Critique and Analysis of “The Third Depression” – historical analysis

In “the Third Depression”, the author contends to there having only been two depressions since the 19th century, with other adverse economic times since then being advanced as recessions that were partially the outcomes of these depressions (Krugman, 2010). Despite this designation, the existence of economic cycles has been widely recognized in market driven economies by many economists (Colander, 2008). In market driven economies individuals have the power to make decisions on what, how much and for whom production is destined (Colander, 2008). Following such freedoms periods of growths and declines – usually advanced to occur in cycles – make a significant characteristic of these markets. The cycles could take two forms; one being alternating expansions and contractions and the other being alternating accelerations and decelerations in growth. Krugman (2010) article implies on such forms by the statement that “Neither the Long Depression of the 19th century nor the Great Depression of the 20th was an era of nonstop decline — on the contrary, both included periods when the economy grew” (p. 1). The aftermath of the 1873 panic and the outcomes of the 1930s depression have thus been behind the inspiration of many economic literature.

1873 Panic and Aftermath

The crisis that started in the 1873 had many factors that acted to fuel long run deflation and instability. Though much literature has lauded the Gold standard of the time with a long-term price stabilizing effect, others have demonized the era for the frequent and in many cases severe contractions (Huffman & Lothian, 1984). Most of those criticizing the Gold standard accused it of uncertainty that further fuelled frequent booms and contractions hence leading to instability as contended by Krugman in his article (Huffman & Lothian, 1984). Despite the 1873 crisis having been insinuated to have started the long depression (Krugman, 2010), the actual period of decline was between 1873 and 1875, with the remainder of the crisis being characterised by a rapid increase in NNP – an index measure of real income as a factor of total trade – but with the deflationary trend (lower prices of commodities) persisting (Huffman & Lothian, 1984).

The origin of the 1873 crisis is attributed to the panic that had a domestic antecedent (Huffman & Lothian, 1984). According to Friedman and Schwartz (1963) the motivator factors were financial challenges experienced by particular U.S railroads resulting in defaults of debts (as cited in Huffman & Lothian, 1984, p. 472). The subsequent significant decline in the U.S greenbacks thus reduced bank-reserve ratios in the first half of the year acted as the spring board for resultant panic (Huffman & Lothian, 1984). By that time the U.S had abandoned the gold standard which it later returned to in 1879 (Huffman & Lothian, 1984). Since the UK still employed the Gold standard, the transmission of the crisis was not that effective (Huffman & Lothian, 1984). Through the bank of England, the UK had also tried to curtail the spread of the crisis into its realms. Though its initial reaction was to increase the discount rate to a high of nine percent, its subsequent and almost immediate reduction of the rate to five percent, helped avoid the full-pledged panic as was being experienced in the US (Huffman & Lothian, 1984). The discount rate thereafter fluctuated between five and six percentages limiting the effects of the panic mainly to the London stock exchange out of the adverse effects on the equity prices (Huffman & Lothian, 1984). The aftermath of the crisis was however an increased susceptibility to economic adversity with the follow-up contractions occurring in 1882, 1890 and 1907 characterizing the return of the U.S to the gold standard (Huffman & Lothian, 1984). Go to part 3 here.

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