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4 - The Great Depression

Published online by Cambridge University Press:  05 June 2014

Steven D. Gjerstad  and
Vernon L. Smith
Steven D. Gjerstad
Affiliation:
Chapman University, California
Vernon L. Smith
Affiliation:
Chapman University, California
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Summary

As explanations of the so-called business cycle, or cycles, when these are really serious, I doubt the adequacy of over-production,…over-confidence, over-investment, over-saving, over-spending, and the discrepancy between saving and investment. I venture the opinion…that in the great booms and depressions each of the above-named factors played a subordinate role as compared with two dominant factors, namely over-indebtedness to start with and deflation following soon after.

Over-investment and over-speculation are often important, but they would have far less serious results were they not conducted with borrowed money.

The same is true as to over-confidence. I fancy that over-confidence seldom does any great harm except when…it beguiles its victims into debt.

– Irving Fisher (1933, pp. 340–1)

Interpretations of the Great Depression

Similarities between the financial crisis in September 2008 and the collapse of the financial system during the Great Depression are widely noted. Yet, the comparability of the origins and transmission of the crises have been neglected. The recent downturn, which originated with a pronounced housing boom and collapse, led to severe household balance sheet problems that were transmitted to lenders and mortgage security investors. Damage to household balance sheets weakened household demand – especially for housing and durable goods – which adversely affected employment, production, and nonresidential fixed investment. This pattern, however, is not recognized in the dominant view as a possible cause of the Great Depression. Contrary to prevailing views of its origins, we argue in this chapter that changes in the levels of mortgage finance and residential construction and the broader economy preceding and during the initial phases of the Great Depression shared many features with the recent Great Recession. Based on data collected by Wickens (1937), we estimate that by the end of the Great Depression, losses onmortgage loans exceeded estimates of losses in the Great Recession, either as a percentage of loans outstanding or as a percentage of aggregate output.

Type
Chapter
Information
Rethinking Housing Bubbles
The Role of Household and Bank Balance Sheets in Modeling Economic Cycles
 , pp. 85 - 121
Publisher: Cambridge University Press
Print publication year: 2014

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