jrlhistory

By Jeremy Luther

Great Depression

            When one thinks of the Great Depression, many images come to mind: shanty towns, high unemployment, little business activity, hoarding, and saving – certainly not spending. Schools and textbooks often cite multiple factors that contributed to the Great Depression, such as the Stock Market Crash of 1929, bad investing practices, trade issues, or the limitations of the gold standard. The following research presents an economic theory of the cause of the Great Depression proposed by Milton Friedman and Anna Schwartz. Friedman and Schwartz suggest the Federal Reserve’s monetary policies allowed for bank failures and caused the Great Depression in the U.S.

Gold Standard

After World War I, many Western nations returned to the gold standard. In their work A Monetary History of the United States, 1867-1960, Friedman and Schwartz discuss the gold standard and its relationship with the contractionary policies of the Federal Reserve. They note that when Britain left the gold standard, other countries began to worry and converted large amounts of dollar assets in the New York money market to gold.^[1] Most countries that stayed on the gold standard used restrictive monetary policies due to the inflexibility of rates.^[2] Some have identified that the nations that dropped the gold standard sooner, like Britain, experienced a quicker and stronger recovery.^[3]

U.S. Banking Crises

Friedman and Schwartz claim that the Stock Market crash of 1929 had no direct effect on publicly held currency, asserting that its effects were “confined to the Stock Market”.^[4] Overall, bank deposits dropped from 1929 to 1933, and the amount of deposited money into U.S. banks did not return to 1929 levels until 1939.^[5] Friedman and Schwartz claimed there was a liquidity crisis in the banks, meaning the banks had less money at hand than people wanted to withdraw.^[6]

Bank failures lessened the desire to deposit, so banks had less and less money.^[7]

In October 1930, there was an increase in deposits of suspended banks, and panic followed.^[8] The failure of the Bank of the United States, a leading institution of its day, shook investor confidence.^[9] The second banking crisis, from February to August 1931, was worse than the previous.^[10] Friedman and Schwartz attribute the third banking crisis to Britain leaving the gold standard and foreign countries withdrawing their gold while U.S. banking customers continued their withdrawals.^[11]

Monetary Policy

Friedman and Schwartz refuted the claim that monetary policy is not related to economic stability. They further stated that, though the economy suffered, the extent of the Great Depression could have been avoided, and they cite the contraction of the Federal Reserve as supportive evidence.^[12] The Federal Reserve had a tight monetary policy, so when mass withdrawals began, many banks closed. This encouraged increasingly panicked behavior by the banks and account holders. Friedman and Schwartz note that many banks either would not or could not borrow from the Federal Reserve.^[13] Part of the contractionary behavior of the Federal Reserve can be explained by the U.S. being on the gold standard, but Friedman and Schwartz assert that the Federal Reserve could have and should have reached out and expanded the monetary base for banks before it became too late.^[14] Without money to distribute and circulate, investments and spending declined.

Friedman and Schwartz compare the monetary collapse of 1929-1933 to the contraction of 1839-1843. They note the similar circumstances – worldwide monetary uncertainty and massive bank closures – to support their purpose in highlighting the banking crises of the Great Depression.^[15] During the Great Depression, over 9,000 banks closed.^[16]Friedman and Schwartz highlighted how the New York Federal Reserve Bank handled the Stock Market crash. During this event, the New York Federal Reserve Bank allowed open market purchases to provide reserves to other New York banks, and banks retained trust.^[17]

Perhaps enacting monetary policies that were opposite of those during the Great Depression contributed to the end of the Great Depression. Friedman and Schwartz’s work does not focus directly on the factors that ended the Great Depression. Instead, they devote most of their work to analyzing the relationship between monetary policy and defending the claim that monetary and economic changes are strongly interrelated.^[18]

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^[1] Milton Friedman and Anna Jacobson Schwartz, “The Great Contraction, 1929-33,” in A Monetary History of the United States, 1867-1960 (Princeton University Press, 1963), 316, http://www.jstor.org/stable/j.ctt7s1vp.10.

^[2] Michael D. Bordo, Christopher J. Erceg, and Charles L. Evans, “Money, Sticky Wages, and the Great Depression,” American Economic Review 90, no. 5 (2000): 1447, https://doi.org/10.1257/aer.90.5.1447.

^[3] Ben S. Bernanke, “Money, Credit, and Banking Lecture,” Journal of Money, Credit, and Banking 27, no. 1 (1995): 11, https://fraser.stlouisfed.org/files/docs/meltzer/bermac95.pdf.

^[4] Milton Friedman and Anna Jacobson Schwartz, “The Great Contraction, 1929-33,” 306.

^[5] U.S. Bureau of the Census. Historical Statistics of the United States, Colonial Times to 1970. Bicentennial ed. 2 parts. Washington, D.C.: U.S. Department of Commerce, Bureau of the Census, 1975.

^[6] Milton Friedman and Anna Jacobson Schwartz, “The Great Contraction, 1929-33,” 319.

^[7] Friedman and Schwartz, “The Great Contraction, 1929-33,” 303.

^[8] Friedman and Schwartz, 308. 

^[9] Friedman and Schwartz, 311. 

^[10] Friedman and Schwartz, 314. 

^[11] Friedman and Schwartz, 316.

^[12] Friedman and Schwartz, 300. 

^[13] Friedman and Schwartz, 319.

^[14] Anderson and Butkiewicz, “Money, Spending, and the Great Depression,” 389.

^[15] Friedman and Schwartz, 299-300. 

^[16] Barry L. Anderson and James L. Butkiewicz, “Money, Spending, and the Great Depression” Southern Economic Journal 47, no. 2 (1980): 389, https://doi.org/10.2307/1057531,  

^[17] Friedman and Schwartz, 306. 

^[18] Friedman and Schwartz. 676. 

Primary Sources:

Cahill, Thomas M. “15 CAUSES OF STOCK MARKET RISE GIVEN: DR. IRVING FISHER TALKS TO BANKERS ASSOCIATION ON PRESENT SITUATION. RECENT FEAR EXPLAINED 15 CAUSES FOR RISE IN MARKET OFFERED.” The Washington Post, Oct 24, 1929. https://www.proquest.com/newspapers/15-causes-stock-market-rise-given/docview/149923318/se-2.

Callender, Harold. “EUROPE’S BIG THREE: AN ECONOMIC APPRAISAL: AN INDUSTRIAL PICTURE OF GREAT BRITAIN, FRANCE AND GERMANY AS THEY ENTER UNDER THE YOUNG PLAN UPON A NEW PHASE OF ECONOMIC DEVELOPMENT GREAT BRITAIN’S POSITION. WAR’S RAVAGES REPAIRED. BALANCING TRADE DEMANDS. THE PROGRESS OF FRANCE. BRITAIN’S EXPORTS. TAXES AND DEBTS.” New York Times, Oct 27, 1929. https://www.proquest.com/newspapers/europes-big-three-economic-appraisal/docview/104772935/se-2.

“FINANCIAL MARKETS: VIOLENT ADVANCES IN SOME STOCKS, DECLINE IN OTHERS– WEEK-END TRADING LARGE.” New York Times, Jul 14, 1929. https://www.proquest.com/newspapers/financial-markets/docview/104727165/se-2.

“MITCHELL DECRIES DECLINE IN STOCKS: ON RETURN FROM EUROPE, HE SAYS MANY ISSUES ARE SELLING BELOW TRUE VALUES. TERMS CONDITIONS SOUND WORRY OVER HIGH TOTAL OF BROKERS’ LEANS IS RIDICULED BY BANKER, WHO FAVORS CHEAPER MONEY. FAVORS LOWER REDISCOUNT RATE. DISCUSSES FOREIGN FINANCING. DECRIES WORRY OVER BROKERS’ LOANS.” New York Times, Oct 23, 1929. https://www.proquest.com/newspapers/mitchell-decries-decline-stocks/docview/104712457/se-2.

Our Financial Editor. “MONEY & STOCKS: MINDING ONE’S BUSINESS.” The Manchester Guardian, Aug 12, 1929. https://www.proquest.com/newspapers/money-stocks/docview/477886500/se-2.

U.S. Bureau of the Census. Historical Statistics of the United States, Colonial Times to 1970. Bicentennial ed. 2 parts. Washington, D.C.: U.S. Department of Commerce, Bureau of the Census, 1975.

U.S. Congress. “Committee on Banking and Currency.” Operation of the National and Federal Reserve Banking Systems: Hearing before the Subcommittee of the Committee on Banking and Currency. Seventy-First Congress, third session, 1931.

Secondary Sources:

Anderson, Barry L., and James L. Butkiewicz. “Money, Spending, and the Great Depression.” Southern Economic Journal 47, no. 2 (1980): 388-403. https://doi.org/10.2307/1057531.

Anderson, Gary M., William F. Shughart II, and Robert D. Tollison. “A Public Choice Theory of the Great Contraction.” Public Choice 59, no. 1 (1988): 3–23. https://doi.org/10.1007/BF00119446.

Bernanke, Ben S. “Money, Credit, and Banking Lecture.” Journal of Money, Credit, and Banking 27, no. 1 (1995): 1-28. https://fraser.stlouisfed.org/files/docs/meltzer/bermac95.pdf.

Bordo, Michael D., Christopher J. Erceg, and Charles L. Evans. “Money, Sticky Wages, and the Great Depression.” American Economic Review 90, no. 5 (2000): 1447–63. https://doi.org/10.1257/aer.90.5.1447.

Friedman, Milton, and Anna Jacobson Schwartz. “The Great Contraction, 1929-33.” In A Monetary History of the United States, 1867-1960. Princeton University Press, 1963. http://www.jstor.org/stable/j.ctt7s1vp.10.

Friedman, Milton, and ANNA JACOBSON SCHWARTZ. “New Deal Changes in the Banking Structure and Monetary Standard.” In A Monetary History of the United States, 1867-1960. Princeton University Press, 1963. http://www.jstor.org/stable/j.ctt7s1vp.11.

Kocher, W. Spencer. “The Great Contraction.” Economic Affairs 26, no. 3 (2006): 70–73. https://doi.org/10.1111/j.1468-0270.2006.00653.x.

Wueschner, Silvano A. Charting Twentieth-Century Monetary Policy : Herbert Hoover and Benjamin Strong, 1917-1927. Westport, CT: Greenwood Press, 1999. doi:10.5040/9798216188223.

Images:

Nelson, Edward. “AN INTERVIEW WITH ANNA J. SCHWARTZ.” Macroeconomic Dynamics 8, no. 3 (2004): 395–417. https://doi.org/10.1017/S1365100504030202.

Friedman, Milton, and Anna Jacobson Schwartz. A Monetary History of the United States, 1867-1960. Princeton University Press, 1963. http://www.jstor.org/stable/j.ctt7s1vp.10.