Causes of the Great Depression

- Structure of the Global Economy: Gold Standard and monetary links - Sanctions to Germany after the WWI - Deregulation of capital markets - US Policy: Hoover and the FED bad policies

The Great Depression was the deepest economic crisis in history. Millions of people fell into poverty and unemployment, not only in the United States but around the world. Economists are still learning the lessons of the Great Depression

Before WWI, London was the biggest world financial hub. London banks financed economic expansion in developing countries.

After WWI, New York emerged as the global center for world finances. U.S. banks gave loans to governments, banks, and companies from other countries, including Germany.

In many countries, Gold Standard was still in effect after WWI. Gold Standard is a monetary system where the quantity of money in circulation is in direct relation with the gold reserves of the monetary authority. The monetary authority purchases and sells gold at a fixed rate.

Gold Standard implies that there is a fixed exchange rate and countries cannot devalue its currency nor conduct an expansive monetary policy. The monetary base is a fixed relationship with the gold reserves. Research shows that countries that left the Gold Standard earlier, saw a greater reduction in the impact of the Great Depression.

Nowadays, many central banks and monetary authorities would increase the monetary base to ease pressures on the real economy. This was not possible under the Gold Standard.

Although Germany left the Gold Standard before 1929, U.S didn't. The U.S. monetary policy couldn't use one of the most important economic policy instruments.

As we will see below, when there is a fixed exchage rate, fluctuations in the interest rate do have an impact in short term capital flows and foreign monetary base. When the interest rates raised in the U.S., this had a negative impact on foreign finances and real economies.