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Ec104 study notes: the great depression
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Revision notes with content from lectures and seminars for EC104 topic 8: the great depression
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The Great DepressionThe world economy in the 1920s
● 1913 - West was pulling ahead (Great Divergence)
○ Integration of the global economy
○ Exports and imports were ⅓ of global Great Depression
○ Gold standard was used which caused low inflation
● WW1 caused the destruction of capital and mobilisation of workers (soldiers) -
Great Depression per capita fell
○ Great Depression is a flow of production and is not directly affected by
the destruction of wealth
○ Reduced trade - dangerous sea transport
○ Gold standard suspended as countries did not want low inflation to
finance the war
○ Countries accumulated war debts
● Reconstruction saw Great Depression per capita start to rise again
○ Roaring 20s saw high growth in the US
○ High EU inflation meant countries went back on the gold standard
● October 1929 - Wall St Crash and the start of the Great Depression
○ Peacetime fall in Great Depression per capita and high unemployment
Debt overhang
● War was financed by borrowing (not tax)
○ Internal debt - owed to lenders within the country
○ External debt - borrowed from foreign lenders
● Created a network of international indebtedness
○ US was the main lender - 60% of lending from 1924-31
○ France and the UK were net indebted to the US
○ Germany had the most debt - 330% of national income in 1921
● Solution - debt monetisation
○ Government prints money to repay, increasing the money supply and
causing inflation - like borrowing from the Central Bank
○ Only works for internal debt - not for German reparations in gold as
foreign currency and gold cannot be created
1920 inflation
● Low UK inflation - prices x2.5 between 1914 and 1920, followed by deflation
● Moderate inflation in Italy and France - prices x4
● Hyperinflation in Germany, Austria, Hungary, Poland
○ Countries that lost WW1 / Poland - new country
○ Unpredictable so you cannot plan for future
, ○ Eichengreen (1992) - German hyperinflation was hard to avoid
because of the size of the reparations
○ Fergurson (1996) - could have been avoided if there was not a deficit
caused by government spending
● November 1923 - stabilisation of German inflation
○ New currency (Rentenmark) backed by bonds and indexed to gold
○ Balanced budget and postponed reparations via the Dawes plan (1924)
○ Germany was back on gold at the pre war parity
The gold standard
● Gold standard is a fixed exchange rate system
● Each currency is convertible to gold at a fixed rate
● Countries are vulnerable to balance of payments crises
The balance of payments
● The balance of payments is the demand for home currency - the supply of
home currency
● Balance of payments= U + X + Supply from abroad - (M + Supply abroad)
● Balance of payments= (X-M+U) + (supply from abroad - abroad supply)
● The balance of payments is made up of the capital and the current account
● Deficit - excess supply of the home currency
● Surplus - excess demand of the home currency
● Floating ER system - balance of payments =0
○ The price automatically adjusts so supply = demand
Balance of payment crises
● Fixed exchange rate system - can be surpluses or deficits
● Deficit - excess supply and an overvalued currency
○ Gold / foreign reserves flow out until supply = demand at the fixed rate
■ BoE will always take pounds, so investors invest in gold
○ Central bank can increase interest to attract foreign capital
■ Increases the capital account and the demand for currency,
decreasing the supply
■ The Central bank monetary policy on a fixed system is to
maintain parity
● Surplus means the currency is undervalued
○ Central bank can decrease the interest rate or they can do nothing
which causes the accumulation of gold (to have when needed) -
sterilisation
■ Done by France and the US in the 1920s
Returning to the gold standard
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