The Great Depression in the United States

This chapter describes and explains the course of aggregate real activity and inflation in America from 1929 through 1937–1938 within the framework of new Keynesian macroeconomic models with financial market frictions. Those models point to plausible causes for the initial downturn, the depth of the subsequent decline in real activity, and the path of inflation and real wages over 1929–1938. One key factor was Federal Reserve interest-rate policy as constrained by the international gold standard and the zero bound on nominal interest rates. Another was the development of a massive financial crisis in which the Federal Reserve System failed to act as lender of last resort, mainly because Fed policymakers did not believe a lender of last resort was needed. The causes of the recession of 1937–1938 are less clear.