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Candidate of economic sciences, PhD Assel K Jumasseitova

Kazakh British Technical University

An Analysis of world economic and financial crisis, 192933

The world economic crisis of the early 1930s was caused by the structural

problems of the international economy of the 1920s. These problems were caused by the changes initiated by the First World War. Governments in the 1920s failed to understand that the world economy was in serious financial crisis, or if they did, they were unwilling to change their policies. Hence, the world economic crisis was inevitable. In the later 1930s, countries did recover from the crisis but recovery was based on domestic recovery, not on international trade.

In the process of the transmission of monetary policy the main thing is the evaluation of the effects of a monetary impulse on relative prices and real demands as it shifts through the economy from its first perspective to its final effect on the main determinants of economic welfare. Interest rate in the money market is the change which occurred by the influence of the monetary injections. There are effects on output that may be large and costly because some prices, money remunerations, or anticipations do not conform instantly. In order to learn from the historical mistakes, it is important to find out the reasons that led to the crisis that impacted not only Europe, but the whole world. To add, there are several mistakes that caused such an economic decline.

Monetary policy is the setting of the money supply by policymakers in the central bank. The money supply refers to the quantity of money available in the economy. Government provides monetary policy through Central Bank.

The Central Bank has three tools in its monetary toolbox:

-  Open-market operations

-  Changing the reserve requirement

-  Changing the discount rate

The Central Bank conducts open-market operations when it buys government bonds from or sells government bonds to the public. When the Central Bank buys government bonds, the money supply increases. The money supply decreases when the Central Bank sells government bonds.

The Central Bank also influences the money supply with reserve requirements, that mean regulations on the minimum amount of reserves that banks must hold against deposits. Increasing the reserve requirement decreases the money supply and decreasing increases the money supply.

The discount rate is the interest rate the Central Bank charges banks for loans. Increasing the discount rate decreases the money supply, decreasing increases the money supply.

The Central Bank must wrestle with two problems that arise due to fractional-reserve banking. The Central Bank does not control the amount of money that households choose to hold as deposits in banks and the amount of money that bankers choose to lend.

The countries most affected were the USA and Germany. GDP in Germany and the USA fell by about 30 per cent between 1929 and 1933. Industrial output fell by about 50 per cent. Unemployment was 25 to 33 per cent of the labour force [1]. Experience of USA during the financial crisis of the Great Depression shows as how Government tried to increase aggregate demand through monetary policy. For the U.S. economy, the most important reason for the downward slope of the aggregate-demand curve is the interest-rate effect

Among the sequences of the 1930s international financial crisis we can highlight that the central European banks were in difficulties because their economies were in depression. Businesses could not repay their borrowings. These banks had borrowed heavily from American banks. These loans were short-term, because they were risky and people would not lend long-term. From 1930, there were major banking crises in the USA. To cover their losses in the USA, foreign banks started to withdraw funds in Europe, especially from Germany. People sold their holdings of European currencies and withdrew funds from banks. Many European banks collapsed.

The Depression affected every country in the world, not just the main industrial countries. Economists in the 1930s and since have argued about the causes of the Depression and also whether US policy could have prevented it, or, once it began, reversed the decline [2]. Two of the most popular approaches are:

a monetary explanation

a Keynesian explanation.

Evidence for the monetarist explanation can be found in the three bank crises between 1929 and 1933, particularly in the policy of the Federal Reserve Bank (the FED) in 1931. The FED allowed real interest rates to rise.

The monetarists say they should have fallen. Keynesian explanations, named after the UK economist John Maynard Keynes, depend on the strength of demand; consumer incomes, investment. According to this view, the reason for the Depression was that there was a fall in investment, which was caused by an autonomous fall in consumption [3].

An implication of the Keynesian view is that there is no automatic reason for demand to rise. For example, falling prices and falling interest rates would not necessarily increase investment, as the monetarists believe. We think that both explanations could be true, they are not substitutes for each other.

Roosevelt became president of USA in 1933 and promised a New Deal. The Federal government would intervene directly in the economy to increase output, and raise prices. This degree of intervention was unprecedented in peacetime.

New deal focused the "3 Rs": relief, recovery, and reform. That is, Relief for the unemployed and poor; Recovery of the economy to normal levels; and Reform of the financial system through monetary policy to prevent a repeat depression [4] .

In reaction during the Crisis Governments tried to use following steps:

-         reduce a shortage of banks liquidity. Banks lose their liquid funds because they cannot borrow as much as they are paying out. Since liquidity (credit) is essential to business, a bank crisis is very damaging;

-         introduce exchange control to stop further runs on the banks. But bankers who had money frozen in one country would withdraw money from another, thus it was a reason of spreading the international financial crisis.

In the main, the New Deal was not successful. It did not lead to rapid

recovery. Income per capita was no higher in 1939 than in 1929. Recovery and growth in the US economy came later through rearmament. The reason of unsuccessfull was that the government misunderstood the relationship between prices output. Federal reserve system decreased level of interest rate in order to increase Money demand and Supply and get a devaluation of dollar. People who hold a particular currency (dollars) might expect the currency to be devalued sooner or later. As long as the exchange rate is fixed they have no reason to hold on to the currency. Better to sell it before it goes down.

The New Deal government in the USA believed that the fall in prices caused the fall in output. Hence their policy was to increase output by increasing prices. In fact, it was the other way round; the fall in prices was caused by the fall in output. Therefore a fall in prices would not increase output.

Reference

1.      Kenwood, A.G. and A.L. Lougheed The growth of the international economy, 18202000: an introductory text. (London: Routledge, 1999) fourth edition: 193210

2.      N.Gregory Mankiw, PRINCIPLES OF ECONOMICS THOMSON SOUTH- WESTERN, 2004, Third Edition: 420.

3.      Sloman ,J. Principles of Economics: an introductory text .seventh edition: 236-244

4.      Griffiths, A. and Wall, S. (2007), Applied Economics: An Introductory Text (11th edition), Prentice Hall