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Reading Notes for November 17, The Great Depression in America

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), pp. 325-52.

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 Press, 1997).

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 as well.

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 doubt.

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 "yes."

Once you make this distinction, understanding Friedman and Schwartz (and their critics) becomes much, much easier.

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Professor of Economics J. Bradford DeLong, 601 Evans Hall, #3880
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