Causes of the Great Depression

The causes of the Great Depression in the early 20th century in the United States have been extensively discussed by economists and remain a matter of active debate. They are part of the larger debate about economic crises and recessions. Although the major economic events that took place during the Great Depression are widely agreed upon, the finer week-to-week and month-to-month fluctuations are often underexplored in historical literature, as aggregate interpretations tend to align more cleanly with the formal requirements of modern macroeconomic modeling and statistical instrumentation.

There was an initial stock market crash that triggered a "panic sell-off" of assets. This was followed by a deflation in asset and commodity prices, dramatic drops in demand and the total quantity of money in the economy, and disruption of trade, ultimately resulting in widespread unemployment (over 13 million people were unemployed by 1932) and impoverishment. However, economists and historians have not reached a consensus on the causal relationships between various events and government economic policies in causing or ameliorating the Depression.

Current mainstream theories may be broadly classified into two main points of view. The first are the demand-driven theories, from Keynesian and institutional economists who argue that the depression was caused by a widespread loss of confidence that led to drastically lower investment and persistent underconsumption. The demand-driven theories argue that the financial crisis following the 1929 crash led to a sudden and persistent reduction in consumption and investment spending, causing the depression that followed. 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 argue that the Great Depression began as an ordinary recession, but that significant policy mistakes by monetary authorities (especially the Federal Reserve) resulted in a sharp contraction of the money supply This, they contend, transformed a downturn into a prolonged recession. Related explanations highlight the role of debt deflation, in which falling prices increased the real burden of debt on households and businesses.

In addition to the Keynesian and monetarist perspectives, several other schools of though offer alternative explanations. Economists from the Austrian school argue that the depression was an inevitable correction of an unsustainable credit-fueled boom during the 1920s, and that subsequent policy interventions prolonged the crisis. Real Business Cycle theorists and some New Classical macroeconomists emphasize supply-side shocks, wage and price rigidities, and institutional factors such as labour market policies and regulation. These views, while differing in emphasis, contribute to a broader and more contested understanding of the causes and severity of the Great Depression.