In the US, the commonly known ‘Roaring Twenties’ was used to refer to a period of social growth and exuberant expansion. However, the period came to an immediate and dramatic end in 1929 after the stock market crash. The occurrence paved the way for the 1930’s Great Depression, which led to an economic contraction of more than 36%. Most well-performing US banks dramatically failed during this period, leading to significant losses on the customer’s savings. In the same period, the level of unemployment grew by more than 25% due to the collapse of firms (Nitschke and Rose, 2021). It is imperative to realize that before the crisis in question, the stock market experienced significant growth. This led to stock speculation, which became a common practice in the market as most traders claimed their piece in the industry. This led to increased demand in the industry as investors got ready to exploit the already viable opportunities.
Before the onset of the Great Depression, there was high demand for stock due to the continued upsurge of share prices. This led to an increase in the number of people in the industry, increasing the demand for products. Due to excessive production levels, the economy stumbled in mid-1929, resulting in oversupply (Bernanke, 2018). Firms were able to earn cheaply because of the increased prices of shares, and this made them invest in various products with indispensable assurance. This practice eventually resulted in oversupply in many parts of the industry. As a result, enterprises had to dump their stock at a loss as share values started to weaken.
On the other hand, the 2007-2009 economic crunch started similarly to Great Depression. The period began some years earlier due to lax borrowing standards and cheap credit. This made it possible for subprime borrowers to realize the desire to own a home. The practice aims to ensure money is available to consumers and enterprises at considerably affordable rates. After the burst of the bubble in 2007, most lending institutions had trillions of dollars and worthless reserves in subprime debts (Bernanke, 2018). In this case, most Americans were left with more obligations and worthless homes. The subsequent economic recession made investors lose their savings, jobs, and homes. The following analysis will analyze the events before the 1929 recession and the 2007-2009 crises. Further, the paper will elaborate on the credibility of Mishkin’s theory in explaining these crunches.
In history, it is clear that society has never experienced a critical state of economic collapse before the recent occurrence in 2008. In this case, a few examples explain momentous happenings that influenced the failure during the Great Depression (Jaffe, 2020). These include the issue of the French revolution or the event of world war two. It is imperious for economists to consider all possible events that can help understand the financial crunch and how they lead society and the economy to collapse.
In light of the economic and political conditions experienced in Europe due to the Great Depression, the need to understand the 1929 crisis was created. This involves appropriately analyzing how the 2008 crisis compares and determining whether the occurrence would have made another depression. With appropriate analysis, it will be apparent that the two crises are similar in magnitude. Both signaled the start of recessions despite their different causes (Nitschke and Rose, 2021). The events that followed included a severe fall in global production, high unemployment rates, and a decline in world commerce. Because of the lessons from the two crises, it is clear that the subsequent recession from 2008 was at Great Depression scale.
The Magnitude of the Financial Crisis
In contemporary history, the 19329 share industry crash started a bad economic contraction, and the 2008 events had equal magnitude. Economist reports have shown that the 2008 crises were at par with the cause of the depression. Twelve months after the economic boom of 2008, the production level declined with the same magnitude as in the first year of the depression. Researchers who have commented on the recent depression have found that the economy is in a worst state than it did in the Great Depression (Nitschke and Rose, 2021). This has been the case in both export valuations and industrial production.
During the recession period, industrial output and global commerce dropped on a lousy trajectory than during the start of the Great Depression. In 2007, the equity industry levels stood at high ranks. However, after 17 months, the standings fell by 56% to $22 trillion from the previous report of $51 trillion (Nitschke and Rose, 2021, P. 39). This represented a general value loss of 50% of the world GDP. From 2007 September, the US 500 index fell by 54.1%, exceeded by the 1929 crash only, which reported a decrease of 83.4% in August (Akerlof, 2019, P. 174). The two depression tales settle that the globe is still experiencing an economic crisis in every bit in the same magnitude as it was in 1929-30 during the Great Depression.
It is evident that the two crashes that resulted in serious events significantly led to a loss of equity because they were similar in magnitude. In addition, the two occurrences beckoned the start of recessions that resulted in a severe decline in global output, and commerce, and increased levels of unemployment (Akerlof, 2019). However, it is imperative to note that the recent crashes, which seem to be similar to the 1929 crisis, have influenced the Great Depression unemployment ranks. The paper explores various causes of the two crashes alongside possible policy responses taken in response to the occurrence.
The Aspects of Economic Crashes
In the economics of the financial industry, banking, and finance, we arrive at three significant stages of the monetary crisis. In this case, the first stage involves initiation, the second focuses on the onset of the banking predicament, and the last level explains the issue of debt deflation. The first stage of such activities led to an increase in interest rates or an enhanced level of uncertainty, which destroyed the financial industry. This is made possible by adverse selection worsening alongside moral threat data asymmetries. The two aspects- adverse selection and moral threat- can be explained to mean a conflict of information, resulting in reduced lending rates. A decrease in lending levels implies low investment and poor economic performance.
In addition, prolonged declines in financial operations lead to panic, especially in banking sectors, and initiate the second stage of the financial crisis. This occurs due to adverse business situations and increased uncertainty in the financial industry. As a result, banks are more likely to ensure, leading to bank failures. In addition, the occurrence of worse asymmetries of information creates room for vicious series where financial operations decline to a more considerable extent. If panic among banking sectors remains unattended, the effect will likely cause deflation due to a reduced supply of finances. This is likely to influence the onset of the third stage of debt deflation. Once again, this leads to worsened data asymmetries and, later, poor economic performance. In this regard, Mishkin asserts that the most critical economic crunch that involved debt deflation was experienced during the Great Depression, which stands to be the worst financial contraction ever witnessed in the history of the US.
One of the primary reasons why the global economy has been able to escape the danger of the Great Depression recession is linked to the 2007-2008 crises. During the period, the economic predicament avoided the total blast of debt deflation and banking terror that ensued after the 1929 financial ruin (Akerlof, 2019). Maintaining this critical analysis in mind, we are now justified to explore various links to the crises and provide a clear resolution that elaborates why the two situations with equal strength resulted in diverse outcomes.
During the onset of the two crises, an increase in interest rates was seen as one of the significant initial signals. In Mishkin’s explanation of the 1928-1929 stock booms and the resulting federal reaction, he asserts that the boom was considered extreme speculation, particularly by federal officials. They concentrated on implementing strict financial policies to raise interest rates to reduce the spread. Reports have shown that countries like the US, Germany, and Sweden, among others, increased their discount rates in the entire period of 1929, before the crash (Abdel-Raheem, 2021). The breakdown was finally witnessed in 1921, the month of October. However, before the commencement of subprime debt predicaments, the Federal body had initiated increasing the rates of interest.
Research shows that the 2007 crisis started with the downfall of the primary mortgage industry and the culmination of the housing boom. This occurred after two consecutive years of increasing lending rates by the change of policies executed by the Federal Reserve (Judge, 2018). With this in mind, it is clear that an increase in interest rates is one of the significant signals that led to both crises. Nevertheless, the two situations are also dissimilar in some specific aspects. In this regard, it is imperative to realize that the boon in housing witnessed in the 1920s was more influenced by financial troubles than the mortgage meltdown. This is the opposite sign scenario of the current industrial condition.
The mortgage predicaments were witnessed after the 1929 crunch, whereas in the event of the 2008 economic scenario, the mortgage issues were the major contributing factors. Indeed, research demonstrates aspects such as regulation shift, usual standards relaxation of cautious lending, lax oversight, and extended period of nonstandard reduced interest rates as the significant changes that led to the 2007-2008 crises (Beker, 2021). These aspects resulted in the mortgage industry boom in the US, followed by the process of securitization, which exposed most of the financial markets to the US debt market. The occurrence resulted in serious turmoil in the financial industry, mainly when the US market for housing started to decline.
On the other hand, the strict fiscal policy led to the 1929 crash of the stock industry, while the rates of interest significantly increased before the 2007-2008 crunches. However, this does not represent the actual cause that led to the occurrence of the crisis. In the same manner, meaningful resemblances and differences exist in how the two situations conversed into the economy. In this regard, the 1929 event resulted in considerable losses to investors. This made them reduce their original spending, and after that, firms joined by reducing their liquidity levels and general expenditure. The event led to an immediate sharp reduction in production levels (Holmes, 2018). The Global Depression report indicates a significant decrease in local products and import prices, leading to deflation.
Moreover, the 2007-2008 events portrayed themselves differently in the global industry. In this regard, mortgage defaults were felt in commercial and investment institutions in the US and globally through a unique connection of derivatives. Later, the occurrence spilled to the actual economy via a dangerous debt crisis and crumpling of equities in the industry. After the 1929 economic predicament, the events of production contraction spread to a large extent worldwide. On the contrary, the 2008 crunch was felt across the globe through securitized debt instruments, which uncovered external banking institutions to the turmoil of the US mortgage industry (Abdel-Raheem, 2021). There is a distinct difference in the foundations of the two crunches and how they conversed into the economy. With this crucial examination, we now focus on the significant dissimilarity and the policy reaction of the two crises.
The Great Policy Difference
It is now clear that the banking panic that resulted from the 1929 and 2008 crunch was severe. However, although it is impossible to understate the degree of severity in both crises, it is evident that the 1929 crunch reduced the supply of money caused by banking failures. This has never been witnessed again, both in the 2008 crunch and other subsequent recessions. Researchers provide that a significant reduction in price levels and productivity during 1929-33 was caused by a decrease in the money supply in the economy (Bessant, 2018). The fall is attributed to the failure of banks, although some research claims that the event could have been avoided through active fiscal policy.
The runs experienced by banks during the 1929 crunch resulted in a massive number of institutional failures. However, there were no such incidences witnessed in the 2008 crisis. This was as a result of the Federal corporation enacted in 1934. The corporation ensured the stability of the deposit ratio, and instead of the expected decline, it rose significantly (Chipeta, 2020). In addition, there were no reported runs among the commercial institutions because investors were assured of the safety of their deposits. Although a considerable number of institutions collapsed in the 1930s, the events from the 2008 crunch were characterized by massive bailouts of giant firms (Quinn and Turner, 2021). This was done to prevent too-big-to-fall problems, where the collapse of significant firms would threaten the existence of the whole financial system.
It is clear from several pieces of research that the 2008 crisis was rescued to a large extent by Federal Reserve funds, Freddie Mac, among others who had notable performances in the mortgage industry. This was trailed by the bailout bill proposal of $700 billion meant to acquire hugely discounted debt alongside other securities to redeem them from an institutional balance sheet and revive lending from banks. Contrary to the 1930’s problem, the recent crunch is a result of insolvency as opposed to the issues of illiquidity. This gives room for the main idea that uncertainties on leading banks’ solvency led to the 2008 crisis (Nitschke and Rose, 2021). In contrast, in 1929, bank failures influenced liquidity downfall hence losing the public’s confidence in the banking system. This was significantly avoided in the 2008 crisis by using regulations and policy responses. In 1929, the illiquidity issue was influenced by banking failures and panic that resulted in a decline in the funds’ supply.
Despite the action of the federal reserve of open market security acquisition, the financial policy in reaction to the 1929 crunch remains a contraction issue. This is based on the feeling that the Federal Reserve response was too late and little (Curott and Watts, 2020). By the time of its reaction, the problem of deflation had been felt in the fragile product industry and durable goods markets. This operates through a common fisher effect where although the Federal Reserve cut the interest rates, the actual charges were growing due to deflation, hence the contraction of the money supply (Quinn and Turner, 2021). This financial policy gave room for deflation to be experienced in the economy, which intensified the problems of debts.
Most borrowers found themselves owing an equal amount but having to repay with more valuable cash due to the deflation effect. Federal report shows how deflation rates in the US rose after 1929 and declined at -10.3% in 1932, where inflation remained at the same level until 1934 (Quinn and Turner, 2021, P.12). On the other hand, in 2008, inflation was 3.8% in the US, reduced to -0.4%, and later rebounded in 2010 to 1.6% (Quinn and Turner, 2021, P. 14). Since inflation can only be experienced following the growth of money supply, deflation is witnessed after contraction and growth afore inflation. In this regard, the 1929 contraction led to deflation and infuriated the economic crisis by encouraging debt devaluation. On the other hand, expansionary policies witnessed in 2008 helped avoid debt deflation and curbed the possibility of worsening depression (Vercelli, 2019). To prevent the illiquidity crunch, the global monetary authorities had to torment the assurance crisis and avoid the solvency of big institutions.
Researchers claim that the significant factor ahead of crisis dynamics in 2008 was significantly dissimilar from that of 1929. Before, the effect was primarily dependent on the downfall in the confidence of the banking system. At the same time, the 2008 crisis was hugely a decline in the sureness of banks following the soundness of big institutions (Cassis and Schenk, 2021). By enacting some of the most unconventional policies and reduction in rates of interest, central banks succeeded in their effort to avoid the liquidity downfall that turned the 1929 crisis into the commonly known Great Depression.
Mishkin’s theory of asymmetry data as an approach to economic crunches helps elaborate the timing patterns in the information and other features of these crises, which are sometimes challenging. The method also explains why financial problems have had such critical consequences in the entire economy over many years (Orús, Mugel and Lizaso, 2019). In this regard, the use of the asymmetry approach provides more reliable data of the crises than the monetarist’s method.
However, the two theories should be complementary since they provided material information on how economic disruption and panic in banking influenced overall economic activities. Nevertheless, the asymmetry does not consider the two aspects as the only financial crisis but also takes a keen interest in other effects, such as the downfall of the stock market (Jaffe, 2020). On the other hand, the asymmetry approach suggests how economic crises outside the post-war period adversely affected the entire economy.
Throughout this analysis, it is now clear how the 2007-2008 crunches were as severe as that experienced in 1929. Despite their variances in the causes, the recent 2008 crisis had equal ability to cause a depression had the monetary authorities failed to utilize the lessons from the Great Depression. This implies that there could be panic in banking with equal magnitude to that experienced in 1929 if more prominent institutions were allowed to fail. This being the case, the subsequent deflation would have resulted in significant depression. In other words, high unemployment rates and contraction in production could have been felt across the globe if proper mitigation measures had been ignored. Apart from economic menace, the level of societal harm that resulted from the Great Depression is inestimable. With this in mind, the collapse set the stage for a political crunch in Europe and other affected countries across the globe.
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