labor policies, and banking and investing. Historically, there had been little federal government oversight in these areas. There was resistance to the idea that the federal government should do things that were not spelled out explicitly in the U.S. Constitution. In Washington, the pro-business Republican administrations, led by presidents Calvin Coolidge and Herbert Hoover, did not concern themselves with questions about what to do in the event of an economic collapse.

 

Black Tuesday

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Concerned citizens standing outside the New York Stock Exchange on Black Tuesday (October 28, 1929), via Federal Reserve History

 

The new technology that drove consumer spending in the 1920s also fueled increased investment in the stock market. By the late 1920s, common citizens could easily buy and sell shares of corporate stock, and did so with gusto. Unfortunately, many individuals and businesses invested recklessly by buying on margin. This meant borrowing money to purchase stock, and paying back the loan when they sold the stock for a profit. Similarly, the booming economy was also leading to an increase in buying on credit, a term meaning borrowing money to purchase goods and services (as opposed to stocks and bonds). Because the economy had been growing rapidly, many people reasoned, it would continue to do so and it would be easy to pay off any loans with one’s rising income and investment profit. Unfortunately, on October 28, 1929, the New York Stock Exchange saw a dramatic collapse. This fateful day, known as Black Tuesday, saw investors panic and sell their stock rapidly, further fueling the collapse.

 

The Stock Market Collapse Becomes the Great Depression: Bank Runs

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A bank run in December 1930, via Chicago Booth Review

 

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Many investors lost everything in the 1929 collapse, and losses spread due to an overextended banking system. During the laissez-faire era, there were few restrictions on how much of customers’ deposits banks could lend. Bank crises and collapses occurred when borrowers could not repay loans, and many banks found themselves without money that depositors were demanding back. In the years following Black Tuesday, many banks collapsed and took depositors’ money with them. Fearing that their bank might go out of business, depositors swarmed banks in bank runs, trying to pull out their cash as quickly as possible.

 

Unfortunately, banks do not keep a substantial percent of all deposits in the form of cash, meaning they can easily run out of cash if there is a run on the bank. During the early days of the Great Depression, banks kept even less cash on hand. Nationwide, bank runs quickly wiped out banks and caused a credit freeze – nobody could get any more loans.

 

Banking Crises Evolve Into the Great Depression:  Unemployment Soars

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Unemployment in the United States, 1930-1945, via San Jose State University

 

With credit unavailable, many businesses and industries that relied on loans were forced to cut back or shut down entirely. Those who had taken out loans previously found those loans demanded in full by desperate banks. The economy that had flowed smoothly on credit in the late 1920s found everyone demanding cash, but there wasn’t much to go around. Businesses laid off thousands of workers, and nobody was hiring.

 

At the time, there were no federal programs to help the jobless, and assisting the unemployed was largely left to local charities. Unfortunately, these local charities were quickly overwhelmed, leaving most unemployed with no relief. In addition, when someone lost his or her job, there was no income to continue making purchases, which led other businesses to fail as most spending slowed dramatically. This painful ripple effect soon spread across the nation. By 1933, unemployment hit a staggering 25 percent, which remains a record.

 

Unemployment Leads to Misery: Homelessness and Hoovervilles

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A Hooverville shack in 1938, via the Library of Congress

 

As unemployment rapidly increased, but programs did not exist to help the jobless retain some form of income, many people lost their homes when they could not continue to make rent or mortgage payments. Just as there were few government programs to help the unemployed, there were few programs to help with mortgage assistance or renters’ assistance. In cities, many people who lost their homes began to congregate in homeless camps and construct crude shacks made from discarded materials. These camps became known as Hoovervilles due to the unpopularity of president Herbert Hoover, whom many Americans blamed for lack of government relief. The term revealed the public’s growing demand for federal government action to combat joblessness, homelessness, and restore trust in the banking system. In addition to bank failures due to bank runs, the fact that banks were repossessing citizens’ homes further intensified Americans’ distrust of banks.

 

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One of the dust storms of the Dust Bowl era of the early-to-mid 1930s, via the Kansas Heritage Center

 

Simultaneously with bank failures and rising unemployment, the Midwest was hit with a devastating Dust Bowl in the early 1930s. A severe drought, coupled with decades of poor soil management, led to massive dust storms that ruined farms, destroyed property, and even caused people to lose their lives. As a result, many farmers on the Great Plains lost their farms and moved west, effectively becoming homeless. The famous American novel The Grapes of Wrath, published in 1939 by John Steinbeck, depicts the plight of Oklahoma farmers who were forced off their land and had to move to California. Unfortunately, during this time of struggle, many did not appreciate the homeless and jobless coming to their cities looking for work. California even passed a law – later deemed unconstitutional – that criminalized helping poor people move into the state!

 

Changing Economic Policy: Franklin D. Roosevelt Pledges a New Deal

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Franklin D. Roosevelt proposed taking strong federal action to ease the Great Depression, via the University of Washington

 

Although everyone knew the economic recession was terribly painful, conventional wisdom at the outset of the Great Depression was that the government should intervene as little as possible in the economy. According to classical economic theory, which was most popular at the time, government intervention was not necessary for unemployment to decrease back to normal. Government efforts to reduce unemployment, regulate banks, and house the homeless could be derided as socialist and authoritarian. By 1932, however, the Depression had only worsened, weakening the public’s faith in laissez-faire economic policies and the wisdom of classical economics.

 

Democratic presidential candidate Franklin D. Roosevelt, governor of New York, won his party’s nomination and pledged a “New Deal” for the American people on July 2.  He declared that, under his leadership, the federal government would take a far greater “responsibility for the broader public welfare.” This would mean the spending of federal dollars – a lot of dollars – to stimulate the economy. Voters strongly agreed and Roosevelt, colloquially known as FDR, won the 1932 presidential election by a landslide over the beleaguered Hoover.

 

A New Economic Theory: Keynesian Economics

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John Maynard Keynes, English economist, via Vision

 

English economist John Maynard Keynes supported FDR’s plan to bring the United States back to prosperity. Keynes disagreed that market economies could simply wait for equilibrium to be restored, as well declared by classical economics. Famously, Keynes had criticized the hands-off belief of classical economists that unemployment would return to normal in the “long run” by stating that “in the long run we are all dead.”  Keynesian economics insisted that the government could reduce unemployment and maintain economic growth through direct stimulation of spending. The federal government could use fiscal policy, or the intentional adjustment of government spending and taxation, to get money flowing. Money spent by the government would flow through consumers and private businesses, allowing those businesses to hire unemployed citizens and begin healing recessionary woes. Keynes rejected traditional economic beliefs like annually-balanced budgets and the gold standard, insisting that freeing up the flow of money was most important, and was the only way to ease a severe recession. Governments could spend more money than they currently had by taking on debt, a practice known as deficit spending, and pay off the debt later when the economy was prosperous again.

 

Success of the New Deal and Keynesian Economics

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Franklin D. Roosevelt on the 1940 campaign trail, via Franklin D. Roosevelt Presidential Library and Museum

 

The beliefs of Keynes and FDR proved successful at alleviating the Great Depression. Franklin D. Roosevelt enacted his New Deal policies upon taking office in March 1933 and spent billions of dollars building new infrastructure. New Deal agencies used federal funds to build highways, parks, courthouses, and other public structures. Millions of men were hired to work on these projects, significantly reducing unemployment. In addition, FDR and Congress passed federal laws regulating banks and securities trading (stocks and bonds) to protect consumers.

 

The United States went off the gold standard to create new money: a dollar bill no longer had to be backed up by a specific quantity of gold. To financially assist the elderly, many of whom had lost their savings when banks failed, the Social Security Administration and its eponymous program were created in 1935. Roosevelt’s initiatives were very popular with the public, and he won re-election by a landslide in 1936.

 

By the end of the decade, New Deal programs had substantially healed the U.S. economy. And, although critics complained that FDR was trying to grab too much power for himself and the executive branch of the federal government, his fiscal policies remained very popular. As a result, he won an unprecedented third term as president in 1940.

 

We’re All Keynesians Now

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President Richard Nixon declared, “We’re all Keynesians now” in 1971, via The Richard Nixon Foundation

 

The tremendous increase in federal spending during World War II (1941-45) definitively ended the Great Depression. However, the world’s positive economic experiences with Keynesian economics and deficit spending kept those policies front-and-center. For example, the U.S. spent billions on federal infrastructure during the 1950s by building the interstate highway system. Federal spending on social programs expanded in the 1960s under President Lyndon Johnson’s Great Society initiatives. Grants to state and city governments significantly expanded, beginning in the 1960s, helping fund local projects that stimulated local economies. Famously, Republican president Richard Nixon in 1971 declared, “we’re all Keynesians now,” reiterating the importance of government stimulation and regulation of the economy. Although critics routinely criticize excessive government spending, Keynesian economic theory and New Deal policies quickly return to prominence as soon as a recession strikes.

 

Economic Effects of the Great Depression Today

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A comparison of federal government stimulus spending during the recession Great Recession of 2008-2010 and the Covid Recession of 2020-2021, via Committee for a Responsible Federal Budget (CRFB)

 

To this day, Keynesian economics, proven by the successes of the New Deal, remains popular with both Democratic and Republican policymakers in Washington. During the recent COVID recession, both Republican president Donald Trump in 2020 and Democratic president Joe Biden in 2021 spent federal dollars to stimulate the U.S. economy by giving checks directly to citizens.

 

In conclusion, the economic reforms brought about by the desperate straits of the Great Depression remain popular tools to maintain prosperity and reduce unemployment today. The economic effects of the Great Depression can be seen in today’s federal grants and infrastructure projects, rules and regulations placed on the banking and investment industries, and labor laws that ban child labor and require minimum wages and overtime pay for workers. Even the most fiscally conservative politicians never advocate seriously for a return to laissez-faire policies, last experienced before Black Tuesday. As a result of the Great Depression, a fiscally active American federal government is here to stay.



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By Owen RustMA Economics in progress w/ MPAOwen is a high school teacher and college adjunct in West Texas. He has an MPA degree from the University of Wyoming and is close to completing a Master’s in Finance and Economics from West Texas A&M. He has taught World History, U.S. History, and freshman and sophomore English at the high school level, and Economics, Government, and Sociology at the college level as a dual-credit instructor and adjunct. His interests include Government and Politics, Economics, and Sociology.