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Difficulty: HardCauses of the Great Depression

“The Federal Reserve’s policy of raising discount rates to combat speculative activity on the New York Stock Exchange is fraught with danger. By restricting credit, the Federal Reserve is not only depressing the domestic commodity market and agriculture but is also drawing gold from the rest of the world. This forces European central banks to raise their own rates to protect their reserves, restricting global credit at a time when Europe is already struggling with war debt. This policy threatens to precipitate a global economic downturn.”

— Adapted from Gustav Cassel, address to the House Committee on Banking and Currency, 1928

Which of the following best describes how the economic dynamics warned of in the excerpt contributed to the onset of the Great Depression?

  1. A
    They prompted the United States to adopt a policy of absolute isolationism that completely severed financial ties with Europe.
  2. B
    They enforced a strictly laissez-faire approach that barred the Federal Reserve from intervening in financial markets.
  3. They restricted the global money supply and destabilized international credit networks.Answer
  4. D
    They represented New Deal regulatory programs that successfully stabilized domestic agricultural prices.

Answer

They restricted the global money supply and destabilized international credit networks.
The correct answer is correct because the Federal Reserve's decisions to raise discount rates in 1928 and 1929 to cool stock market speculation had severe international consequences. Under the gold standard, raising U.S. interest rates attracted gold reserves to the United States, forcing European central banks to raise their interest rates to protect their own gold reserves. This collective tightening of credit restricted the global money supply, depressed international trade, and destabilized global credit networks, directly contributing to the onset of the Great Depression.

Step-by-Step Solution

1
Analyze the stimulus to identify the central argument concerning Federal Reserve policy.
The author warns that the Federal Reserve's high discount rates to curb speculation are draining gold from Europe and restricting global credit.
To understand the specific mechanism of economic disruption highlighted in the text.
2
Connect the Federal Reserve's monetary actions to the international economic environment of the late 1920s.
Higher U.S. interest rates attracted international capital, forcing European nations on the gold standard to raise their own interest rates, which depressed their economies.
To trace the transmission of U.S. monetary policy to the global economy.
3
Evaluate the options to determine which one accurately reflects the international credit and monetary contraction caused by these policies.
The option describing the restriction of global money supply and destabilization of credit networks correctly identifies the causal link.
To identify the correct answer based on historical evidence of the international gold standard's collapse and the onset of the global depression.

Key Concept

Flawed monetary policies and their international transmission under the gold standard as causes of the Great Depression.
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Topics

Causes of the Great Depression

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