Between 1929 and 1933, employment fell about 25 percent and output fell about 30 percent in the United States. By 1939, employment and output remained well below their 1929 levels. Why did employment and output fall so much in the early 1930s? Why did they remain so low a decade later?

In this article, we address these two questions by evaluating macroeconomic performance in the United States from 1929 to 1939. This period consists of a decline in economic activity (1929-33) followed by a recovery (1934-39). Our definition of the Great Depression as a 10-year event differs from the standard definition of the Great Depression, which is the 1929-33 decline. We define the Depression this way because employment and output remained well below their 1929 levels in 1939.

We examine the Depression from the perspective of neoclassical growth theory. By neoclassical growth theory, we mean the optimal growth model in Cass 1965 and Koopmans 1965 augmented with various shocks that cause employment and output to deviate from their deterministic steady-state paths as in Kydland and Prescott 1982.(1)

We use neoclassical growth theory to study macroeconomic performance during the 1930s the way other economists have used the theory to study postwar business cycles. We first identify a set of shocks considered important in postwar economic declines: technology shocks, fiscal policy shocks, trade shocks, and monetary shocks. We then ask whether those shocks, within the neoclassical frame-work, can account for the decline and the recovery in the 1930s. This method allows us to understand which data from the 1930s are consistent with neoclassical theory and, especially, which observations are puzzling from the neoclassical perspective.

In our analysis, we treat the 1929-33 decline as a long and severe recession.(2) But the neoclassical approach to analyzing business cycles is not just to assess declines in economic activity, but to assess recoveries as well. When we compare the decline and recovery during the Depression to a typical postwar business cycle, we see striking differences in duration and scale. The decline, as well as the recovery, during the Depression lasted about four times as long as the postwar business cycle average. Moreover, the size of the decline in output in the 1930s was about 10 times the size of the average decline. (See Table 1.)

What factors were responsible for these large differences in the duration and scale of the Depression? One possibility is that the shocks - the unexpected changes in technology, preferences, endowments, or government policies that lead output to deviate from its existing steady-state growth path - were different in the 1930s. One view is that the shocks responsible for the 1929-33 decline were much larger and more persistent versions of the same shocks that are important in shorter and milder declines. Another view is that the types of shocks responsible for the 1929-33 decline were fundamentally different from those considered to be the driving factors behind typical cyclical declines.

To evaluate these two distinct views, we analyze data from the 1930s using the neoclassical growth model. Our main finding differs from the standard view that the most puzzling aspect of the Depression is the large decline between 1929 and 1933. We find that while it may be possible to account for the 1929-33 decline on the basis of the shocks we consider, none of those shocks can account for the 1934-39 recovery. Theory predicts large increases in employment and output beginning in 1934 that return real economic activity rapidly to trend. This prediction stands in sharp contrast to the data, suggesting to us that we need a new shock to account for the weak recovery.

We begin our study by examining deviations in output and inputs from the trend growth that theory predicts in the absence of any shocks to the economy. This examination not only highlights the severity of the economic decline between 1929 and 1933, but also raises questions about the recovery that began in 1934. …