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Macro Economy Chapter 05. The Great Depression (1929–1939)

The Great Depression (1929–1939): The Birth of Modern Macro

Summary

The Great Depression in the United States is usually dated from the 1929 economic peak to the 1933 trough, with another severe recession in 1937–1938. During these years, spending collapsed, unemployment surged, and prices fell, which made “aggregate demand” (total spending in the economy) a very real and measurable problem. The crisis pushed economists and policymakers to rely more on hard data like GDP, unemployment, and price indexes, instead of only narrative descriptions. Modern debates about the Depression developed around several competing explanations: a major monetary contraction, a breakdown of credit and banking, and policy limits created by the international monetary system (especially the gold standard). Policy responses were not only about boosting spending; they also included major financial reforms designed to stop bank runs and rebuild trust, such as stronger banking regulation and deposit insurance. These reforms aimed to stabilize the financial system so that households and firms would feel safe keeping money in banks. The Depression era also ускорated the development of national income accounting and standardized macro statistics, which helped turn macroeconomics into an empirical, policy-oriented field. Overall, the Depression became a “founding case” for modern macro because it linked big economic outcomes to measurable aggregates, financial stability, and the policy regime in place.

Key Takeaways

  • The Great Depression is best anchored to a clear episode chronology: the NBER dates the major U.S. contraction from a 1929 peak to a 1933 trough, with a second sharp recession in 1937–1938. [1]
  • The crisis made “aggregate demand” concrete: collapsing spending, surging unemployment, and deflation pushed economists to connect theory to measurable macro aggregates (income, output, employment). [2][3][8][4]
  • Competing explanations—monetary contraction, credit/intermediation breakdown, and policy constraints under the international monetary regime—shaped modern macro’s core debates and toolkits. [9][10][12][13]
  • Depression-era reforms did not just aim to stimulate demand; they also rebuilt financial institutions (notably banking regulation and deposit insurance) to stabilize expectations and prevent runs. [6][7][5]
  • The Depression era accelerated macro measurement (national income accounting and standardized aggregates), helping transform macroeconomics into an empirical, policy-facing discipline. [4][2][3][15]

1. From downturn to catastrophe: an episode chronology anchored by data

The standard U.S. business-cycle chronology identifies a major contraction beginning at a peak in 1929 and ending at a trough in 1933. [1] The same chronology also identifies a subsequent recession in 1937–1938, often treated as a distinct episode within the broader 1930s macroeconomic turmoil. [1] For consistency, this chapter uses 1929–1939 as its main analytic window, while noting that some institutional narratives extend the “Depression era” frame into the early 1940s; that difference reflects episode-bounding conventions rather than disagreement about the 1929–1933 collapse or the 1937–1938 downturn. [1][5]

A practical reason the Depression becomes a “birth of modern macro” episode is that it is unusually legible through the macroeconomic aggregates that later became standard policy language. Annual GDP and its expenditure components (consumption, investment, government, net exports) are available in a consistent national-accounts table format beginning in 1929, enabling decompositions of collapse and recovery in terms of spending categories rather than anecdote. [2] Likewise, high-frequency historical unemployment series exist for the Depression era (including explicit NBER Macrohistory identifiers covering 1929–1942), allowing the labor-market catastrophe to be tracked month-by-month rather than inferred from scattered accounts. [3]

Fact: Contemporary institutional narratives emphasize a combination of severe real-side contraction, banking distress, and deflationary dynamics as defining features of the Depression era. [5][7][12]
Interpretation: Those features together created the modern macro “problem set”: not only why output falls, but why unemployment can remain high, why prices may fall rather than rise, and why financial instability can amplify macro shocks. [8][10][15]

2. Aggregate demand in practice: spending, prices, and employment

Facts (supported)

  • The availability of annual GDP and its expenditure breakdown from 1929 onward makes it possible to frame the Depression as a collapse and partial recovery of aggregate spending, not only as a sequence of events. [2]
  • The NBER Macrohistory archive provides historical unemployment-rate series spanning the Depression era, documenting mass unemployment in the early 1930s as a measurable macroeconomic outcome rather than a purely descriptive one. [3]
  • Keynes’ The General Theory of Employment, Interest and Money (1936) formalized a framework in which deficient demand and involuntary unemployment could persist, reorienting macroeconomic reasoning toward the determinants of employment and output at the aggregate level. [8]

Interpretation (reasoned, foundations cited)

When modern readers say “aggregate demand” in a Depression context, they are usually referring to a practical composite: the economy-wide willingness and ability to spend, reflected in GDP’s expenditure components and in the employment outcomes those spending patterns support. [2][8] That framing is not merely definitional; it implies a policy question: if unemployment persists, should policy focus on restoring spending directly (demand management), on repairing monetary/financial transmission, or on removing regime constraints that prevent stabilization? [8][9][10][12]

This is why the Depression sits at the hinge between economic history and macroeconomics as a policy discipline. The crisis demanded not only explanations but operational metrics—output, income, employment—that could discipline competing narratives. [4][2][3]

3. Three explanatory traditions: money, credit, and regime constraints

A central intellectual legacy of the Depression is that “what caused it” is not a single claim but a structured competition among mechanisms that map into different policy levers. [9][10][12][13]

3.1 The monetary contraction tradition

Fact (about the argument): Friedman and Schwartz, in A Monetary History of the United States, 1867–1960, present a monetarist interpretation that emphasizes monetary contraction and the monetary consequences of banking distress as central to turning a downturn into the Great Depression. [9]
Interpretation: In modern macro terms, this tradition prioritizes the aggregate demand channel operating through money, credit conditions, and nominal spending—implying that stabilization hinges on preventing monetary collapse and maintaining a functioning monetary transmission mechanism. [9][8]

3.2 The financial-intermediation and propagation tradition

Fact (about the argument): Bernanke’s 1983 paper argues that financial crisis can propagate and deepen the Depression through “nonmonetary” channels—specifically, disruptions to credit intermediation and borrower–lender relationships that reduce real activity beyond what a money-stock story alone would capture. [10]
Synthesis: This complements rather than simply replaces monetarist claims: even if monetary aggregates matter, the functioning of financial intermediation can add an additional amplification mechanism. [10][9]
Interpretation: This line of reasoning foreshadows a modern macro emphasis on “financial accelerators,” where damaged balance sheets and impaired intermediation convert shocks into persistent output and employment losses. [10]

3.3 The regime-constraint and international transmission tradition

Fact (about the argument): Eichengreen’s Golden Fetters emphasizes how the gold standard constrained monetary autonomy and shaped deflationary dynamics and crisis transmission across countries. [12]
Fact (about the evidence in the cited work): Eichengreen and Sachs (1985) provide empirical evidence linking exchange-rate regime shifts (notably depreciation/abandonment of gold parity) with recovery patterns in the 1930s. [13]

HIGH-RISK CLAIM (causal interpretation): It is easy—but often incorrect—to restate the Eichengreen–Sachs result as “leaving gold caused recovery everywhere and in the same way.” What the chapter can responsibly claim from the Source Pack is narrower: the cited research links exchange-rate regime changes and recovery outcomes in the 1930s and frames gold as a binding policy constraint. [13][12] Stronger causal wording would require careful discussion of identification and country heterogeneity beyond what is summarized here. [citation needed]

4. Policy response and controversy: stabilization, banking reform, and competing readings

Facts (supported)

Major Depression-era policy change included structural reforms to banking and depositor protection. The Federal Reserve History account of the Banking Act of 1933 (Glass–Steagall) identifies it as a key reform episode in U.S. financial regulation and crisis response. [6] FDIC historical material situates deposit insurance and related institutional changes within the Depression-era banking crisis context and the policy response to failures and depositor runs. [7] More generally, institutional narratives of the Depression foreground banking distress and policy reforms aimed at restoring financial stability and confidence. [5][7]

Synthesis (supported by multiple sources)

The policy regime shift of the 1930s cannot be described solely as “stimulus” versus “austerity.” A substantial component of the response involved redesigning the financial system’s institutional plumbing—regulation, separation rules, and deposit insurance—reflecting a view that stabilization requires credible financial infrastructure, not only higher spending. [6][7][5] In parallel, scholarly accounts of the Depression’s dynamics emphasize monetary mechanisms, financial propagation, and regime constraints—each implying different “best” stabilization tools. [9][10][12][13]

Interpretation (reasoned, foundations cited)

Because the Depression became the defining macroeconomic catastrophe, the post-Depression macro policy conversation was drawn toward frameworks that could explain sustained unemployment and incomplete recovery, and that could justify a credible stabilization apparatus. Keynes’ framework provided a language for persistent unemployment and the logic of demand management. [8] Monetarist and financial-propagation frameworks provided a language for policy failures in monetary/financial stabilization and the real consequences of financial distress. [9][10] The international gold-standard literature provided a language for external constraints and the macroeconomic costs of defending a fixed parity under deflationary pressure. [12][13]

HIGH-RISK CLAIM (magnitude and attribution): Romer (1992) is frequently summarized as arguing that monetary expansion accounts for nearly all U.S. recovery prior to 1942 and that fiscal policy played a comparatively minor role in the prewar recovery. [11] This statement is high-risk in casual retellings because its accuracy depends on Romer’s exact definitions of “recovery,” the policy measures used, and her identification strategy. [11] Any numerical restatement (percentages, exact contributions) would require quoting or reproducing her calculations precisely. [citation needed]

HIGH-RISK CLAIM (model-based generalization): Cole and Ohanian (2004) argue—within a general equilibrium framework—that specific New Deal policies can help explain the persistence of Depression-like conditions, emphasizing policy-induced distortions as a mechanism. [14] It is high-risk to translate this into a broad claim like “the New Deal prolonged the Depression” without specifying which policies, which modeled channels, and what counterfactual the paper constructs. [14] A careful chapter treatment should present it as one prominent, debated interpretation rather than a settled fact. [14][15]

Research Lens: How modern macro ideas crystalized—and what they implied for policy

Dominant questions formed in the 1930s: Why can unemployment persist? What determines economy-wide spending? How do money and finance transmit shocks? What constraints limit stabilization? [8][9][10][12]
Competing frameworks that became enduring pillars:

  • Keynesian demand framework: persistent involuntary unemployment and the case for demand management. [8]
  • Monetarist framework: monetary contraction and stabilization via preventing monetary collapse. [9]
  • Financial propagation framework: credit intermediation breakdown as an amplifier that policy must repair. [10]
  • Regime-constraint framework: fixed-parity commitments (gold) can force deflationary adjustment and constrain policy autonomy. [12][13]
    Policy implication (synthesis): “Stabilization” becomes plural—macroeconomic management is not only about spending levels, but also about credible monetary/financial backstops and, where applicable, the policy space created or destroyed by regime commitments. [8][9][10][12][13]

5. What Changed: institutions, policy tools, and measurement

Institutions and policy tools

A major institutional break in U.S. financial governance is associated with Depression-era reforms, including Glass–Steagall (as treated in Federal Reserve History) and the introduction of deposit insurance through the FDIC’s Depression-era context. [6][7] Interpretation: The prominence of these reforms in institutional histories is consistent with scholarly accounts that treat financial distress and impaired intermediation as macroeconomically consequential propagation channels, though the magnitude attributable to any single reform is not established here. [5][7][10]

Internationally, the Depression-era experience became a canonical case of regime constraints: the gold standard is treated as limiting monetary autonomy and shaping crisis transmission and recovery. [12] Eichengreen and Sachs provide an empirical analysis connecting exchange-rate regime shifts and recovery outcomes in the 1930s, reinforcing the idea that “policy space” is itself a macro variable. [13]

Measurement and data infrastructure

The Depression also catalyzed macroeconomics as a measurement-based discipline. Kuznets’ National Income, 1929–1932 exemplifies early systematic national-income accounting work produced in the crisis context. [4] Modern-style aggregate tables that allow decomposition of GDP by expenditure categories (available from 1929 onward) support precisely the kind of empirical reasoning that Depression debates demanded. [2] Likewise, the availability of historical unemployment series in the NBER Macrohistory database reflects the institutionalization of employment measurement as a core macro outcome, not a side statistic. [3]

Synthesis: Taken together—new institutional stabilization architecture and maturing macro measurement—the Depression era helped create the modern macro policy regime: policymakers could increasingly diagnose problems in standardized aggregates and respond with a growing set of institutional tools. [6][7][4][2][3][8]

6. Why It Matters Now

The Great Depression is often treated as macroeconomics’ benchmark crisis because it concentrates, within a single historical episode, the core themes that later defined the field’s policy and research agenda—monetary collapse, financial instability, and binding regime constraints. [9][10][12][13]

The Depression’s legacy is also methodological: it reinforced the practical necessity of shared measurement infrastructure—national income concepts, decomposable output aggregates, and trackable employment indicators—so that competing explanations could be debated against common empirical objects. [4][2][3]

In that sense, the Depression is where “aggregate demand” became operational as a policy-relevant construct—contested across frameworks, but increasingly discussed in terms of standardized aggregates and transmissible mechanisms (money, intermediation, and constraints). [8][2][9][10][12][13]

Data and Series Used (data appendix)

  • Business-cycle chronology (peaks/troughs; including 1929–1933 contraction and 1937–1938 recession): NBER Business Cycle Expansions and Contractions. [1]
  • National accounts (annual GDP and expenditure components from 1929 onward): FRED “Table 1.1.5. Gross Domestic Product: Annual” (GDP release table format). [2]
  • Historical unemployment series (monthly; Depression-era coverage with explicit series identifiers): NBER Macrohistory Database, Income and Employment (e.g., unemployment rate series spanning 1929–1942). [3]

References (Source Pack)

  1. National Bureau of Economic Research (NBER). (2023). US Business Cycle Expansions and Contractions. [1]
  2. Federal Reserve Bank of St. Louis (FRED). Table 1.1.5. Gross Domestic Product: Annual (release table). [2]
  3. National Bureau of Economic Research (NBER). NBER Macrohistory Database: VIII. Income and Employment (incl. Depression-era unemployment series identifiers). [3]
  4. Kuznets, Simon. (1934; NBER). National Income, 1929–1932. National Bureau of Economic Research. [4]
  5. Richardson, Gary. The Great Depression (1929–1941). Federal Reserve History. [5]
  6. Maues, Julia. (2013). Banking Act of 1933 (Glass-Steagall). Federal Reserve History. [6]
  7. Federal Deposit Insurance Corporation (FDIC). The Great Depression and World War II (1930–1939). FDIC History. [7]
  8. Keynes, John Maynard. (1936). The General Theory of Employment, Interest and Money. London: Macmillan. [8]
  9. Friedman, Milton, and Anna J. Schwartz. (1963). A Monetary History of the United States, 1867–1960. Princeton: Princeton University Press. [9]
  10. Bernanke, Ben S. (1983). “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression.” American Economic Review, 73(3), 257–276. [10]
  11. Romer, Christina D. (1992). “What Ended the Great Depression?” The Journal of Economic History, 52(4), 757–784. [11]
  12. Eichengreen, Barry. (1992). Golden Fetters: The Gold Standard and the Great Depression, 1919–1939. Oxford University Press. [12]
  13. Eichengreen, Barry, and Jeffrey Sachs. (1985). “Exchange Rates and Economic Recovery in the 1930s.” The Journal of Economic History, 45(4), 925–946. [13]
  14. Cole, Harold L., and Lee E. Ohanian. (2004). “New Deal Policies and the Persistence of the Great Depression: A General Equilibrium Analysis.” Journal of Political Economy, 112(4), 779–816. [14]
  15. Rauchway, Eric. (2008). The Great Depression and the New Deal: A Very Short Introduction. Oxford University Press. [15]

Further Reading (from the Source Pack)

  • Keynes (1936), The General Theory of Employment, Interest and Money. [8]
  • Friedman & Schwartz (1963), A Monetary History of the United States, 1867–1960. [9]
  • Bernanke (1983), “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression.” [10]
  • Eichengreen (1992), Golden Fetters. [12]
  • Romer (1992), “What Ended the Great Depression?” [11]
  • Rauchway (2008), The Great Depression and the New Deal: A Very Short Introduction. [15]