Reading Notes for November 17, The Great Depression
Economics 210a, Fall 1999
Milton Friedman and Anna J. Schwartz (1963), "The Great
Contraction," in A Monetary History of the United States
(Princeton: Princeton University Press).
Christina Romer (1993), "The Nation in Depression,"
Journal of Economic Perspectives 25:1 (Winter), pp. 49-66.
Christina D. Romer (1990), "The
Great Crash and the Onset of the Great Depression,"
Quarterly Journal of Economics 105:3 (August), pp. 597-624.
Robert Margo (1988), "Interwar Unemployment in the United
States," in Barry Eichengreen and T.J. Hatton,eds., Interwar
Unemployment in International Perspective (Boston: Kluwer),
J. Bradford DeLong (1997), "American
Fiscal Policy in the Shadow of the Great Depression",
in Michael Bordo, Claudia Goldin, and Eugene White, eds., The
Defining Moment: The Great Depression and the American Economy
in the Twentieth Century (Chicago: University of Chicago
It is straightforward to narrate the slide of the world into
the Great Depression. The 1920's saw a stock market boom in the
U.S. as the result of general optimism: businessmen and economists
believed that the newly-born Federal Reserve would stabilize
the economy, and that the pace of technological progress guaranteed
rapidly rising living standards and expanding markets. The U.S.
Federal Reserve's attempts in 1928 and 1929 to raise interest
rates to discourage stock speculation brought on an initial recession.
Caught by surprise, firms cut back their own plans for further
purchase of producer durable goods; firms making producer durables
cut back production; out-of-work consumers and those who feared
they might soon be out of work cut back purchases of consumer
durables, and firms making consumer durables faced falling demand
Falls in prices--deflation--during the Depression set in motion
contractions in production which riggered additional falls in
prices. With prices falling at ten percent per year, investors
could calculate that they would earn less profit investing now
than delaying investment until next year when their dollars would
stretch ten percent further. Banking panics and the collapse
of the world monetary system cast doubt on everyone's credit,
and reinforced the belief that now was a time to watch and wait.
The slide into the Depression, with increasing unemployment,
falling production, and falling prices, continued throughout
Herbert Hoover's Presidential term.
There is no fully satisfactory explanation
of why the Depression happened when it did. If such depressions
were always a possibility in an unregulated capitalist economy,
why weren't there two, three, many Great Depressions in the years
before World War II? Milton Friedman and Anna Schwartz argued
that the Depression was the consequence of an incredible sequence
of blunders in monetary policy. But those controlling policy
during the early 1930s thought they were following the same gold-standard
rules of conduct as their predecessors. Were they wrong? If they
were wrong, why did they think they were following in the footsteps
of their predecessors? If they were not wrong, why was the
Great Depression the only Great Depression?
At its nadir, the Depression was collective insanity. Workers
were idle because firms would not hire them to work their machines;
firms would not hire workers to work machines because they saw
no market for goods; and there was no market for goods because
workers had no incomes to spend. Orwell's account of the Depression
in Britain, The Road to Wigan Pier, speaks of "...several
hundred men risk[ing] their lives and several hundred women scrabbl[ing]
in the mud for hours... searching eagerly for tiny chips of coal"
in slagheaps so they could heat their homes. For them, this arduously-gained
"free" coal was "more important almost than food."
All around them the machinery they had previously used to mine
in five minutes more than they could gather in a day stood idle.
The United States Business Cycle, 1890-1940
The Great Depression has central place in twentieth century
economic history. In its shadow, all other depressions are insignificant.
Whether assessed by the relative shortfall of production from
trend, by the duration of slack production, or by the product-depth
times duration-of these two measures, the Great Depression is
an order of magnitude larger than other depressions: it is off
the scale. All other depressions and recessions are from an aggregate
perspective (although not from the perspective of those left
unemployed or bankrupt) little more than ripples on the tide
of ongoing economic growth. The Great Depression cast the survival
of the economic system, and the political order, into serious
The United States Business Cycle, 1950-1990
So how to analyze the Great Depression? Begin with Friedman
and Schwartz: they are the defining narrative of this literature--the
people against whom everyone else is reacting, or with whom everyone
else is agreeing.
I find that it is much easier to read Friedman and Schwartz
if you try to keep two questions distinct and separate in your
mind. The first is: "Did the Federal Reserve do something
that caused the Great Depression?" The second is: "Could
the Federal Reserve have done something to stop the Great Depression?"
Friedman and Schwartz do not distinguish between these two questions.
But I think that they should--for I think that the answer to
the first is "no," and the answer to the second is
Once you make this distinction, understanding Friedman and
Schwartz (and their critics) becomes much, much easier.