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The Great Depression as a Credit Boom Gone Wrong

The experience of the 1990s renewed economists’ interest in the role of credit in macroeconomic fluctuations. The locus classicus of the credit-boom view of economic cycles is the expansion of the 1920s and the Great Depression. In this paper we ask how well quantitative measures of the credit boom phenomenon can explain the uneven expansion of the 1920s and the slump of the 1930s. We complement this macroeconomic analysis with three sectoral studies that shed further light on the explanatory power of the credit boom interpretation: the property market, consumer durables industries, and high-tech sectors. We conclude that the credit boom view provides a useful perspective on both the boom of the 1920s and the subsequent slump. In particular, it directs attention to the role played by the structure of the financial sector and the interaction of finance and innovation. The credit boom and its ultimate impact were especially pronounced where the organization and history of the financial sector led intermediaries to compete aggressively in providing credit. And the impact on financial markets and the economy was particularly evident in countries that saw the development of new network technologies with commercial potential that in practice took considerable time to be realized. In addition, the structure and management of the monetary regime mattered importantly. The procyclical character of the foreign exchange component of global international reserves and the failure of domestic monetary authorities to use stable policy rules to guide the more discretionary approach to monetary management that replaced the more rigid rules-based gold standard of the earlier era are key for explaining the developments in credit markets that helped to set the stage for the Great Depression.