One of the key reasons that the Great Depression became a depression as opposed to 'The Great Recession' that we are currently experiencing after the 2008 crash, is seen to be the consequence of the "Globalisation Backlash" that occurred in the inter-war period. The Gold Standard that restricted countries to a fixed exchange rate meant that governments who wanted to maintain the G.S. equilibrium saw it necessary to use deflationary policies and protectionist tariffs to restrict the inflow of foreign goods into the country.
The UK escaped the worst of the Great Depression because they left the Gold Standard early and were able as a result to use more flexible monetary policy and devalue the pound. But how can we relate this to the UK at present?
Economists are often criticised at present for their inability to have predicted the current crisis, the fact is that economic downturns are difficult to predict; Keynes found it so hard to determine the causes that he attributed them to "animal spirits". However what economist have done in the current crisis is promote the right response - arguably all that we can do. In the recent crisis governments have promoted vigorous monetary expansion policies with the drop in interest rates to close to "zero" in the USA and UK, and quantitative easing by the UK government. In the USA, fiscal policies have seen true Keynesian spending that has created a record peace-time budget deficit; far more than was ever done in the 1930s. Most economists will argue even FDR's New Deal could not be seen as true Keynesian as it was too concerned that the budget deficit would cause significant unrest.
This is where my key point lies; Hoover in 1932 fearful of "opinion" of the "large" budget deficit that he was running passed the Revenue Act; which increased taxes substantially; curbing recovery. Then FDR in 1937 became concerned by potentially inflationary excess reserves so raised bank requirements; reducing lending and also federal spending - unemployment increased, GDP fell and the USA was plunged into a second recession.
It was these weak government decisions that prompted a prolonged depression in the World Economy. My concern is that in the UK Mr Cameron did not do his history homework as well as Obama and is becoming too fearful of running a large deficit and high inflation - his spending cuts and plans for increased taxes in April this year, along with his threats of interest rate increases to curb inflation, could be a recipe for disaster.
Inflation may be high (due in part to the decision to raise VAT in January, which was largely passed on to the consumer), but jacking up interest rates will only decrease the level of investment (increased saving and increased borrowing); combine this with increased taxes and more cuts and we could see a repeat of the 1937 double dip.
All we can do is sit back and cross our fingers, and hope that Mr Cameron does not become too discontent with the situation of a large budget deficit and doesn't try and fix that problem until the economy is repaired.
