A New, Eclectic View of the Great Depression: Concluding Thoughts

24 Jul


While the gold standard played a critical role in the propagation of the Great Depression, it was not the only factor at play.  Of course, Fed policy played a role in the contraction, but Bernanke and Fischer both offer convincing evidence that debt-deflation was another contributing factor to the declines in output and prices.  Additionally, recovery was not merely the result of depreciation or abandonment of the gold standard, as this must have been met with a subsequent expansionary monetary policy to halt the deflationary pressure.  Indeed, this has been the point of focus by Bordo, Choudhri, and Schwartz (2002), who offer convincing evidence against Eichengreen’s argument that the US could not provide liquidity because of a commitment to gold.  The authors suggest that because the US had such vast quantities of gold and was a large, closed economy, expansionary monetary policy was not constrained by maintenance of the gold standard.  In their model, they show that had the US expanded the monetary base by $1 billion, as opposed to $37 million, at two decisive periods, even in the most compromising scenario of perfect capital mobility, expansionary monetary policy would have “successfully averted” the US banking panics, thereby halting the deflation and subsequent worldwide crisis—“without endangering convertibility.”


If it was not already apparent to the reader coming in, it should be rather obvious now that the Depression of the 1930s was not a monolith—it did not solely affect the US, but it affected every major industrialized economy at the time.  Additionally, it was likely not the result of any single cause, but rather of a multitude.  I hope the reader has also found that although there is debate among the particulars, there is also much agreement.  The vast majority of economists generally agree that the major proximate causes of the US deflation were the banking crises and the failure of the Federal Reserve to offset the subsequent decline in the money multiplier.  It is also agreed upon that the US deflation was transmitted abroad via the gold standard, and that leaving gold is highly correlated with rapidity of recovery.  The point of contention seems to be whether or not the US would have been able to accommodate monetary policy while maintaining a commitment to gold.

Further research which does not rely on a model of counterfactuals would help allay this point of contention.  It would be necessary to gather empirical evidence of other instances during the Depression in which a large economy engaged in open market operations sufficient to quell the deflation.  Unfortunately, the US seems to be the only economy during the Depression of the 1930s to fit this bill.  However, today’s crisis may offer room for comparative research. Perhaps it would be informative to look at the US monetary response and its affect on exchange rates and the value of the dollar, using this as a proxy for credibility of maintain adherence to gold?  Or, maybe there is some better proxy to look at?  Thus, although Bordo, Choudhri, and Schwartz offer a competing argument against “golden fetters,” all counterfactual models are better when there is corroborating empirical evidence, and until then, the “golden fetters” does not deserve to be put to rest just yet.

On a side note, while attending Milton Friedman’s 90th birthday party, Bernanke spoke and commented that You’re (Friedman) right.  We (the Fed) did it. We’re very sorry…We won’t do it again.”  In the wake of QE3, I ask, what was it he would not let happen again?  Surely it was not to exemplify Federal Reserve incompetence?  Well, whatever the case may be, I am working doggedly to put together a comprehensive analysis of the major policies affecting the Great Recession of 2008 and beyond.  It’s a bit scattered at the moment, but I’ll be putting up bits and pieces as they come together.


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