A New, Eclectic View of the Great Depression- Introduction

16 Jul

Black Tuesday 1929

A coherent understand of the nature and causes of the Great Depression of the 1930s remains the “Holy Grail” of macroeconomics, and the subject has been hotly debated ever since John Maynard Keynes’s General Theory of Employment, Interest and Money débuted in 1936 (Bernanke, 1993).  Indeed, Robert Skidelsky  (1996) has argued that without the Great Depression, the General Theory may never have found a publisher, and the economics profession, and macroeconomics in particular, would be dramatically altered from its present state.  Relative stagnation in the advancement of hypotheses occurred in the decade lasting from the mid 1970s to the mid ‘80s, and it wasn’t until Barry Eichengreen’s groundbreaking work in the mid ’80s that the research took on a new vigor

Milton Friedman and Anna Schwarz’ 1963 publication of  A Monetary History of the United States, 1867-1960, and Peter Temin’s subsequent rejoinder in his 1976 publication Did Monetary Forces Cause the Great Depression? characterized the debate that lasted up until the mid 1980s, with one side giving a definitive “yes” in response and the other giving a definitive “no (Bernanke, 1993).  The monetary hypothesis focuses on the “unprecedented decline in the nominal money supply,” with M1 falling a staggering 26.5% between 1929 and 1933 (Bernanke, 1993).  Friedman and Schwartz assert that the proximate causes of this decline in M1 were the result of both severe banking crises, in the form of bank runs, and the Federal Reserve’s failure to respond with sufficient quantitative easing to accommodate the decline in the nominal money supply (Snowdon and Vane, 2005).  The Fed’s failure to accommodate is blamed on its incompetence and poor management.  IN terms of the equation of exchange—where the money supply (M) times velocity (v) equals the price level (P) times output (Y)—an exogenous decline in M caused the decline in P and Y, with V playing only a passive role.  Temin opposed this view, and concentrated on endogenous, real factors as the cause of the decline in aggregate demand.[1]  As Temin argued, it was the public’s demand for liquidity and the accompanying decline in consumption spending that precipitated the downturn.  Thus, the decline in prices and output is seen as the result of a drop in V.  This Friedman-Temin debate persisted until the mid 1980s, and during this period little progress was made in new theories of the proximate cause of the Great Depression, as both sides merely argued past one another.

Barry Eichengreen’s series of publications in 1984, ’85, and ’86 broke this decade of research of stagnation.  As Ben Bernanke points out in his 1993 publication in “The Journal of Monetary Economics,” the focus had previously been strictly on the US or Great Britain, with little to no mention of the other industrialized or peripheral economies, and Eichengreen’s identification of the interwar gold standard was the first hypothesis that recognized a unified transmission mechanism that could account for the global nature of the downturn (Bernanke, 1993).  According to this view, the Depression was the “inevitable” consequence of “perverse,” “contradictory” policies pursed by the central banks of nations adhering to the “flawed interwar gold-standard (Bernanke, 1993) (Snowdon and Vane, 2005).  This rapidly ignited further research advancement influences by Eichengreen’s internationalist perspective and focus on the inter-war gold standard.

The intention of this 3 part series is to lay out a single, coherent interpretation of the Great Depression.  What the reader will find is that there is not one single answer.  While I draw heavily on the monetarist, internationalist, and gold fetters view of the Depression, these are not the only interpretations that come into play; non-monetary factors and debt-deflation played critical roles as well.  While this is not a small task, it is my hope that the reader will find this eclectic interpretation an informative overview and addition to the existing literature on subject.

Part II is on its way , in which I’ll briefly explain the differences between the pre and inter-war gold standards and the effect on the international economy .  After that you can expect to see a series discussing some significant macro-repercussions as a consequence of government micro-regulation of the housing and financial markets, and some startling similarities between the Great Depression and the Great Recession of 2008 and beyond.  Thus, in order to gather context for today, one must examine the past.

Copyright Nelson R Hoffman


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