Central bank and the Great Depression

     The Great Depression is one of most serious financial crisis in the history. The Great Depression start from the United States, then swept the entire capitalist world, the formation of an unprecedented, sustained the longest in the world economic crisis. Many scholars explained it from different angles. Today, I am focus on the role of central bank in the Great Depression.

                                            

In the Panic of 1907, due to without central bank, it caused pervasive USA economic recession and bank failures. After that, the government created Federal Reserve System (FED) as American central bank in 1913. Although FED had established, the US government believed "Invisible-hand" will control the market. The graph 1 shows the US real GDP booming from 1920 to 1929. But after a brief economic boom, crazy stock investment finally led to the dreaded "Black Thursday" and triggered financial crisis. In my opinion, the negative effects of central bank are important in the Great Depression.

Graph 1: US real GDP from 1920 to 1929

First of all, there was no deposit insurance system. Commercial banks do not have deposit reserves in the central bank, when the bank run happen. It will cause bankrupt and lose trust from savers. Central bank did not established an effective deposit insurance for avoid bankrupt. Secondly, central bank have no regulation about the credit consumption. As we can see the graph 2, the growth of S&P stock index are much higher than the GDP increase. When economic crisis broke out, the monetary credit suddenly tightening, led to currency credit crisis. 

                                            Graph 2: US annualized growth rate from 1920 to 1929

Thirdly, effective macroeconomic management has not been established, central bank have no idea about economic adjustment, which led to a serious loss of control. Last but not least, the FED did not created regulation to supervise security market. Over-expansion securities market means bubbles.

In conclusion, central bank is an important factor of financial crisis. For the healthy economy, the economy should not only control by the market, but also need government macroeconomic management like central bank regulation. In fact, because of macro-control policies, the United States smoothly through the Great Depression. I will analyse it in the future blog.

Data:

The data for graph collected from http://www.measuringworth.com/

The video collected from http://www.youtube.com

Reference: 

1. Frank, Robert H and Bernanke, Ben S. (2007). Principles of macroeconomics (3rd ed.). Boston: McGraw- Hill/lrwin. p. 98. ISBN 0-07-319397-6

2. Murray Rothbard, America's Great Depression. (2000) Ludwig von Mises Institute. PP. 159-163.