Causes of The Great Depression

The causes of the Great Depression are a matter of active debate among economists, and are part of the larger debate about economic crises, although the popular belief is that the Great Depression was caused by the 1929 crash of the stock market. The specific economic events that took place during the Great Depression have been studied thoroughly: a deflation in asset and commodity prices, dramatic drops in demand and credit, and disruption of trade, ultimately resulting in widespread unemployment and hence poverty. However, historians lack consensus in determining the causal relationship between various events and the government economic policy in causing or ameliorating the Depression.

Current theories may be broadly classified into two main points of view and several heterodox points of view.

First, there are demand-driven theories, such as Keynesian economics and Institutional economists who argue that the recession was caused by underconsumption and over-investment (thereby causing an economic bubble). The consensus among demand-driven theories is that a large-scale loss of confidence led to a sudden reduction in consumption and investment spending. Once panic and deflation set in, many people believed they could avoid further losses by keeping clear of the markets. Holding money therefore became profitable as prices dropped lower and a given amount of money bought ever more goods, exacerbating the drop in demand.

Second, there are the monetarists, who believe that the Great Depression started as an ordinary recession, but that significant policy mistakes by monetary authorities (especially the Federal Reserve), caused a shrinking of the money supply which greatly exacerbated the economic situation, causing a recession to descend into the Great Depression. Related to this explanation are those who point to debt deflation causing those who borrow to owe ever more in real terms.

There are various heterodox theories that reject the explanations of the Keynesians and monetarists. Some new classical macroeconomists have argued that various labor market policies imposed at the start caused the length and severity of the Great Depression. The Austrian school of economics focuses on the macroeconomic effects of money supply and how central banking decisions can lead to malinvestment.