The Turning Point of Economic Thought: How the Great Depression Redefined Theory and Policy

Abstract Book of the 11th International Conference on Research in Management and Economics

Year: 2026

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The Turning Point of Economic Thought: How the Great Depression Redefined Theory and Policy

Dow Lee

ABSTRACT:

The Great Depression, from 1929 through the late 1930s, revealed fundamental limitations in classical economic theory, which assumed markets would self-correct through price and wage flexibility. Adherence to the gold standard worsened the crisis by constraining monetary policy, delaying recovery, and intensifying unemployment and output decline. Countries that abandoned gold earlier, such as the United Kingdom and the United States, recovered more quickly, while those that clung to it, like France and Germany, experienced prolonged stagnation. These cases show how rigid adherence to classical monetary principles deepened the Depression and limited governments’ ability to respond effectively.
Keynesian economics emerged as a critical response, emphasizing that aggregate demand, the total spending by households, businesses, and governments, determines output and employment. Insufficient demand could persist despite flexible markets, requiring active policy intervention. Keynes introduced concepts such as liquidity preference and government-driven fiscal stimulus to stabilize economies. The practical application of these ideas, exemplified by U.S. New Deal programs, demonstrated the effectiveness of public works, direct subsidies, and tax reductions in boosting demand and employment. Policymakers initially skeptical of intervention gradually embraced these strategies as classical remedies failed, reshaping expectations of state responsibility during crises.
The transition from classical to Keynesian economics represents a transformative moment in the history of economic thought, showing how crises can drive intellectual innovation and policy change. Internationally, Keynesian ideas influenced postwar institutions and economic governance, while later schools critiqued discretionary demand management. Studying the Great Depression provides enduring lessons for debates on government intervention, market stability, and economic recovery, highlighting the interplay between theory, policy, and real-world outcomes in shaping economic history.

Keywords: Great Depression; Keynesian Economics; Aggregate Demand