is owned and operated by the Economic History Association
with the support of other sponsoring organizations.

The Panic of 1819: The First Great Depression

Author(s):Browning, Andrew H.
Reviewer(s):Haulman, Clyde A.

Published by EH.Net (January 2020)

Andrew H. Browning, The Panic of 1819: The First Great Depression. Columbia, MO: University of Missouri Press, 2019. x + 439 pp. $45 (hardcover), ISBN: 978-0-8262-2183-4.

Reviewed for EH.Net by Clyde A. Haulman, Department of Economics, College of William and Mary.

Andrew H. Browning chronicles the events and unfolds the complexities of the U.S. economy at the end of the second decade of the nineteenth century in his excellently researched and insightful book, The Panic of 1819. Most often, historians and economists have looked at this period as a typical post-war boom and bust while focusing attention on the political and social changes that were driving the young nation. Browning digs deeper and in doing so makes a strong case that the Panic of 1819 was more than the usual post-war cycle.

Beginning with an overview of the years leading up to the crisis, Browning looks at Napoleon’s decision to sell the Louisiana Territory, Mr. Jefferson’s embargo, and Mr. Madison’s war as critical elements in setting the stage for the westward expansion that would dominate the American economy for decades. Although much has been written about the Market and Transportation Revolutions that began during this period and helped shape the nature of economic relationships in the new nation, Browning adds insights about the Corporate Revolution, “a distinctly American surge in limited-liability joint-stock companies” (p. 66). It is this innovation that ensured capital for the interdependent growth in markets and transportation. He concludes setting the stage for the panic with a discussion of the impact of unusually cold temperatures in the middle of the decade (exacerbated by the explosion of the Tambora volcano in 1815). The resulting summer snow and drought in the Northern Hemisphere drove up grain prices and encouraged many Americans to move westward.

Even when grain prices leveled off (although cotton prices continued rising), demand for western land, particularly in Alabama, Ohio, Indiana, and Illinois, continued to accelerate. The sale of land in Alabama increased over twenty times between 1816 and 1818. Encouraged by easy loan terms and funded by the new Second Bank of the United States and the numerous state banks that had sprung up in the years following the demise of the First Bank, a full-blown speculative bubble erupted. Browning covers in detail the well-known role of the Second Bank in the expansion and ensuing contraction. He emphasizes the importance Treasury officials and the Second Bank’s management attached to the 1818-1819 maturation of Louisiana bonds requiring payment in specie, mostly to foreign holders.

With the collapse in full swing, Browning deftly uses a wide range of contemporary sources, especially newspapers and periodicals representing all parts of the country as well as government documents and records, to chronicle the progress of the downturn. Reporting on falling prices, declines in output, and high levels of unemployment, Browning first looks at the eastern part of the nation and then the west. Details provided by the stories of particular individuals enhance the description of the hard times with its rapid increase in bankruptcies and legal actions for debt.

Browning concludes his study with three chapters considering the impact of the Panic. The first discusses the range of relief efforts enacted in many states including restructuring of poor assistance, the use of minimum appraisal and stay laws, and restrictions on bank charters. Increased cost of poor relief in the wake of the Panic along with the Second Great Awakening’s moral views led to changes in public attitudes toward the poor and to reductions in funding that set the tone for much of the next century. The next chapter highlights increased democratic participation stemming from relief efforts and a focus on political corruption that stimulated growth in organized political factions. Browning’s final chapter links the effects of the Panic and the role of the Second Bank in heightening sectionalism to the growing factional politics and the focus on states’ rights of the Jacksonian era.

A question for economists left unanswered by Browning’s work is the disconnect between contemporary reports of significant declines in output and severe unemployment and the findings of empirical work by Joseph H. Davis (Quarterly Journal of Economics, 119:4 (2004), pp. 1177-215.) and Vadim Khramov and John Ridings Lee (IMF Working Paper, 13/214, 2013). Davis uses 43 output series to develop an index of industrial production for the period 1790-1915. For the Panic years (1819-1821), 27 series are available and show an increase of 9.6 percent in industrial output derived from increasing demand in the broader economy. Similarly, creating an index using inflation, unemployment, the budget deficit, and changes in real GDP, Khramov and Lee find the Panic of 1819 to be the second mildest downturn of the nineteenth century.

Now that Browning has catalogued the extensive contemporary reports on output and unemployment during the Panic of 1819, what might those who study the period do to improve empirical measures of the early nineteenth century economy and to reconcile those data with contemporary perceptions about the Panic and its economic impact?

Until that work is completed, Andrew Browning has given us a masterful study of an often overlooked economic crisis and has rightfully subtitled his work “The First Great Depression.”

Clyde Haulman is the author of Virginia and the Panic of 1819: The First Great Depression and the Commonwealth (2008).

Copyright (c) 2020 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator ( Published by EH.Net (January 2020). All EH.Net reviews are archived at

Subject(s):Macroeconomics and Fluctuations
Markets and Institutions
Geographic Area(s):North America
Time Period(s):19th Century

Hall of Mirrors: The Great Depression, the Great Recession, and the Uses — and Misuses — of History

Author(s):Eichengreen, Barry
Reviewer(s):Rockoff, Hugh

Published by EH.Net (February 2016)

Barry Eichengreen, Hall of Mirrors: The Great Depression, the Great Recession, and the Uses — and Misuses — of History. New York: Oxford University Press, 2015. vi + 512 pp. $30 (hardcover), ISBN: 978-0-19-939200-1.

Reviewed for EH.Net by Hugh Rockoff, Department of Economics, Rutgers University.
Barry Eichengreen knows as much or more about the financial history of the Great Depression as any living economic historian, and it shows in this splendid new book which compares the Great Recession with the Great Depression. The U.S. story, on which I will focus here, is the centerpiece, but as might be expected from Eichengreen, what happened in the rest of the world is also explored in detail. Eichengreen’s thesis is straightforward. In 2008 the United States, and with it the rest of the world, was headed for another Great Depression. Thanks to strong doses of monetary and fiscal stimulus, and lender-of-last-resort operations, especially in the United States, a second Great Depression was averted. Ideas were important: Much of the success can be attributed to John Maynard Keynes, Milton Friedman, and Anna Schwartz, and the lessons they drew from the Great Depression. But there was a downside to success. Because of the severity of the crisis in the 1930s the financial system underwent a massive reform that put it in a tough but effective straightjacket. The Great Recession was milder; politicians and lobbyists who opposed strict regulation regrouped, and the reforms were moderate at best. The Great Depression and the Great Recession were separated by eighty years, a long period of financial stability produced, according to Eichengreen, by New Deal financial reforms. But, he concludes, because the damage done by deregulation was only partly undone, “we are likely to see another such crisis in less than eighty years (p. 387).”

The analysis in the book is rigorous. Nevertheless, Eichengreen has written a book that can be read by policy makers, journalists, and the famous, and hopefully numerous, intelligent layperson. There are no charts, tables, or equations. Indeed, it would make a good textbook for an undergraduate course on the financial crisis. Eichengreen writes clearly. And he has sprinkled the text with biographical snippets that both inform and entertain. We meet William Jennings Bryan in the 1920s when he is using his oratorical skills to sell real estate in Florida; and we meet Charles Dawes, prominent banker, Vice President, Nobel Peace Prize winner (for his work on German Reparations), and composer of the melody for “It’s All in the Game.”

To make his case that the two crises were similar except for actions taken by governments, Eichengreen recounts both crises and identifies one parallel after another. The 1920s had Charles Ponzi; we had Bernie Madoff. In the 1920s the head of the Bank of England, Montagu Norman, was given, perhaps unconsciously, to “constructive ambiguity” (p. 23); we had Alan Greenspan. The 1920s witnessed the Florida land boom; we had subprime mortgages. Charles Dawes’s bank got needed assistance from the Reconstruction Finance Corporation, but the Guardian Group in Detroit was allowed to fail; we had Bear Stearns and Lehman Brothers. And this is just a taste. Eichengreen adds many, many more. Indeed, the parallels come so thick and fast that one is reminded of the phrase Albert Einstein used to describe two distant particles that were thought to be entangled: “spooky action at a distance.”

The book is divided into four parts. Part I, “The Best of Times,” consists of six chapters that cover the 1920s and the first decade of our century.  Here we learn (without attempting to be exhaustive) about real estate booms in the twenties, the attempt after World War I to reconstruct the gold standard, the repeated attempts to solve the German reparations problem, the Smoot-Hawley tariff, and the U.S. Stock market bubble. Then Eichengreen turns to our era and describes financial deregulation, the subprime mortgage boom, the expansion of the shadow banking sector, and the spread of this type of banking to Europe. Eichengreen doesn’t present new, controversial interpretations of events. Rather he presents conclusions based on careful readings of the available literature including the latest work by economic historians. What is new is the web of parallels he draws between the two crises. Others, of course, have noted the similarities, not the least Ben Bernanke as he wrestled with the crisis; but no one has created such a large catalog of parallels.

In Part II, “The Worst of Times,” nine chapters in all, we learn first about the stock market crash in 1929, the banking crises of 1930-33, and the spread of the Great Depression to Europe. Then he turns to the Great Recession: Bear Stearns, Lehman Brothers, AIG and all that, and the spread of the crisis to Europe.

In the seven chapters of Part III, “Toward Better Times,” we learn about Roosevelt’s attempts to revive the economy: the National Industrial Recovery Act, the Reconstruction Finance Corporation, Federal Reserve Policy in the 1930s, and Roosevelt’s conflicted ideas about budget deficits. European responses to the crisis are also discussed at length, and Japan’s Korekiyo Takahashi is celebrated as the finance minister who got it right. Takahashi, aided it must be said by costly Japanese military adventures, authorized a heavy dose of money-financed deficit spending and the result was the best economic performance among the industrial nations. Eichengreen then turns to our crisis: zero interest rates, quantitative easing, bailouts, and the fiscal stimulus. The argument is usually that what the government did helped, but more should have been done.

In Part IV, “Avoiding the Next Time,” Eichengreen focusses particularly on Dodd-Frank and the Euro. His main efforts are directed at explaining why so little was done to prevent another crisis. A number of potential reforms get favorable mentions: consolidation of regulatory agencies, higher capital requirements for financial institutions, and regulations that limit risk taking. But Eichengreen doesn’t rank possible reforms or explain in detail how they would work. Here I wanted Eichengreen to go on a bit, and tell us more about his ideas on what should have and presumably still can be done to prevent another crisis. His approach to Glass-Steagall is an example of his above the fray stance toward regulation. Eichengreen mentions Glass-Steagall, and the separation of commercial from investment banking many times — one chapter is titled “Shattered Glass.” He rejects the argument made mostly forcefully by Andrew Ross Sorkin (2012) — although it is one that must have occurred to many observers — that ending the separation of commercial and investment banking didn’t have much to do with causing the crisis. After all, Merrill Lynch, Bear Stearns, and Lehman brothers were not branches of commercial banks when they went off the rails. And AIG was an insurance company. Eichengreen tells us that ending Glass Steagall was “indicative of a trend” (p. 424), which it surely was, but he seems to feel that it was more than that. Here I would have liked to learn more about Eichengreen’s ideas about how ending Glass-Steagall undermined the system. Did it create moral hazard, because firms knew they could merge with a bank if they got in trouble? Or was it some other mechanism? And more urgently, I would have liked to have read more about Eichengreen’s views on how high a priority restoring Glass-Steagall should be, and where the lines should be drawn.

Comment and Conclusion

Eichengreen’s book is a synthesis. It pulls together an enormous body of studies by economic historians, policy makers, and journalists. Specialists in financial history will be familiar with many parts of the story. But I doubt there are any who will not learn a great deal from reading Eichengreen’s account. While I was persuaded by most of Eichengreen’s arguments I did have a recurring concern about how far we can go as social scientists, as opposed to policy advocates, in making assertions about what would have happened if alternative policies had been followed on the basis of two observations. It is one thing to claim that without aggressive monetary and fiscal actions and bailouts we might have ended up in another Great Depression.  And for me, as I suspect for most of us, that possibility justifies much of what was done. Even, say, a one-third chance of another Great Depression makes pulling out the stops worthwhile. But that claim is very different from the claim that we would have ended up in a Great Depression if less had been done. The truth is that we can’t be sure what path the economy would have followed if less had been done, or where we would be today.

Consider the following table which shows unemployment after four financial panics. When you compare 2008 only with 1930, it seems clear that we did a lot a better after the panic of 2008, and the things we did in 2008 “worked” at least up to a point: We avoided a Great Depression. On the other hand, we did, arguably, worse after 2008 than after the panic of 1907 when help for the economy was provided mainly through the circumscribed lender-of last-resort actions undertaken by J.P. Morgan.  And we did almost exactly the same as after the crisis of 1893, when only some limited stimulus came well after the crisis in the form of gold inflows and spending on the Spanish-American War. In fact, the 2008 and 1893 unemployment rates are so similar that it looks like another case of “spooky action at a distance.”

2008 1930 1907 1893
-1 4.6 2.9 2.5 4.3
0 5.8 8.9 3.1 6.8
1 9.3 15.7 7.5 9.3
2 9.6 22.9 5.7 8.5
3 8.9 20.9 5.9 9.3
4 8.1 16.2 7.0 8.5
5 7.4 14.4 5.9 7.8
6 6.2 10.0 5.7 5.9
7 5.3 9.2 8.5 5.0

Source: Historical Statistics of the United States, Millennial Edition: Volume 2, Work and Welfare, series Ba475 for 1893, 1907, and 1930 (pp. 2-82 and 2-83), and the standard Bureau of Labor Statistics series for 2008.

My point is not that 1893 is necessarily a better analog than 1930. One could argue the point, but I don’t think we know. Constructing a counterfactual macroeconomic history of a financial crisis and recession is essentially an exercise in forecasting, and we economists are just not very good at macroeconomic forecasting. We are in the position, I believe, of physicians in days gone by: we have some drugs that experience tells us sometimes relieve pain and suffering. But how they work and why they work in some cases and not in others, and what the long-run side effects are – we have some ideas we can discuss, or more likely debate, but the bottom line is that we don’t know.

(If we were entangled with the Depression of 1890s, we would want to know what happened in 1901 the year that corresponds to 2016. Among other things, 1901 began with a slide on the stock market of about 9%. Sound familiar?! Despite a spring rally the market finished the year off by about the same percentage. By the way, this is just an observation; I am not giving investment advice.)

Many excellent books and articles have been written about the financial crisis of 2008 and there will undoubtedly be many more. Gary Gorton’s papers and books and Ben Bernanke’s memoir immediately spring to mind, but the list of good books and articles is already a long one. There is nothing like a financial crisis to concentrate the minds of economists. However, if financial history is not your thing, and you want to read just one book about the financial crisis, you couldn’t do better than Hall of Mirrors.


Andrew Ross Sorkin, “Reinstating an Old Rule Is Not a Cure for Crisis” New York Times, May 21, 2012.

Hugh Rockoff is Distinguished Professor of Economics at Rutgers University and a Research Associate with the National Bureau of Economic Research.

Copyright (c) 2016 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator ( Published by EH.Net (February 2016). All EH.Net reviews are archived at

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Macroeconomics and Fluctuations
Geographic Area(s):General, International, or Comparative
North America
Time Period(s):20th Century: Pre WWII
20th Century: WWII and post-WWII

Monetary Policy and the Onset of the Great Depression: The Myth of Benjamin Strong as Decisive Leader

Author(s):Toma, Mark
Reviewer(s):Smith, Daniel J.

Published by EH.Net (May 2015)

Mark Toma, Monetary Policy and the Onset of the Great Depression: The Myth of Benjamin Strong as Decisive Leader. New York: Palgrave Macmillan, 2013. xix + 214 pp. $115 (hardcover), ISBN: 978-1-137-37254-3.

Reviewed for EH.Net by Daniel J. Smith, Department of Economics, Troy University.

Mark Toma’s short, but dense Monetary Policy and the Onset of the Great Depression: The Myth of Benjamin Strong as a Decisive Leader provides a revisionist history of the Benjamin Strong leadership years at the Fed leading up the Great Depression. Despite the title, the book focuses entirely on this period and doesn’t delve into the actual causes of the Great Depression. Rather than provide a casual explanation of the Great Depression per se, Toma’s project is to convince monetarist and Austrian economists that both of their accepted histories of the Great Depression are empirically unfounded. Thus, Toma argues that mismanaged monetary policy — tightening per the monetarist narrative or loosening per the Austrian narrative — can be ruled out as a causal factor of the Great Depression.

In questioning the Strong decisive leader theory — the theory that Benjamin Strong played a decisive role in the monetary policies of the 1920’s as the President of the influential New York Federal Reserve Bank and that his untimely death ultimately led to the wrong-headed policies that brought on the Great Depression — Toma does not stand alone. Temin (1989, 35), Wheelock (1992), and Brunner and Meltzer (1968) all question the strong leader hypothesis. However, Toma discredits each of their theories and forges a completely new explanation for why Strong’s leadership was not a decisive factor. Toma makes the case that the Fed operated as a self-regulating, decentralized system. According to Toma, this system operated effectively as intended, so the credit for Friedman and Schwartz’s (1963, Ch. 6) description of the 1921-1929 Fed era as the “high tide” of the Fed system should go to the founders of the Fed, not Benjamin Strong.

Overall, the book would have benefitted from a more thorough engagement with the modern literature. Instead of addressing modern developments and more nuanced and refined arguments in the monetarist and Austrian tradition, Toma sets up the book against the narratives of Rothbard (1975) and Friedman and Schwartz (1963).

Modern accounts have certainly built upon and improved upon Rothbard’s America’s Great Depression (e.g., Garrison 1999; White 2012; Eichengreen and Mitchener 2003; Laidler 2003). In addition, modern Austrians have also made sure to note that the monetarist and Austrian narrative aren’t mutually exclusive or contradictory (Horwitz 2012; Selgin 2013). As Eichengreen and Mitchener (2003, 53) put it, “a horse-race is not the appropriate context in which to assess theories of the Great Depression. The Depression was a complex and multifaceted event.” While Toma addresses the distinctive Austrian and monetarist explanation, he does not address this modern synthetic narrative.
On a similar note, monetarists and new Keynesians have also built upon and improved the monetarist account beyond Friedman and Schwartz (1963) (e.g., Romer 1993; Bordo, Erceg, and Evans 2000; Hall and Ferguson 1998). A third explanation, real factor productivity, is left unexamined by Toma (Kehoe and Prescott 2007; Cole and Ohanian 2001; Temin 1976; Gordon and Wilcox 1981). Finally, Toma also leaves out important new developments in the literature on the Great Depression from a comparative institutions framework examining the experiences of other countries during the Great Depression (Bernanke 1995). Toma certainly levies some convincing challenges to the above literature, but by not specifically addressing it in this book he leaves a lot of territory uncovered.

While the book provides a thorough theoretical and empirical case for Toma’s contention, it lacks convincing anecdotal evidence, especially in regard to the Fed’s independence, which does not seem to support Toma’s narrative of Fed self-regulation. Given the difficulties of empirically measuring these types of influences on monetary policy, supplemental anecdotal evidence is necessary (Smith and Boettke, forthcoming).

For instance, the independence of the Fed was undermined immediately during World War I (Hanna 1936; Mehrling 2011, Ch. 2; Eichengreen 1992; Meltzer 2003, Ch. 3). As Friedman and Schwartz (1963, 216) argue, “The Federal Reserve became to all intents and purposes the bond-selling window of the Treasury, using its monetary powers almost exclusively to that end.”  Many early Fed Board members actually held the opinion that the Fed was just “an adjunct of the Treasury Department rather than an independent body” after this encroachment of their independence (Kettl 1986, 25). In fact, the Board meetings were actually held in the Treasury Department and the Secretary of Treasury was the Chairperson of the Board ex officio until the Banking Act of 1935 (Havrilesky 1995, 44; Kettl 1986, 24). According Benjamin Strong, if the Fed did not deliver the desired Treasury support, it would have been “an invitation to Congress to have their power modified — a perfectly unthinkable and most dangerous possibility” (as quoted in Kettl 1986, 26-7).

Pressures from the executive branch, legislative branch, and the Treasury were all exerted on the Fed to provide easy monetary policy even following World War I. The Treasury used its positions on the Fed Board to ensure that the price of government bonds didn’t fall (Eichengreen 1992, 114; Friedman and Schwartz 1963, 223-4, 228; Havrilesky 1995, 44).  For instance, the Secretary of the Treasury, Carter Glass, threatened to have Benjamin Strong removed from office by the President when Strong threatened to raise rates without the approval of the Board (Clifford 1965, 114-6). From the legislative branch, strong pressure from agricultural interests to keep interest rates low resulted in the introduction of an agricultural member on the Board and the inclusion of nine month’s agriculture paper in the rediscounting facilities of the Reserve Banks (Hanna 1936, 623; Meltzer 2003, 114). As Meltzer (2003, 132) summarizes, “Congressmen from agricultural areas, particularly in the South and West, were highly critical of the higher discount rates in those regions. Bills were introduced limiting the System’s [Fed’s] ability to increase rates. The Federal Reserve yielded to this political pressure by lowering discount rates.”
The same pressures that were exerted following World War I remained in place leading into the Great Depression (Meltzer 2003, Ch. 4). The Fed caved into these pressures, expanding the money supply by 34 percent in between June 1922 and June 1927, and another 10 percent in between June 1927 and December 1928 (White 2012, 69).

Toma’s book levies a serious challenge against two strong economic traditions and their interpretations of arguably one of the most important economic events in American economic history. It offers yet another theoretical and empirical factor that scholars of the Great Depression will have to wrestle with in order to advance our understanding of this “Holy Grail of macroeconomics” (Bernanke 1995, 1).

Bernanke, Benjamin (1995). “The Macroeconomics of the Great Depression: A Comparative Approach,” Journal of Money, Credit and Banking 27(1): 1-28.

Bordo, Michael, Christopher Erceg, and Charles Evans (2000). “Money, Sticky Wages and the Great Depression.” American Economics Review 90, 1447-1463.

Brunner, Karl and Allan H. Meltzer (1968). “What Did We Learn from the Monetary Experience of the United States in the Great Depression?” Canadian Journal of Economics 1(2): 334-348.

Clifford, A. Jerome (1965). The Independence of the Federal Reserve System. Philadelphia: University of Pennsylvania Press.

Cole, Hal, and Lee Ohanian (2001). “Reexamining the Contribution of Money and Banking Shocks to the Great Depression.” In Benjamin Bernanke and Kenneth Rogoff (Eds.), NBER Macroeconomics Annual 2000, pp. 183-227. Cambridge, MA: MIT Press.

Eichengreen Barry (1992). Golden Fetters: The Gold Standard and the Great Depression, 1919-1939. New York: Oxford University Press.

Eichengreen, Barry and Kris Mitchener (2003). “The Great Depression as a Credit Boom Gone Wrong,” BIS Working Paper No. 137. Available online:

Friedman, Milton and Anna J. Schwartz (1963). A Monetary History of the United States, 1867-1960. Princeton, NJ: Princeton University Press.

Garrison, Roger (1999). “The Great Depression Revisited,” The Independent Review 3(4): 595-603.

Gordon, Robert J., and James Wilcox (1981). “Monetarist Interpretations of the Great Depression: Evaluation and Critique.” In Karl Brunner (Ed.), The Great Depression Revisited, pp. 49-107. Boston: Martinus Nijhoff, 49-107.

Hall, Thomas E. and J. David Ferguson (1998). The Great Depression: An International Disaster of Perverse Economic Policies. Ann Arbor: University of Michigan Press.

Hanna, John (1936). “The Banking Act of 1935,” Virginia Law Review 22(6): 617-641.

Havrilesky, Thomas (1995). The Pressures on American Monetary Policy (second edition). Norwell, MA:  Kluwer Academic Publishers

Horwitz, Steven (2012). “What the Austrian Business Cycle Theory Can and Cannot Explain,” Coordination Problem. Available online:

Kehoe, Timothy J., and Edward C. Prescott (2007). “Great Depressions of the Twentieth Century,” In Timothy J. Kehoe and Edward C. Prescott (Eds.), Great Depressions of the Twentieth Century. Minneapolis: Federal Reserve Bank of Minneapolis.

Kettl, Donald F. (1986). Leadership at the Fed. New Haven, CT: Yale University Press.

Laidler, David (2003). “The Price Level, Relative Prices and Economic Stability: Aspects of the Interwar Debate,” BIS Working Papers, No. 136. Available online:

Mehrling, Perry (2011). The New Lombard Street: How the Fed Became the Dealer of Last Resort. Princeton, NJ: Princeton University Press.

Meltzer, Allan H. (2003). A History of the Federal Reserve, Volume 1: 1913-1951. Chicago, IL: University of Chicago Press.

Romer, Christina D. (1993). “The Nation in Depression,” Journal of Economic Perspectives 7(2): 19-39.

Rothbard, Murray (1975). America’s Great Depression. Kansas City: Sheed and Ward, Inc.

Selgin, George (2013). “Booms, Bubbles, Busts, and Bogus Dichotomies,” Alt-M, August 30. Available online:

Smith, Daniel J. and Peter J. Boettke (forthcoming). “An Episodic History of Federal Reserve Independence,” The Independent Review.

Temin, Peter (1976). Did Monetary Forces Cause the Great Depression? New York: W. W. Norton.

Temin, Peter (1989). Lessons from the Great Depression. Cambridge, MA: MIT Press.

Wheelock, David C. (1992). “Monetary Policy in the Great Depression: What the Fed Did, and Why,” Federal Reserve Bank of St. Louis Review 74(2): 3-28.

White, Lawrence H. (2012). The Clash of Economic Ideas: The Great Policy Debates and Experiments of the Last Hundred Years. New York: Cambridge University Press.

Daniel J. Smith is an Associate Professor of Economics in the Jonson Center at Troy University.

Copyright (c) 2015 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator ( Published by EH.Net (May 2015). All EH.Net reviews are archived at

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):North America
Time Period(s):20th Century: Pre WWII

The Great Depression of the 1930s: Lessons for Today

Editor(s):Crafts, Nicholas
Fearon, Peter
Reviewer(s):Hanes, Christopher

Published by EH.Net (January 2014)

Nicholas Crafts and Peter Fearon, editors, The Great Depression of the 1930s: Lessons for Today. Oxford: Oxford University Press, 2013. xiv + 459  pp. ₤68/$125 (hardcover), ISBN: 978-0-19-966318-7.

Reviewed for EH.Net by Christopher Hanes, Department of Economics, SUNY-Binghamton.

This is not an ordinary edited volume. Every paper seems to have been specially written for it and fits the title. Each views an aspect of the interwar era in light of theoretical and policy issues related to our own post-2008 depression, and draws explicit lessons. And check out the list of contributors, which (in addition to editors Nicholas Crafts and Peter Fearon) includes Michael Bordo, Charles Calomiris, Forrest Capie, Barry Eichengreen, Alexander Field, Price Fishback, Timothy Hatton, John Landon-Lane, Joseph Mason, Roger Middleton, Kris Mitchener, Albrecht Ritschl, Peter Temin, Mark Thomas, John Wallis, and Nikolaus Wolf! The volume includes many of the best economic historians working on the interwar era, scholars worth reading. Crafts and Fearon contribute two papers that would be, by themselves, worth the price of the book if the book were not so absurdly expensive. All of the papers are admirably up to date on the current macroeconomics literature, including recent attempts to account for events of the 1930s in terms of real business cycle and New Keynesian models. Monetary policy at the zero bound, hysteresis in the natural rate of unemployment, recovery from a financial crisis and regulatory reforms, the euro and the gold standard – these and many other topics are well-covered.

Of course, some things are not covered so well. The geographic scope is limited. All but one contribution focuses on the interwar experience of America and/or Britain. The exception is a paper about Germany by Albrecht Ritschl. Not well covered: the current policy issue of fiscal stimulus versus “austerity,” the value of the fiscal policy multiplier and “expansionary austerity” – can a country’s bond rates be so strongly affected by forecast budget balance as to counteract direct effects of government spending on employment? Roger Middleton’s paper, about Britain, is supposed to get at that. It is even titled “Can Contractionary Fiscal Policy be Expansionary?” But it does not answer its own question. This is partly because Britain and America do not provide the right natural experiments. Neither country tried fiscal stimulus; neither was ever in serious danger of losing international investors’ confidence that its bonds would be repaid (in domestic currency, at least). I suspect other countries’ 1930s experience would be more relevant. A few issues dear to this reviewer’s heart appear in the volume hardly at all, though they are quite approachable through interwar British and American experience: the possibility of “secular stagnation” (or, can the natural rate of interest be negative?); the effect of “quantitative easing” on term and liquidity premiums; policies to deal with widespread underwater mortgages. But no one book can cover everything.

I do criticize the book, seriously, on two counts. First, the names of authors of works cited by the contributors do not appear in the index, with three exceptions: Harold Cole, Paul Krugman and Alan Meltzer. (What’s so special about these guys?) It is impossible for a reader to, for example, look for discussions of recent papers that particularly interest him. I guess the editors originally intended to have a separate Index of Cited Work, then forgot to provide one. Second, there is no introduction to the volume explaining its origin and purpose. Who is the intended audience? The book jacket says it is “written at a level that will be comprehensible to advanced undergraduates in economics and history while also being a valuable source of reference for policymakers.” No, it isn’t. Let alone policymakers, very few undergraduates will comprehend the book’s charts of VAR variance decompositions and statements like this: “Let yt be an [n,1] vector of i = 1,…..n time series yi … Let xt be an [n,p+1).1] vector that includes the first p lags …” (p. 120). Actually, the book reads like the Journal of Economic Perspectives. I imagine it was really intended for economists and graduate students. I recommend it especially to the latter, as it provides reliable overviews of many important issues and should inspire several dissertations.

Christopher Hanes has published papers in numerous journals including the American Economic Review, Quarter Journal of Economics, Journal of Economic History, and Explorations in Economic History.  He is the author of “The Liquidity Trap and U.S. Interest Rates in the 1930s,” Journal of Money, Credit and Banking (2006).

Copyright (c) 2014 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator ( Published by EH.Net (January 2014). All EH.Net reviews are archived at

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Macroeconomics and Fluctuations
Geographic Area(s):Europe
North America
Time Period(s):20th Century: Pre WWII
20th Century: WWII and post-WWII

Economic Recovery in the Great Depression

Frank G. Steindl, Oklahoma State University


The Great Depression has two meanings. One is the horrendous debacle of 1929-33 during which unemployment rose from 3 to 25 percent as the nation’s output fell over 25 percent and prices over 30 percent, in what also has been called the Great Contraction. A second meaning has the Great Depression as the entire decade of the thirties, the anxieties and apprehensions for which John Steinbeck’s The Grapes of Wrath is a metaphor. Much has been written about the unprecedented drop in economic activity in the Great Contraction, with questions about its causes and the reasons for its protracted decline especially prominent. The amount of scholarship devoted to these issues dwarfs that dealing with the recovery. But there indeed was a recovery, though long, tortuous, and uneven. In fact, it was well over twice as long as the contraction.

The economy hit its trough in March 1933. Whether or not by coincidence, President Franklin D. Roosevelt took office that month, initiating the New Deal and its fabled first hundred days, among which was the creation in June 1933 of its principal recovery vehicle, the NIRA — National Industrial Recovery Act.

Facts of the Recovery

Figure 1 uses monthly data. This allows us to see more finely the movements of the economy, as contrasted with the use of quarterly or annual data. For present purposes, the decade of the Depression runs from August 1929, when the economy was at its business cycle peak, through March 1933, the contraction trough, to June 1942, when the economy clearly was back to it long-run high-employment trend.

Figure 1 depicts the behavior of industrial output and prices over the Great Depression decade, the former as measured by the Index of Industrial Employment and the latter by the Wholesale Price Index.[1] Among the notable features are the large declines in output and prices in the Great Contraction, with the former falling 52 percent and the latter 37 percent. Another noteworthy feature is the sharp, severe 1937-38 depression, when in twelve months output fell 33 percent and prices 11 percent. A third feature is the over-two-year deflation in the face of a robust increase in output following the 1937-38 depression.

The behavior of the unemployment rate is shown in Figure 2.[2] The dashed line shows the reported official data, which do not count as employed those holding “temporary” relief jobs. The solid line adjusts the official series by including those holding such temporary jobs as employed, the effect of which is to reduce the unemployment rate (Darby 1976). Each series rises from around 3 to about 23 percent between 1929 and 1932. The official series then climbs to near 25 percent the following year whereas the adjusted series is over four percentage points lower. Each continues declining the rest of the recovery, though both rise sharply in 1938. By 1940, each is still in double digits.

Three other charts that are helpful for understanding the recovery are Figures 3, 4, and 5. The first of these shows that the monetary base of the economy — which is the reserves of commercial banks plus currency held by the public — grew principally through increases in the stock of gold In contrast to the normal situation, the base did not increase because of credit provided by the Federal Reserve System. Such credit was essentially constant. That is, the Fed, the nation’s central bank, was basically passive for most of the recovery. The rise in the stock of gold occurred initially because of revaluation of gold from $20.67 to $35 an ounce in 1933-34 (which though not changing the physical holdings of gold raised the value of such holdings by 69 percent). The physical stock of gold now valued at the higher price then increased because of an inflow of gold principally from Europe due to the deteriorating political and economic situation there.

Figure 4 shows the behavior of the stock of money, both the narrow M1and broader M2 measures of it. The shaded area shows the decreases in those money stocks in the 1937-38 depression. Those declines were one of the reasons for that depression, just as the large declines in the money stock in 1929-33 were major factors responsible for the Great Contraction. During the Contraction of 1929-33, the narrow measure of the money stock — currency held by the public and demand deposits, M1 — fell 28 percent and the broader measure of it (M1 plus time deposits at commercial banks) fell 35 percent. These declines were major factors in causing the sharp decline that was the debacle of 1929-33.

Lastly, the budget position of the federal government is shown in Figure 5. One of the notable features is the sharp increase in expenditures in mid-1936 and the equally sharp decrease thereafter. The budget therefore went dramatically into deficit, and then began to move toward a surplus by the end of 1936, largely due to the tax revenues arising from the Social Security Act of 1935.

Reasons for Recovery

In Golden Fetters (1992), Barry Eichengreen advanced the basis for the most widely accepted understanding of the slide and recovery of economies in the 1930s. The depression was a worldwide phenomenon, as indicated in Figure 6, which shows the behavior of industrial production for several major countries. His basic thesis related to the gold standard and the manner in which countries altered their behavior under it during the 1930s. Under the classical “rules of the game,” countries experiencing balance of payments deficits financed those deficits by exporting gold. The loss of gold forced them to contract their money stock, which then resulted in deflationary pressures. Countries running balance of payments surpluses received gold, which expanded their money stocks, thereby inducing expansionary pressures. According to Eichengreen’s framework, countries did not “play by the rules” of the international gold standard during the depression era. Rather, countries losing gold were forced to contract. Those receiving gold, however, did not expand. This generated a net deflationary bias, as a result of which the depression was world wide for those countries on the gold standard. As countries cut their ties to gold, which the U.S. did in early 1933, they were free to pursue expansionary monetary and fiscal policies, and this is the principal reason underlying the recovery. The inflow of gold into the U.S., for instance, expanded the reserves of the banking system, which became the basis for the increases in the stock of money.

The quantity theory of money is a useful framework that can be used to understand movements of prices and output. The theory holds that increases in the supply of money relative to the demand results in increased spending on goods, services, financial assets, and real capital. The theory can be expressed in the following equation, where M is the stock of money, V is velocity, the rate at which it is spent, which is the mirror side of the demand for money — the desire to hold it. P is the price level and y is real output.

Increases in M relative to V result in increases in P and y.

Research into the forces of recovery generally concludes that the growth of the money supply (M) was the principal cause of the rise in output (y) after March 1933, the trough of the Great Contraction. Furthermore, those increases in the money stock also pushed up the price level (P).

Four studies expressly dealing with the recovery are of note. Milton Friedman and Anna Schwartz show that “the broad movements in the stock of money correspond with those in income” (1963, 497) and argue that “the rapid rate of rise in the money stock certainly promoted and facilitated the concurrent economic expansion” (1963, 544). Christina Romer concludes that the growth of the money stock was “crucial to the recovery. If [it] had been held to its normal level, the U.S. economy in 1942 would have been 50 percent below its pre-Depression trend path” (1992, 768-69). She also finds that fiscal policy “contributed almost nothing to the recovery” (1992, 767), a finding that mirrors much of the postwar research on the influence of fiscal policy, and stands in contrast to the views of much of the public as it came to believe that the fiscal budget deficits of President Roosevelt were fundamental in promoting recovery.[3]

Ben Bernanke (1995) similarly stresses the importance of the growth of the money stock as basic to the recovery. He focuses on the gold standard as a restraint on independent monetary actions, finding that “the evidence is that countries leaving the gold standard recovered substantially more rapidly and vigorously than those who did not” (1995, 12) because they “had greater freedom to initiate expansionary monetary policies” (1995, 15).

More recently Allan Meltzer (2003) finds the recovery driven by increases in the stock of money, based on an expanding monetary base due to gold. “The main policy stimulus to output came from the rise in money, an unplanned consequence of the 1934 devaluation of the dollar against gold. Later in the decade the rising threat of war, and war itself supplemented the $35 gold price as a cause of the rise in gold and money” (2003, 573).

That the recovery was due principally to the growth of the stock of money appears to be a robust conclusion of postwar research into causes of the 1930s recovery.

The manner in which the stock of money increased is important. The growing stock of gold increased the reserves of banks, hence the monetary base. With their greater reserves, banks did two things. First, they held some as precautionary reserves, called excess reserves. This is measured on the left hand side of Figure 7. Secondly, they bought U.S.government securities, more than tripling their holdings, as seen on the right hand axis of Figure 7. Also, as seen there, commercial bank loans increased only slightly in the recovery, rising only 25 percent in over nine years.[4] The principal impetus to the growth of the money stock, therefore, was banks’ increased purchases of U.S. government securities, both ones already outstanding and ones issued to finance the deficits of those years.

The 1937-38 Depression and Revival

After four years of recovery, the economy plunged into a deep depression in May 1937, as output fell 33 percent and prices 11 percent in twelve months (shown in Figure 1). Two developments were identified with being principally responsible for the depression.[5] The one most prominently identified by contemporary scholars is the action of the Federal Reserve.

As the Fed saw the volume of excess reserves climbing month after month, it became concerned about the potential inflationary consequences if banks were to begin making more loans, thereby expanding the money supply and driving up prices. The Banking Act of 1935 gave the Fed authority to change reserve requirements. With its newly granted authority, it decided upon a “preemptive strike” against what it regarded as incipient inflation. Because it thought that those excess reserves were due to a “shortage of borrowers,” it therefore raised reserve requirements, the effect of which was to impound in required reserves the former excess reserves. The increased requirements were in fact doubled, in three steps: August 1936, March 1937, and May 1937. As Figure 7 exhibits, excess reserves therefore fell. The principal effect of the doubling of reserve requirements was to reduce the stock of money, as shown in the shaded area of Figure 4.[6]

A second factor causing the depression was the falling federal budget deficit, due to two considerations. First, there was a sharp one-time rise in expenditures in mid-1936, due to the payment of a World War I Veterans’ Bonus. Thereafter, expenditures fell — the “spike” in the figure. Secondly, the Social Security Act of 1935 mandated collection of payroll taxes beginning in 1937, with the first payments to be made several years later. The joint effect of these two was to move the budget to near surplus by late 1937.

During the depression, both output and prices fell, as was their usual behavior in depressions. The bottom of the depression was May 1938, one year after it began. Thereafter, output began growing quite robustly, rising 58 percent by August 1940. Prices, however, continued to fall, for over two years. Figure 8 shows the depression and revival experience from May 1937 through August 1940, the month in which prices last fell. The two shaded areas are the year-long depression and the price “spike” in September 1939. Of interest is that the shock of the war that spurred the price jump did not induce expectations of further price rises. Prices continued to fall for another year, through August 1940.

Difficulties with Current Understanding

According to the currently accepted interpretation, the recovery owes its existence to increases in the stock of money. One difficulty with this view is the marked contrast to the price experience of recovery through mid-1937. How could rising prices in the 1933 turnaround be fundamental to the recovery but not in the vigorous, later recovery, when prices actually fell? Another difficulty is that the continued rise in the stock of money is due to the political turmoil in Europe. There is little intrinsic to the U.S economy that contributed. Presumably, had there been no continuing inflow of gold raising the monetary base and money stock, the economy would have languished until the demands of World War II would have made their impact. In other words, would there have been virtually no recovery had there been no Adolf Hitler?

Of more consequence is the conundrum presented by the experience of more than two years of deflation in the face of dramatically rising aggregate demand, of which the sharply rising money stock appears as a major force. If the rising stock of money were fundamental to the recovery, then prices and output would have been rising, as the aggregate demand for output, spurred also by increasing fiscal budget deficits, would have been increasing relative to aggregate supply. But in the present instance, prices were declining, not rising. Something else was driving the economy during the entire recovery, but the seemingly dominant aggregate demand pressures obscured it in the early part.

One prospective impetus to aggregate supply would be declining real wages that would spur the hiring of additional workers. But with prices declining, it is unlikely that real wages would have fallen in the revival from the late 1930s depression. The evidence as indicated in Figure 9 shows that they in fact increased. With few exceptions, real wages increased throughout the entire deflationary period, rising 18 percent overall and 6 percent in the revival. The real wage rate, by rising, was thus a detriment to increased supply. Real wages cannot therefore be a factor inducing greater aggregate supply.

The economic phenomenon that was driving the recovery was probably increasing productivity. An early indication of this comes from the pioneering work of Robert Solow (1957) who in the course of examining factors contributing to economic growth developed data on the behavior of productivity. In support of this, Alexander Field presents both macroeconomic and microeconomic evidence showing that “the years 1929-41 were, in the aggregate, the most technologically progressive of any comparable period in U.S. economic history” (2003, 1399).

The rapid productivity increases were an important factor explaining the seemingly anomalous problem of rapid recovery and the stubbornness of the unemployment rate. In today’s parlance, this has come to be known as a “jobless recovery,” one in which rising productivity generates increased output rather than greater labor input producing more.

To acknowledge that productivity increases were crucial to the economic recovery is not however the end of the story because we are still left trying to understand the mechanisms underlying their sharp increases. What induced such increases? Serendipity — the idea that productivity increased at just the right time and in the appropriate amounts — is not an appealing explanation.

More likely, there is something intrinsic to the economy that encapsulates mechanisms — that is, incentives spurring inventive capital and labor innovations generating productivity increases, as well as other factors — that move the economy back to its potential.


Bernanke, Ben S. “The Macroeconomics of the Great Depression: A Comparative Approach.” Journal of Money, Credit, and Banking 27 (1995): 1-28.

Darby, Michael R. “Three-and-a-Half Million U.S. Employees Have Been Mislaid: Or an Explanation of Unemployment, 1934-41.” Journal of Political Economy 84 (1976):1-16.

Eichengreen, Barry. Golden Fetters: The Gold Standard and the Great Depression 1919-1939. New York: Oxford University Press, 1992.

Field, Alexander J. “The Most Technologically Progressive Decade of the Century.” American Economic Review 93 2003): 1399-1413.

Friedman, Milton and Anna J. Schwartz. A Monetary History of the United States: 1867-1960. Princeton, NJ: Princeton University Press, 1963.

Meltzer, Allan H. A History of the Federal Reserve, volume 1, 1913-1951. Chicago: University of Chicago Press, 2003.

Romer, Christina D. “What Ended the Great Depression?” Journal of Economic History 52 (1992): 757-84.

Solow, Robert M. “Technical Change and the Aggregate Production Function.” Review of Economics and Statistics 39 (1957): 312-20.

Smithies, Arthur. “The American Economy in the Thirties.” American Economic Review Papers and Proceedings 36 (1946):11-27.

Steindl, Frank G. Understanding Economic Recovery in the 1930s: Endogenous Propagation in the Great Depression. Ann Arbor: University of Michigan Press, 2004.

[1] Industrial production and the nation’s real output, real GDP, are highly correlated. The correlation relation is 98 percent, both for quarterly and annual data over the recovery period

[2] Data on the unemployment rate are available only on an annual basis for the Depression decade.

[3] In fact, large numbers of academics held that view, of which Arthur Smithies’ address to the American Economic Association is an example. His assessment was that “My main conclusion … is that fiscal policy did prove to be … the only effective means to recovery” (1946, 25, emphasis added).

[4] Real loans — loans relative to the price level — in fact declined, falling 24 percent in the 111 months of recovery.

[5] A third factor was the action of the U.S. Treasury as it “sterilized” gold, at the instigation of the Federal Reserve. By sterilization of gold, the Treasury prevented the gold inflows from increasing bank reserves.

[6] The reason the stock of money fell is that banks responded to the increased reserve requirements by trying to rebuild their excess reserves. That is, the banks did not regard their excess reserves as surplus reserves, but rather as precautionary reserves. This contrasted with the Federal Reserve’s view that the excess reserves were surplus ones, due to a “shortage” of borrowers at banks.

Citation: Steindl, Frank. “Economic Recovery in the Great Depression”. EH.Net Encyclopedia, edited by Robert Whaples. March 16, 2008. URL

An Overview of the Great Depression

Randall Parker, East Carolina University

This article provides an overview of selected events and economic explanations of the interwar era. What follows is not intended to be a detailed and exhaustive review of the literature on the Great Depression, or of any one theory in particular. Rather, it will attempt to describe the “big picture” events and topics of interest. For the reader who wishes more extensive analysis and detail, references to additional materials are also included.

The 1920s

The Great Depression, and the economic catastrophe that it was, is perhaps properly scaled in reference to the decade that preceded it, the 1920s. By conventional macroeconomic measures, this was a decade of brisk economic growth in the United States. Perhaps the moniker “the roaring twenties” summarizes this period most succinctly. The disruptions and shocking nature of World War I had been survived and it was felt the United States was entering a “new era.” In January 1920, the Federal Reserve seasonally adjusted index of industrial production, a standard measure of aggregate economic activity, stood at 81 (1935–39 = 100). When the index peaked in July 1929 it was at 114, for a growth rate of 40.6 percent over this period. Similar rates of growth over the 1920–29 period equal to 47.3 percent and 42.4 percent are computed using annual real gross national product data from Balke and Gordon (1986) and Romer (1988), respectively. Further computations using the Balke and Gordon (1986) data indicate an average annual growth rate of real GNP over the 1920–29 period equal to 4.6 percent. In addition, the relative international economic strength of this country was clearly displayed by the fact that nearly one-half of world industrial output in 1925–29 was produced in the United States (Bernanke, 1983).

Consumer Durables Market

The decade of the 1920s also saw major innovations in the consumption behavior of households. The development of installment credit over this period led to substantial growth in the consumer durables market (Bernanke, 1983). Purchases of automobiles, refrigerators, radios and other such durable goods all experienced explosive growth during the 1920s as small borrowers, particularly households and unincorporated businesses, utilized their access to available credit (Persons, 1930; Bernanke, 1983; Soule, 1947).

Economic Growth in the 1920s

Economic growth during this period was mitigated only somewhat by three recessions. According to the National Bureau of Economic Research (NBER) business cycle chronology, two of these recessions were from May 1923 through July 1924 and October 1926 through November 1927. Both of these recessions were very mild and unremarkable. In contrast, the 1920s began with a recession lasting 18 months from the peak in January 1920 until the trough of July 1921. Original estimates of real GNP from the Commerce Department showed that real GNP fell 8 percent between 1919 and 1920 and another 7 percent between 1920 and 1921 (Romer, 1988). The behavior of prices contributed to the naming of this recession “the Depression of 1921,” as the implicit price deflator for GNP fell 16 percent and the Bureau of Labor Statistics wholesale price index fell 46 percent between 1920 and 1921. Although thought to be severe, Romer (1988) has argued that the so-called “postwar depression” was not as severe as once thought. While the deflation from war-time prices was substantial, revised estimates of real GNP show falls in output of only 1 percent between 1919 and 1920 and 2 percent between 1920 and 1921. Romer (1988) also argues that the behaviors of output and prices are inconsistent with the conventional explanation of the Depression of 1921 being primarily driven by a decline in aggregate demand. Rather, the deflation and the mild recession are better understood as resulting from a decline in aggregate demand together with a series of positive supply shocks, particularly in the production of agricultural goods, and significant decreases in the prices of imported primary commodities. Overall, the upshot is that the growth path of output was hardly impeded by the three minor downturns, so that the decade of the 1920s can properly be viewed economically as a very healthy period.

Fed Policies in the 1920s

Friedman and Schwartz (1963) label the 1920s “the high tide of the Reserve System.” As they explain, the Federal Reserve became increasingly confident in the tools of policy and in its knowledge of how to use them properly. The synchronous movements of economic activity and explicit policy actions by the Federal Reserve did not go unnoticed. Taking the next step and concluding there was cause and effect, the Federal Reserve in the 1920s began to use monetary policy as an implement to stabilize business cycle fluctuations. “In retrospect, we can see that this was a major step toward the assumption by government of explicit continuous responsibility for economic stability. As the decade wore on, the System took – and perhaps even more was given – credit for the generally stable conditions that prevailed, and high hopes were placed in the potency of monetary policy as then administered” (Friedman and Schwartz, 1963).

The giving/taking of credit to/by the Federal Reserve has particular value pertaining to the recession of 1920–21. Although suggesting the Federal Reserve probably tightened too much, too late, Friedman and Schwartz (1963) call this episode “the first real trial of the new system of monetary control introduced by the Federal Reserve Act.” It is clear from the history of the time that the Federal Reserve felt as though it had successfully passed this test. The data showed that the economy had quickly recovered and brisk growth followed the recession of 1920–21 for the remainder of the decade.

Questionable Lessons “Learned” by the Fed

Moreover, Eichengreen (1992) suggests that the episode of 1920–21 led the Federal Reserve System to believe that the economy could be successfully deflated or “liquidated” without paying a severe penalty in terms of reduced output. This conclusion, however, proved to be mistaken at the onset of the Depression. As argued by Eichengreen (1992), the Federal Reserve did not appreciate the extent to which the successful deflation could be attributed to the unique circumstances that prevailed during 1920–21. The European economies were still devastated after World War I, so the demand for United States’ exports remained strong many years after the War. Moreover, the gold standard was not in operation at the time. Therefore, European countries were not forced to match the deflation initiated in the United States by the Federal Reserve (explained below pertaining to the gold standard hypothesis).

The implication is that the Federal Reserve thought that deflation could be generated with little effect on real economic activity. Therefore, the Federal Reserve was not vigorous in fighting the Great Depression in its initial stages. It viewed the early years of the Depression as another opportunity to successfully liquidate the economy, especially after the perceived speculative excesses of the 1920s. However, the state of the economic world in 1929 was not a duplicate of 1920–21. By 1929, the European economies had recovered and the interwar gold standard was a vehicle for the international transmission of deflation. Deflation in 1929 would not operate as it did in 1920–21. The Federal Reserve failed to understand the economic implications of this change in the international standing of the United States’ economy. The result was that the Depression was permitted to spiral out of control and was made much worse than it otherwise would have been had the Federal Reserve not considered it to be a repeat of the 1920–21 recession.

The Beginnings of the Great Depression

In January 1928 the seeds of the Great Depression, whenever they were planted, began to germinate. For it is around this time that two of the most prominent explanations for the depth, length, and worldwide spread of the Depression first came to be manifest. Without any doubt, the economics profession would come to a firm consensus around the idea that the economic events of the Great Depression cannot be properly understood without a solid linkage to both the behavior of the supply of money together with Federal Reserve actions on the one hand and the flawed structure of the interwar gold standard on the other.

It is well documented that many public officials, such as President Herbert Hoover and members of the Federal Reserve System in the latter 1920s, were intent on ending what they perceived to be the speculative excesses that were driving the stock market boom. Moreover, as explained by Hamilton (1987), despite plentiful denials to the contrary, the Federal Reserve assumed the role of “arbiter of security prices.” Although there continues to be debate as to whether or not the stock market was overvalued at the time (White, 1990; DeLong and Schleifer, 1991), the main point is that the Federal Reserve believed there to be a speculative bubble in equity values. Hamilton (1987) describes how the Federal Reserve, intending to “pop” the bubble, embarked on a highly contractionary monetary policy in January 1928. Between December 1927 and July 1928 the Federal Reserve conducted $393 million of open market sales of securities so that only $80 million remained in the Open Market account. Buying rates on bankers’ acceptances1 were raised from 3 percent in January 1928 to 4.5 percent by July, reducing Federal Reserve holdings of such bills by $193 million, leaving a total of only $185 million of these bills on balance. Further, the discount rate was increased from 3.5 percent to 5 percent, the highest level since the recession of 1920–21. “In short, in terms of the magnitudes consciously controlled by the Fed, it would be difficult to design a more contractionary policy than that initiated in January 1928” (Hamilton, 1987).

The pressure did not stop there, however. The death of Federal Reserve Bank President Benjamin Strong and the subsequent control of policy ascribed to Adolph Miller of the Federal Reserve Board insured that the fall in the stock market was going to be made a reality. Miller believed the speculative excesses of the stock market were hurting the economy, and the Federal Reserve continued attempting to put an end to this perceived harm (Cecchetti, 1998). The amount of Federal Reserve credit that was being extended to market participants in the form of broker loans became an issue in 1929. The Federal Reserve adamantly discouraged lending that was collateralized by equities. The intentions of the Board of Governors of the Federal Reserve were made clear in a letter dated February 2, 1929 sent to Federal Reserve banks. In part the letter read:

The board has no disposition to assume authority to interfere with the loan practices of member banks so long as they do not involve the Federal reserve banks. It has, however, a grave responsibility whenever there is evidence that member banks are maintaining speculative security loans with the aid of Federal reserve credit. When such is the case the Federal reserve bank becomes either a contributing or a sustaining factor in the current volume of speculative security credit. This is not in harmony with the intent of the Federal Reserve Act, nor is it conducive to the wholesome operation of the banking and credit system of the country. (Board of Governors of the Federal Reserve 1929: 93–94, quoted from Cecchetti, 1998)

The deflationary pressure to stock prices had been applied. It was now a question of when the market would break. Although the effects were not immediate, the wait was not long.

The Economy Stumbles

The NBER business cycle chronology dates the start of the Great Depression in August 1929. For this reason many have said that the Depression started on Main Street and not Wall Street. Be that as it may, the stock market plummeted in October of 1929. The bursting of the speculative bubble had been achieved and the economy was now headed in an ominous direction. The Federal Reserve’s seasonally adjusted index of industrial production stood at 114 (1935–39 = 100) in August 1929. By October it had fallen to 110 for a decline of 3.5 percent (annualized percentage decline = 14.7 percent). After the crash, the incipient recession intensified, with the industrial production index falling from 110 in October to 100 in December 1929, or 9 percent (annualized percentage decline = 41 percent). In 1930, the index fell further from 100 in January to 79 in December, or an additional 21percent.

Links between the Crash and the Depression?

While popular history treats the crash and the Depression as one and the same event, economists know that they were not. But there is no doubt that the crash was one of the things that got the ball rolling. Several authors have offered explanations for the linkage between the crash and the recession of 1929–30. Mishkin (1978) argues that the crash and an increase in liabilities led to a deterioration in households’ balance sheets. The reduced liquidity2 led consumers to defer consumption of durable goods and housing and thus contributed to a fall in consumption. Temin (1976) suggests that the fall in stock prices had a negative wealth effect on consumption, but attributes only a minor role to this given that stocks were not a large fraction of total wealth; the stock market in 1929, although falling dramatically, remained above the value it had achieved in early 1928, and the propensity to consume from wealth was small during this period. Romer (1990) provides evidence suggesting that if the stock market were thought to be a predictor of future economic activity, then the crash can rightly be viewed as a source of increased consumer uncertainty that depressed spending on consumer durables and accelerated the decline that had begun in August 1929. Flacco and Parker (1992) confirm Romer’s findings using different data and alternative estimation techniques.

Looking back on the behavior of the economy during the year of 1930, industrial production declined 21 percent, the consumer price index fell 2.6 percent, the supply of high-powered money (that is, the liabilities of the Federal Reserve that are usable as money, consisting of currency in circulation and bank reserves; also called the monetary base) fell 2.8 percent, the nominal supply of money as measured by M1 (the product of the monetary base3 multiplied by the money multiplier4) dipped 3.5 percent and the ex post real interest rate turned out to be 11.3 percent, the highest it had been since the recession of 1920–21 (Hamilton, 1987). In spite of this, when put into historical context, there was no reason to view the downturn of 1929–30 as historically unprecedented. Its magnitude was comparable to that of many recessions that had previously occurred. Perhaps there was justifiable optimism in December 1930 that the economy might even shake off the negative movement and embark on the path to recovery, rather like what had occurred after the recession of 1920–21 (Bernanke, 1983). As we know, the bottom would not come for another 27 months.

The Economy Crumbles

Banking Failures

During 1931, there was a “change in the character of the contraction” (Friedman and Schwartz, 1963). Beginning in October 1930 and lasting until December 1930, the first of a series of banking panics now accompanied the downward spasms of the business cycle. Although bank failures had occurred throughout the 1920s, the magnitude of the failures that occurred in the early 1930s was of a different order altogether (Bernanke, 1983). The absence of any type of deposit insurance resulted in the contagion of the panics being spread to sound financial institutions and not just those on the margin.

Traditional Methods of Combating Bank Runs Not Used

Moreover, institutional arrangements that had existed in the private banking system designed to provide liquidity – to convert assets into cash – to fight bank runs before 1913 were not exercised after the creation of the Federal Reserve System. For example, during the panic of 1907, the effects of the financial upheaval had been contained through a combination of lending activities by private banks, called clearinghouses, and the suspension of deposit convertibility into currency. While not preventing bank runs and the financial panic, their economic impact was lessened to a significant extent by these countermeasures enacted by private banks, as the economy quickly recovered in 1908. The aftermath of the panic of 1907 and the desire to have a central authority to combat the contagion of financial disruptions was one of the factors that led to the establishment of the Federal Reserve System. After the creation of the Federal Reserve, clearinghouse lending and suspension of deposit convertibility by private banks were not undertaken. Believing the Federal Reserve to be the “lender of last resort,” it was apparently thought that the responsibility to fight bank runs was the domain of the central bank (Friedman and Schwartz, 1963; Bernanke, 1983). Unfortunately, when the banking panics came in waves and the financial system was collapsing, being the “lender of last resort” was a responsibility that the Federal Reserve either could not or would not assume.

Money Supply Contracts

The economic effects of the banking panics were devastating. Aside from the obvious impact of the closing of failed banks and the subsequent loss of deposits by bank customers, the money supply accelerated its downward spiral. Although the economy had flattened out after the first wave of bank failures in October–December 1930, with the industrial production index steadying from 79 in December 1930 to 80 in April 1931, the remainder of 1931 brought a series of shocks from which the economy was not to recover for some time.

Second Wave of Banking Failure

In May, the failure of Austria’s largest bank, the Kredit-anstalt, touched off financial panics in Europe. In September 1931, having had enough of the distress associated with the international transmission of economic depression, Britain abandoned its participation in the gold standard. Further, just as the United States’ economy appeared to be trying to begin recovery, the second wave of bank failures hit the financial system in June and did not abate until December. In addition, the Hoover administration in December 1931, adhering to its principles of limited government, embarked on a campaign to balance the federal budget. Tax increases resulted the following June, just as the economy was to hit the first low point of its so-called “double bottom” (Hoover, 1952).

The results of these events are now evident. Between January and December 1931 the industrial production index declined from 78 to 66, or 15.4 percent, the consumer price index fell 9.4 percent, the nominal supply of M1 dipped 5.7 percent, the ex post real interest rate5 remained at 11.3 percent, and although the supply of high-powered money6 actually increased 5.5 percent, the currency–deposit and reserve–deposit ratios began their upward ascent, and thus the money multiplier started its downward plunge (Hamilton, 1987). If the economy had flattened out in the spring of 1931, then by December output, the money supply, and the price level were all on negative growth paths that were dragging the economy deeper into depression.

Third Wave of Banking Failure

The economic difficulties were far from over. The economy displayed some evidence of recovery in late summer/early fall of 1932. However, in December 1932 the third, and largest, wave of banking panics hit the financial markets and the collapse of the economy arrived with the business cycle hitting bottom in March 1933. Industrial production between January 1932 and March 1933 fell an additional 15.6 percent. For the combined years of 1932 and 1933, the consumer price index fell a cumulative 16.2 percent, the nominal supply of M1 dropped 21.6 percent, the nominal M2 money supply fell 34.7 percent, and although the supply of high-powered money increased 8.4 percent, the currency–deposit and reserve–deposit ratios accelerated their upward ascent. Thus the money multiplier continued on a downward plunge that was not arrested until March 1933. Similar behaviors for real GDP, prices, money supplies and other key macroeconomic variables occurred in many European economies as well (Snowdon and Vane, 1999; Temin, 1989).

An examination of the macroeconomic data in August 1929 compared to March 1933 provides a stark contrast. The unemployment rate of 3 percent in August 1929 was at 25 percent in March 1933. The industrial production index of 114 in August 1929 was at 54 in March 1933, or a 52.6 percent decrease. The money supply had fallen 35 percent, prices plummeted by about 33 percent, and more than one-third of banks in the United States were either closed or taken over by other banks. The “new era” ushered in by “the roaring twenties” was over. Roosevelt took office in March 1933, a nationwide bank holiday was declared from March 6 until March 13, and the United States abandoned the international gold standard in April 1933. Recovery commenced immediately and the economy began its long path back to the pre-1929 secular growth trend.

Table 1 summarizes the drop in industrial production in the major economies of Western Europe and North America. Table 2 gives gross national product estimates for the United States from 1928 to 1941. The constant price series adjusts for inflation and deflation.

Table 1
Indices of Total Industrial Production, 1927 to 1935 (1929 = 100)

1927 1928 1929 1930 1931 1932 1933 1934 1935
Britain 95 94 100 94 86 89 95 105 114
Canada 85 94 100 91 78 68 69 82 90
France 84 94 100 99 85 74 83 79 77
Germany 95 100 100 86 72 59 68 83 96
Italy 87 99 100 93 84 77 83 85 99
Netherlands 87 94 100 109 101 90 90 93 95
Sweden 85 88 100 102 97 89 93 111 125
U.S. 85 90 100 83 69 55 63 69 79

Source: Industrial Statistics, 1900-57 (Paris, OEEC, 1958), Table 2.

Table 2
U.S. GNP at Constant (1929) and Current Prices, 1928-1941

Year GNP at constant (1929) prices (billions of $) GNP at current prices (billions of $)
1928 98.5 98.7
1929 104.4 104.6
1930 95.1 91.2
1931 89.5 78.5
1932 76.4 58.6
1933 74.2 56.1
1934 80.8 65.5
1935 91.4 76.5
1936 100.9 83.1
1937 109.1 91.2
1938 103.2 85.4
1939 111.0 91.2
1940 121.0 100.5
1941 131.7 124.7

Contemporary Explanations

The economics profession during the 1930s was at a loss to explain the Depression. The most prominent conventional explanations were of two types. First, some observers at the time firmly grounded their explanations on the two pillars of classical macroeconomic thought, Say’s Law and the belief in the self-equilibrating powers of the market. Many argued that it was simply a question of time before wages and prices adjusted fully enough for the economy to return to full employment and achieve the realization of the putative axiom that “supply creates its own demand.” Second, the Austrian school of thought argued that the Depression was the inevitable result of overinvestment during the 1920s. The best remedy for the situation was to let the Depression run its course so that the economy could be purified from the negative effects of the false expansion. Government intervention was viewed by the Austrian school as a mechanism that would simply prolong the agony and make any subsequent depression worse than it would ordinarily be (Hayek, 1966; Hayek, 1967).

Liquidationist Theory

The Hoover administration and the Federal Reserve Board also contained several so-called “liquidationists.” These individuals basically believed that economic agents should be forced to re-arrange their spending proclivities and alter their alleged profligate use of resources. If it took mass bankruptcies to produce this result and wipe the slate clean so that everyone could have a fresh start, then so be it. The liquidationists viewed the events of the Depression as an economic penance for the speculative excesses of the 1920s. Thus, the Depression was the price that was being paid for the misdeeds of the previous decade. This is perhaps best exemplified in the well-known quotation of Treasury Secretary Andrew Mellon, who advised President Hoover to “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” Mellon continued, “It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people” (Hoover, 1952). Hoover apparently followed this advice as the Depression wore on. He continued to reassure the public that if the principles of orthodox finance were faithfully followed, recovery would surely be the result.

The business press at the time was not immune from such liquidationist prescriptions either. The Commercial and Financial Chronicle, in an August 3, 1929 editorial entitled “Is Not Group Speculating Conspiracy, Fostering Sham Prosperity?” complained of the economy being replete with profligate spending including:

(a) The luxurious diversification of diet advantageous to dairy men … and fruit growers …; (b) luxurious dressing … more silk and rayon …; (c) free spending for automobiles and their accessories, gasoline, house furnishings and equipment, radios, travel, amusements and sports; (d) the displacement from the farms by tractors and autos of produce-consuming horses and mules to a number aggregating 3,700,000 for the period 1918–1928 … (e) the frills of education to thousands for whom places might better be reserved at bench or counter or on the farm. (Quoted from Nelson, 1991)

Persons, in a paper which appeared in the November 1930 Quarterly Journal of Economics, demonstrates that some academic economists also held similar liquidationist views.

Although certainly not universal, the descriptions above suggest that no small part of the conventional wisdom at the time believed the Depression to be a penitence for past sins. In addition, it was thought that the economy would be restored to full employment equilibrium once wages and prices adjusted sufficiently. Say’s Law will ensure the economy will return to health, and supply will create its own demand sufficient to return to prosperity, if we simply let the system work its way through. In his memoirs published in 1952, 20 years after his election defeat, Herbert Hoover continued to steadfastly maintain that if Roosevelt and the New Dealers would have stuck to the policies his administration put in place, the economy would have made a full recovery within 18 months after the election of 1932. We have to intensify our resolve to “stay the course.” All will be well in time if we just “take our medicine.” In hindsight, it challenges the imagination to think up worse policy prescriptions for the events of 1929–33.

Modern Explanations

There remains considerable debate regarding the economic explanations for the behavior of the business cycle between August 1929 and March 1933. This section describes the main hypotheses that have been presented in the literature attempting to explain the causes for the depth, protracted length, and worldwide propagation of the Great Depression.

The United States’ experience, considering the preponderance of empirical results and historical simulations contained in the economic literature, can largely be accounted for by the monetary hypothesis of Friedman and Schwartz (1963) together with the nonmonetary/financial hypotheses of Bernanke (1983) and Fisher (1933). That is, most, but not all, of the characteristic phases of the business cycle and depth to which output fell from 1929 to 1933 can be accounted for by the monetary and nonmonetary/financial hypotheses. The international experience, well documented in Choudri and Kochin (1980), Hamilton (1988), Temin (1989), Bernanke and James (1991), and Eichengreen (1992), can be properly understood as resulting from a flawed interwar gold standard. Each of these hypotheses is explained in greater detail below.

Nonmonetary/Nonfinancial Theories

It should be noted that I do not include a section covering the nonmonetary/nonfinancial theories of the Great Depression. These theories, including Temin’s (1976) focus on autonomous consumption decline, the collapse of housing construction contained in Anderson and Butkiewicz (1980), the effects of the stock market crash, the uncertainty hypothesis of Romer (1990), and the Smoot–Hawley Tariff Act of 1930, are all worthy of mention and can rightly be apportioned some of the responsibility for initiating the Depression. However, any theory of the Depression must be able to account for the protracted problems associated with the punishing deflation imposed on the United States and the world during that era. While the nonmonetary/nonfinancial theories go a long way accounting for the impetus for, and first year of the Depression, my reading of the empirical results of the economic literature indicates that they do not have the explanatory power of the three other theories mentioned above to account for the depths to which the economy plunged.

Moreover, recent research by Olney (1999) argues convincingly that the decline in consumption was not autonomous at all. Rather, the decline resulted because high consumer indebtedness threatened future consumption spending because default was expensive. Olney shows that households were shouldering an unprecedented burden of installment debt – especially for automobiles. In addition, down payments were large and contracts were short. Missed installment payments triggered repossession, reducing consumer wealth in 1930 because households lost all acquired equity. Cutting consumption was the only viable strategy in 1930 for avoiding default.

The Monetary Hypothesis

In reviewing the economic history of the Depression above, it was mentioned that the supply of money fell by 35 percent, prices dropped by about 33 percent, and one-third of all banks vanished. Milton Friedman and Anna Schwartz, in their 1963 book A Monetary History of the United States, 1867–1960, call this massive drop in the supply of money “The Great Contraction.”

Friedman and Schwartz (1963) discuss and painstakingly document the synchronous movements of the real economy with the disruptions that occurred in the financial sector. They point out that the series of bank failures that occurred beginning in October 1930 worsened economic conditions in two ways. First, bank shareholder wealth was reduced as banks failed. Second, and most importantly, the bank failures were exogenous shocks and led to the drastic decline in the money supply. The persistent deflation of the 1930s follows directly from this “great contraction.”

Criticisms of Fed Policy

However, this raises an important question: Where was the Federal Reserve while the money supply and the financial system were collapsing? If the Federal Reserve was created in 1913 primarily to be the “lender of last resort” for troubled financial institutions, it was failing miserably. Friedman and Schwartz pin the blame squarely on the Federal Reserve and the failure of monetary policy to offset the contractions in the money supply. As the money multiplier continued on its downward path, the monetary base, rather than being aggressively increased, simply progressed slightly upwards on a gently positive sloping time path. As banks were failing in waves, was the Federal Reserve attempting to contain the panics by aggressively lending to banks scrambling for liquidity? The unfortunate answer is “no.” When the panics were occurring, was there discussion of suspending deposit convertibility or suspension of the gold standard, both of which had been successfully employed in the past? Again the unfortunate answer is “no.” Did the Federal Reserve consider the fact that it had an abundant supply of free gold, and therefore that monetary expansion was feasible? Once again the unfortunate answer is “no.” The argument can be summarized by the following quotation:

At all times throughout the 1929–33 contraction, alternative policies were available to the System by which it could have kept the stock of money from falling, and indeed could have increased it at almost any desired rate. Those policies did not involve radical innovations. They involved measures of a kind the System had taken in earlier years, of a kind explicitly contemplated by the founders of the System to meet precisely the kind of banking crisis that developed in late 1930 and persisted thereafter. They involved measures that were actually proposed and very likely would have been adopted under a slightly different bureaucratic structure or distribution of power, or even if the men in power had had somewhat different personalities. Until late 1931 – and we believe not even then – the alternative policies involved no conflict with the maintenance of the gold standard. Until September 1931, the problem that recurrently troubled the System was how to keep the gold inflows under control, not the reverse. (Friedman and Schwartz, 1963)

The inescapable conclusion is that it was a failure of the policies of the Federal Reserve System in responding to the crises of the time that made the Depression as bad as it was. If monetary policy had responded differently, the economic events of 1929–33 need not have been as they occurred. This assertion is supported by the results of Fackler and Parker (1994). Using counterfactual historical simulations, they show that if the Federal Reserve had kept the M1 money supply growing along its pre-October 1929 trend of 3.3 percent annually, most of the Depression would have been averted. McCallum (1990) also reaches similar conclusions employing a monetary base feedback policy in his counterfactual simulations.

Lack of Leadership at the Fed

Friedman and Schwartz trace the seeds of these regrettable events to the death of Federal Reserve Bank of New York President Benjamin Strong in 1928. Strong’s death altered the locus of power in the Federal Reserve System and left it without effective leadership. Friedman and Schwartz maintain that Strong had the personality, confidence and reputation in the financial community to lead monetary policy and sway policy makers to his point of view. Friedman and Schwartz believe that Strong would not have permitted the financial panics and liquidity crises to persist and affect the real economy. Instead, after Governor Strong died, the conduct of open market operations changed from a five-man committee dominated by the New York Federal Reserve to that of a 12-man committee of Federal Reserve Bank governors. Decisiveness in leadership was replaced by inaction and drift. Others (Temin, 1989; Wicker, 1965) reject this point, claiming the policies of the Federal Reserve in the 1930s were not inconsistent with the policies pursued in the decade of the 1920s.

The Fed’s Failure to Distinguish between Nominal and Real Interest Rates

Meltzer (1976) also points out errors made by the Federal Reserve. His argument is that the Federal Reserve failed to distinguish between nominal and real interest rates. That is, while nominal rates were falling, the Federal Reserve did virtually nothing, since it construed this to be a sign of an “easy” credit market. However, in the face of deflation, real rates were rising and there was in fact a “tight” credit market. Failure to make this distinction led money to be a contributing factor to the initial decline of 1929.


Cecchetti (1992) and Nelson (1991) bolster the monetary hypothesis by demonstrating that the deflation during the Depression was anticipated at short horizons, once it was under way. The result, using the Fisher equation, is that high ex ante real interest rates were the transmission mechanism that led from falling prices to falling output. In addition, Cecchetti (1998) and Cecchetti and Karras (1994) argue that if the lower bound of the nominal interest rate is reached, then continued deflation renders the opportunity cost of holding money negative. In this instance the nature of money changes. Now the rate of deflation places a floor on the real return nonmoney assets must provide to make them attractive to hold. If they cannot exceed the rate on money holdings, then agents will move their assets into cash and the result will be negative net investment and a decapitalization of the economy.

Critics of the Monetary Hypothesis

The monetary hypothesis, however, is not without its detractors. Paul Samuelson observes that the monetary base did not fall during the Depression. Moreover, expecting the Federal Reserve to have aggressively increased the monetary base by whatever amount was necessary to stop the decline in the money supply is hindsight. A course of action for monetary policy such as this was beyond the scope of discussion prevailing at the time. In addition, others, like Moses Abramovitz, point out that the money supply had endogenous components that were beyond the Federal Reserve’s ability to control. Namely, the money supply may have been falling as a result of declining economic activity, or so-called “reverse causation.” Moreover the gold standard, to which the United States continued to adhere until March 1933, also tied the hands of the Federal Reserve in so far as gold outflows that occurred required the Federal Reserve to contract the supply of money. These views are also contained in Temin (1989) and Eichengreen (1992), as discussed below.

Bernanke (1983) argues that the monetary hypothesis: (i) is not a complete explanation of the link between the financial sector and aggregate output in the 1930s; (ii) does not explain how it was that decreases in the money supply caused output to keep falling over many years, especially since it is widely believed that changes in the money supply only change prices and other nominal economic values in the long run, not real economic values like output ; and (iii) is quantitatively insufficient to explain the depth of the decline in output. Bernanke (1983) not only resurrected and sharpened Fisher’s (1933) debt deflation hypothesis, but also made further contributions to what has come to be known as the nonmonetary/financial hypothesis.

The Nonmonetary/Financial Hypothesis

Bernanke (1983), building on the monetary hypothesis of Friedman and Schwartz (1963), presents an alternative interpretation of the way in which the financial crises may have affected output. The argument involves both the effects of debt deflation and the impact that bank panics had on the ability of financial markets to efficiently allocate funds from lenders to borrowers. These nonmonetary/financial theories hold that events in financial markets other than shocks to the money supply can help to account for the paths of output and prices during the Great Depression.

Fisher (1933) asserted that the dominant forces that account for “great” depressions are (nominal) over-indebtedness and deflation. Specifically, he argued that real debt burdens were substantially increased when there were dramatic declines in the price level and nominal incomes. The combination of deflation, falling nominal income and increasing real debt burdens led to debtor insolvency, lowered aggregate demand, and thereby contributed to a continuing decline in the price level and thus further increases in the real burden of debt.

The “Credit View”

Bernanke (1983), in what is now called the “credit view,” provided additional details to help explain Fisher’s debt deflation hypothesis. He argued that in normal circumstances, an initial decline in prices merely reallocates wealth from debtors to creditors, such as banks. Usually, such wealth redistributions are minor in magnitude and have no first-order impact on the economy. However, in the face of large shocks, deflation in the prices of assets forfeited to banks by debtor bankruptcies leads to a decline in the nominal value of assets on bank balance sheets. For a given value of bank liabilities, also denominated in nominal terms, this deterioration in bank assets threatens insolvency. As banks reallocate away from loans to safer government securities, some borrowers, particularly small ones, are unable to obtain funds, often at any price. Further, if this reallocation is long-lived, the shortage of credit for these borrowers helps to explain the persistence of the downturn. As the disappearance of bank financing forces lower expenditure plans, aggregate demand declines, which again contributes to the downward deflationary spiral. For debt deflation to be operative, it is necessary to demonstrate that there was a substantial build-up of debt prior to the onset of the Depression and that the deflation of the 1930s was at least partially unanticipated at medium- and long-term horizons at the time that the debt was being incurred. Both of these conditions appear to have been in place (Fackler and Parker, 2001; Hamilton, 1992; Evans and Wachtel, 1993).

The Breakdown in Credit Markets

In addition, the financial panics which occurred hindered the credit allocation mechanism. Bernanke (1983) explains that the process of credit intermediation requires substantial information gathering and non-trivial market-making activities. The financial disruptions of 1930–33 are correctly viewed as substantial impediments to the performance of these services and thus impaired the efficient allocation of credit between lenders and borrowers. That is, financial panics and debtor and business bankruptcies resulted in a increase in the real cost of credit intermediation. As the cost of credit intermediation increased, sources of credit for many borrowers (especially households, farmers and small firms) became expensive or even unobtainable at any price. This tightening of credit put downward pressure on aggregate demand and helped turn the recession of 1929–30 into the Great Depression. The empirical support for the validity of the nonmonetary/financial hypothesis during the Depression is substantial (Bernanke, 1983; Fackler and Parker, 1994, 2001; Hamilton, 1987, 1992), although support for the “credit view” for the transmission mechanism of monetary policy in post-World War II economic activity is substantially weaker. In combination, considering the preponderance of empirical results and historical simulations contained in the economic literature, the monetary hypothesis and the nonmonetary/financial hypothesis go a substantial distance toward accounting for the economic experiences of the United States during the Great Depression.

The Role of Pessimistic Expectations

To this combination, the behavior of expectations should also be added. As explained by James Tobin, there was another reason for a “change in the character of the contraction” in 1931. Although Friedman and Schwartz attribute this “change” to the bank panics that occurred, Tobin points out that change also took place because of the emergence of pessimistic expectations. If it was thought that the early stages of the Depression were symptomatic of a recession that was not different in kind from similar episodes in our economic history, and that recovery was a real possibility, the public need not have had pessimistic expectations. Instead the public may have anticipated things would get better. However, after the British left the gold standard, expectations changed in a very pessimistic way. The public may very well have believed that the business cycle downturn was not going to be reversed, but rather was going to get worse than it was. When households and business investors begin to make plans based on the economy getting worse instead of making plans based on anticipations of recovery, the depressing economic effects on consumption and investment of this switch in expectations are common knowledge in the modern macroeconomic literature. For the literature on the Great Depression, the empirical research conducted on the expectations hypothesis focuses almost exclusively on uncertainty (which is not the same thing as pessimistic/optimistic expectations) and its contribution to the onset of the Depression (Romer, 1990; Flacco and Parker, 1992). Although Keynes (1936) writes extensively about the state of expectations and their economic influence, the literature is silent regarding the empirical validity of the expectations hypothesis in 1931–33. Yet, in spite of this, the continued shocks that the United States’ economy received demonstrated that the business cycle downturn of 1931–33 was of a different kind than had previously been known. Once the public believed this to be so and made their plans accordingly, the results had to have been economically devastating. There is no formal empirical confirmation and I have not segregated the expectations hypothesis as a separate hypothesis in the overview. However, the logic of the above argument compels me to be of the opinion that the expectations hypothesis provides an impressive addition to the monetary hypothesis and the nonmonetary/financial hypothesis in accounting for the economic experiences of the United States during the Great Depression.

The Gold Standard Hypothesis

Recent research on the operation of the interwar gold standard has deepened our understanding of the Depression and its international character. The way and manner in which the interwar gold standard was structured and operated provide a convincing explanation of the international transmission of deflation and depression that occurred in the 1930s.

The story has its beginning in the 1870–1914 period. During this time the gold standard functioned as a pegged exchange rate system where certain rules were observed. Namely, it was necessary for countries to permit their money supplies to be altered in response to gold flows in order for the price-specie flow mechanism to function properly. It operated successfully because countries that were gaining gold allowed their money supply to increase and raise the domestic price level to restore equilibrium and maintain the fixed exchange rate of their currency. Countries that were losing gold were obligated to permit their money supply to decrease and generate a decline in their domestic price level to restore equilibrium and maintain the fixed exchange rate of their currency. Eichengreen (1992) discusses and extensively documents that the gold standard of this period functioned as smoothly as it did because of the international commitment countries had to the gold standard and the level of international cooperation exhibited during this time. “What rendered the commitment to the gold standard credible, then, was that the commitment was international, not merely national. That commitment was activated through international cooperation” (Eichengreen, 1992).

The gold standard was suspended when the hostilities of World War I broke out. By the end of 1928, major countries such as the United States, the United Kingdom, France and Germany had re-established ties to a functioning fixed exchange rate gold standard. However, Eichengreen (1992) points out that the world in which the gold standard functioned before World War I was not the same world in which the gold standard was being re-established. A credible commitment to the gold standard, as Hamilton (1988) explains, required that a country maintain fiscal soundness and political objectives that insured the monetary authority could pursue a monetary policy consistent with long-run price stability and continuous convertibility of the currency. Successful operation required these conditions to be in place before re-establishment of the gold standard was operational. However, many governments during the interwar period went back on the gold standard in the opposite set of circumstances. They re-established ties to the gold standard because they were incapable, due to the political chaos generated after World War I, of fiscal soundness and did not have political objectives conducive to reforming monetary policy such that it could insure long-run price stability. “By this criterion, returning to the gold standard could not have come at a worse time or for poorer reasons” (Hamilton, 1988). Kindleberger (1973) stresses the fact that the pre-World War I gold standard functioned as well as it did because of the unquestioned leadership exercised by Great Britain. After World War I and the relative decline of Britain, the United States did not exhibit the same strength of leadership Britain had shown before. The upshot is that it was an unsuitable environment in which to re-establish the gold standard after World War I and the interwar gold standard was destined to drift in a state of malperformance as no one took responsibility for its proper functioning. However, the problems did not end there.

Flaws in the Interwar International Gold Standard

Lack of Symmetry in the Response of Gold-Gaining and Gold-Losing Countries

The interwar gold standard operated with four structural/technical flaws that almost certainly doomed it to failure (Eichengreen, 1986; Temin, 1989; Bernanke and James, 1991). The first, and most damaging, was the lack of symmetry in the response of gold-gaining countries and gold-losing countries that resulted in a deflationary bias that was to drag the world deeper into deflation and depression. If a country was losing gold reserves, it was required to decrease its money supply to maintain its commitment to the gold standard. Given that a minimum gold reserve had to be maintained and that countries became concerned when the gold reserve fell within 10 percent of this minimum, little gold could be lost before the necessity of monetary contraction, and thus deflation, became a reality. Moreover, with a fractional gold reserve ratio of 40 percent, the result was a decline in the domestic money supply equal to 2.5 times the gold outflow. On the other hand, there was no such constraint on countries that experienced gold inflows. Gold reserves were accumulated without the binding requirement that the domestic money supply be expanded. Thus the price–specie flow mechanism ceased to function and the equilibrating forces of the pre-World War I gold standard were absent during the interwar period. If a country attracting gold reserves were to embark on a contractionary path, the result would be the further extraction of gold reserves from other countries on the gold standard and the imposition of deflation on their economies as well, as they were forced to contract their money supplies. “As it happened, both of the two major gold surplus countries – France and the United States, who at the time together held close to 60 percent of the world’s monetary gold – took deflationary paths in 1928–1929” (Bernanke and James, 1991).

Foreign Exchange Reserves

Second, countries that did not have reserve currencies could hold their minimum reserves in the form of both gold and convertible foreign exchange reserves. If the threat of devaluation of a reserve currency appeared likely, a country holding foreign exchange reserves could divest itself of the foreign exchange, as holding it became a more risky proposition. Further, the convertible reserves were usually only fractionally backed by gold. Thus, if countries were to prefer gold holdings as opposed to foreign exchange reserves for whatever reason, the result would be a contraction in the world money supply as reserves were destroyed in the movement to gold. This effect can be thought of as equivalent to the effect on the domestic money supply in a fractional reserve banking system of a shift in the public’s money holdings toward currency and away from bank deposits.

The Bank of France and Open Market Operations

Third, the powers of many European central banks were restricted or excluded outright. In particular, as discussed by Eichengreen (1986), the Bank of France was prohibited from engaging in open market operations, i.e. the purchase or sale of government securities. Given that France was one of the countries amassing gold reserves, this restriction largely prevented them from adhering to the rules of the gold standard. The proper response would have been to expand their supply of money and inflate so as not to continue to attract gold reserves and impose deflation on the rest of the world. This was not done. France continued to accumulate gold until 1932 and did not leave the gold standard until 1936.

Inconsistent Currency Valuations

Lastly, the gold standard was re-established at parities that were unilaterally determined by each individual country. When France returned to the gold standard in 1926, it returned at a parity rate that is believed to have undervalued the franc. When Britain returned to the gold standard in 1925, it returned at a parity rate that is believed to have overvalued the pound. In this situation, the only sustainable equilibrium required the French to inflate their economy in response to the gold inflows. However, given their legacy of inflation during the 1921–26 period, France steadfastly resisted inflation (Eichengreen, 1986). The maintenance of the gold standard and the resistance to inflation were now inconsistent policy objectives. The Bank of France’s inability to conduct open market operations only made matters worse. The accumulation of gold and the exporting of deflation to the world was the result.

The Timing of Recoveries

Taken together, the flaws described above made the interwar gold standard dysfunctional and in the end unsustainable. Looking back, we observe that the record of departure from the gold standard and subsequent recovery was different for many different countries. For some countries recovery came sooner. For some it came later. It is in this timing of departure from the gold standard that recent research has produced a remarkable empirical finding. From the work of Choudri and Kochin (1980), Eichengreen and Sachs (1985), Temin (1989), and Bernanke and James (1991), we now know that the sooner a country abandoned the gold standard, the quicker recovery commenced. Spain, which never restored its participation in the gold standard, missed the ravages of the Depression altogether. Britain left the gold standard in September 1931, and started to recover. Sweden left the gold standard at the same time as Britain, and started to recover. The United States left in March 1933, and recovery commenced. France, Holland, and Poland continued to have their economies struggle after the United States’ recovery began as they continued to adhere to the gold standard until 1936. Only after they left did recovery start; departure from the gold standard freed a country from the ravages of deflation.

The Fed and the Gold Standard: The “Midas Touch”

Temin (1989) and Eichengreen (1992) argue that it was the unbending commitment to the gold standard that generated deflation and depression worldwide. They emphasize that the gold standard required fiscal and monetary authorities around the world to submit their economies to internal adjustment and economic instability in the face of international shocks. Given how the gold standard tied countries together, if the gold parity were to be defended and devaluation was not an option, unilateral monetary actions by any one country were pointless. The end result is that Temin (1989) and Eichengreen (1992) reject Friedman and Schwartz’s (1963) claim that the Depression was caused by a series of policy failures on the part of the Federal Reserve. Actions taken in the United States, according to Temin (1989) and Eichengreen (1992), cannot be properly understood in isolation with respect to the rest of the world. If the commitment to the gold standard was to be maintained, monetary and fiscal authorities worldwide had little choice in responding to the crises of the Depression. Why did the Federal Reserve continue a policy of inaction during the banking panics? Because the commitment to the gold standard, what Temin (1989) has labeled “The Midas Touch,” gave them no choice but to let the banks fail. Monetary expansion and the injection of liquidity would lower interest rates, lead to a gold outflow, and potentially be contrary to the rules of the gold standard. Continued deflation due to gold outflows would begin to call into question the monetary authority’s commitment to the gold standard. “Defending gold parity might require the authorities to sit idly by as the banking system crumbled, as the Federal Reserve did at the end of 1931 and again at the beginning of 1933” (Eichengreen, 1992). Thus, if the adherence to the gold standard were to be maintained, the money supply was endogenous with respect to the balance of payments and beyond the influence of the Federal Reserve.

Eichengreen (1992) concludes further that what made the pre-World War I gold standard so successful was absent during the interwar period: credible commitment to the gold standard activated through international cooperation in its implementation and management. Had these important ingredients of the pre-World War I gold standard been present during the interwar period, twentieth-century economic history may have been very different.

Recovery and the New Deal

March 1933 was the rock bottom of the Depression and the inauguration of Franklin D. Roosevelt represented a sharp break with the status quo. Upon taking office, a bank holiday was declared, the United States left the interwar gold standard the following month, and the government commenced with several measures designed to resurrect the financial system. These measures included: (i) the establishment of the Reconstruction Finance Corporation which set about funneling large sums of liquidity to banks and other intermediaries; (ii) the Securities Exchange Act of 1934 which established margin requirements for bank loans used to purchase stocks and bonds and increased information requirements to potential investors; and (iii) the Glass–Steagal Act which strictly separated commercial banking and investment banking. Although delivering some immediate relief to financial markets, lenders continued to be reluctant to extend credit after the events of 1929–33, and the recovery of financial markets was slow and incomplete. Bernanke (1983) estimates that the United States’ financial system did not begin to shed the inefficiencies under which it was operating until the end of 1935.


Policies designed to promote different economic institutions were enacted as part of the New Deal. The National Industrial Recovery Act (NIRA) was passed on June 6, 1933 and was designed to raise prices and wages. In addition, the Act mandated the formation of planning boards in critical sectors of the economy. The boards were charged with setting output goals for their respective sector and the usual result was a restriction of production. In effect, the NIRA was a license for industries to form cartels and was struck down as unconstitutional in 1935. The Agricultural Adjustment Act of 1933 was similar legislation designed to reduce output and raise prices in the farming sector. It too was ruled unconstitutional in 1936.

Relief and Jobs Programs

Other policies intended to provide relief directly to people who were destitute and out of work were rapidly enacted. The Civilian Conservation Corps (CCC), the Tennessee Valley Authority (TVA), the Public Works Administration (PWA) and the Federal Emergency Relief Administration (FERA) were set up shortly after Roosevelt took office and provided jobs for the unemployed and grants to states for direct relief. The Civil Works Administration (CWA), created in 1933–34, and the Works Progress Administration (WPA), created in 1935, were also designed to provide work relief to the jobless. The Social Security Act was also passed in 1935. There surely are other programs with similar acronyms that have been left out, but the intent was the same. In the words of Roosevelt himself, addressing Congress in 1938:

Government has a final responsibility for the well-being of its citizenship. If private co-operative endeavor fails to provide work for the willing hands and relief for the unfortunate, those suffering hardship from no fault of their own have a right to call upon the Government for aid; and a government worthy of its name must make fitting response. (Quoted from Polenberg, 2000)

The Depression had shown the inaccuracies of classifying the 1920s as a “new era.” Rather, the “new era,” as summarized by Roosevelt’s words above and initiated in government’s involvement in the economy, began in March 1933.

The NBER business cycle chronology shows continuous growth from March 1933 until May 1937, at which time a 13-month recession hit the economy. The business cycle rebounded in June 1938 and continued on its upward march to and through the beginning of the United States’ involvement in World War II. The recovery that started in 1933 was impressive, with real GNP experiencing annual rates of the growth in the 10 percent range between 1933 and December 1941, excluding the recession of 1937–38 (Romer, 1993). However, as reported by Romer (1993), real GNP did not return to its pre-Depression level until 1937 and real GNP did not catch up to its pre-Depression secular trend until 1942. Indeed, the unemployment rate, peaking at 25 percent in March 1933, continued to dwell near or above the double-digit range until 1940. It is in this sense that most economists attribute the ending of the Depression to the onset of World War II. The War brought complete recovery as the unemployment rate quickly plummeted after December 1941 to its nadir during the War of below 2 percent.

Explanations for the Pace of Recovery

The question remains, however, that if the War completed the recovery, what initiated it and sustained it through the end of 1941? Should we point to the relief programs of the New Deal and the leadership of Roosevelt? Certainly, they had psychological/expectational effects on consumers and investors and helped to heal the suffering experienced during that time. However, as shown by Brown (1956), Peppers (1973), and Raynold, McMillin and Beard (1991), fiscal policy contributed little to the recovery, and certainly could have done much more.

Once again we return to the financial system for answers. The abandonment of the gold standard, the impact this had on the money supply, and the deliverance from the economic effects of deflation would have to be singled out as the most important contributor to the recovery. Romer (1993) stresses that Eichengreen and Sachs (1985) have it right; recovery did not come before the decision to abandon the old gold parity was made operational. Once this became reality, devaluation of the currency permitted expansion in the money supply and inflation which, rather than promoting a policy of beggar-thy-neighbor, allowed countries to escape the deflationary vortex of economic decline. As discussed in connection with the gold standard hypothesis, the simultaneity of leaving the gold standard and recovery is a robust empirical result that reflects more than simple temporal coincidence.

Romer (1993) reports an increase in the monetary base in the United States of 52 percent between April 1933 and April 1937. The M1 money supply virtually matched this increase in the monetary base, with 49 percent growth over the same period. The sources of this increase were two-fold. First, aside from the immediate monetary expansion permitted by devaluation, as Romer (1993) explains, monetary expansion continued into 1934 and beyond as gold flowed to the United States from Europe due to the increasing political unrest and heightened probability of hostilities that began the progression to World War II. Second, the increase in the money supply matched the increase in the monetary base and the Treasury chose not to sterilize the gold inflows. This is evidence that the monetary expansion resulted from policy decisions and not endogenous changes in the money multiplier. The new regime was freed from the constraints of the gold standard and the policy makers were intent on taking actions of a different nature than what had been done between 1929 and 1933.

Incompleteness of the Recovery before WWII

The Depression had turned a corner and the economy was emerging from the abyss in 1933. However, it still had a long way to go to reach full recovery. Friedman and Schwartz (1963) comment that “the most notable feature of the revival after 1933 was not its rapidity but its incompleteness.” They claim that monetary policy and the Federal Reserve were passive after 1933. The monetary authorities did nothing to stop the fall from 1929 to 1933 and did little to promote the recovery. The Federal Reserve made no effort to increase the stock of high-powered money through the use of either open market operations or rediscounting; Federal Reserve credit outstanding remained “almost perfectly constant from 1934 to mid-1940” (Friedman and Schwartz, 1963). As we have seen above, it was the Treasury that was generating increases in the monetary base at the time by issuing gold certificates equal to the amount of gold reserve inflow and depositing them at the Federal Reserve. When the government spent the money, the Treasury swapped the gold certificates for Federal Reserve notes and this expanded the monetary base (Romer, 1993). Monetary policy was thought to be powerless to promote recovery, and instead it was fiscal policy that became the implement of choice. The research shows that fiscal policy could have done much more to aid in recovery – ironically fiscal policy was the vehicle that was now the focus of attention. There is an easy explanation for why this is so.

The Emergences of Keynes

The economics profession as a whole was at a loss to provide cogent explanations for the events of 1929–33. In the words of Robert Gordon (1998), “economics had lost its intellectual moorings, and it was time for a new diagnosis.” There were no convincing answers regarding why the earlier theories of macroeconomic behavior failed to explain the events that were occurring, and worse, there was no set of principles that established a guide for proper actions in the future. That changed in 1936 with the publication of Keynes’s book The General Theory of Employment, Interest and Money. Perhaps there has been no other person and no other book in economics about which so much has been written. Many consider the arrival of Keynesian thought to have been a “revolution,” although this too is hotly contested (see, for example, Laidler, 1999). The debates that The General Theory generated have been many and long-lasting. There is little that can be said here to add or subtract from the massive literature devoted to the ideas promoted by Keynes, whether they be viewed right or wrong. But the influence over academic thought and economic policy that was generated by The General Theory is not in doubt.

The time was right for a set of ideas that not only explained the Depression’s course of events, but also provided a prescription for remedies that would create better economic performance in the future. Keynes and The General Theory, at the time the events were unfolding, provided just such a package. When all is said and done, we can look back in hindsight and argue endlessly about what Keynes “really meant” or what the “true” contribution of Keynesianism has been to the world of economics. At the time the Depression happened, Keynes represented a new paradigm for young scholars to latch on to. The stage was set for the nurturing of macroeconomics for the remainder of the twentieth century.

This article is a modified version of the introduction to Randall Parker, editor, Reflections on the Great Depression, Edward Elgar Publishing, 2002.


Olney, Martha. “Avoiding Default:The Role of Credit in the Consumption Collapse of 1930.” Quarterly Journal of Economics 114, no. 1 (1999): 319-35.

Anderson, Barry L. and James L. Butkiewicz. “Money, Spending and the Great Depression.” Southern Economic Journal 47 (1980): 388-403.

Balke, Nathan S. and Robert J. Gordon. “Historical Data.” In The American Business Cycle: Continuity and Change, edited by Robert J. Gordon. Chicago: University of Chicago Press, 1986.

Bernanke, Ben S. “Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression.” American Economic Review 73, no. 3 (1983): 257-76.

Bernanke, Ben S. and Harold James. “The Gold Standard, Deflation, and Financial Crisis in the Great Depression: An International Comparison.” In Financial Markets and Financial Crises, edited by R. Glenn Hubbard. Chicago: University of Chicago Press, 1991.

Brown, E. Cary. “Fiscal Policy in the Thirties: A Reappraisal.” American Economic Review 46, no. 5 (1956): 857-79.

Cecchetti, Stephen G. “Prices during the Great Depression: Was the Deflation of 1930-1932 Really Anticipated?” American Economic Review 82, no. 1 (1992): 141-56.

Cecchetti, Stephen G. “Understanding the Great Depression: Lessons for Current Policy.” In The Economics of the Great Depression, edited by Mark Wheeler. Kalamazoo, MI: W.E. Upjohn Institute for Employment Research, 1998.

Cecchetti, Stephen G. and Georgios Karras. “Sources of Output Fluctuations during the Interwar Period: Further Evidence on the Causes of the Great Depression.” Review of Economics and Statistics 76, no. 1 (1994): 80-102

Choudri, Ehsan U. and Levis A. Kochin. “The Exchange Rate and the International Transmission of Business Cycle Disturbances: Some Evidence from the Great Depression.” Journal of Money, Credit, and Banking 12, no. 4 (1980): 565-74.

De Long, J. Bradford and Andrei Shleifer. “The Stock Market Bubble of 1929: Evidence from Closed-end Mutual Funds.” Journal of Economic History 51, no. 3 (1991): 675-700.

Eichengreen, Barry. “The Bank of France and the Sterilization of Gold, 1926–1932.” Explorations in Economic History 23, no. 1 (1986): 56-84.

Eichengreen, Barry. Golden Fetters: The Gold Standard and the Great Depression, 1919–1939. New York: Oxford University Press, 1992.

Eichengreen, Barry and Jeffrey Sachs. “Exchange Rates and Economic Recovery in the 1930s.” Journal of Economic History 45, no. 4 (1985): 925-46.

Evans, Martin and Paul Wachtel. “Were Price Changes during the Great Depression Anticipated? Evidence from Nominal Interest Rates.” Journal of Monetary Economics 32, no. 1 (1993): 3-34.

Fackler, James S. and Randall E. Parker. “Accounting for the Great Depression: A Historical Decomposition.” Journal of Macroeconomics 16 (1994): 193-220.

Fackler, James S. and Randall E. Parker. “Was Debt Deflation Operative during the Great Depression?” East Carolina University Working Paper, 2001.

Fisher, Irving. “The Debt–Deflation Theory of Great Depressions.” Econometrica 1, no. 4 (1933): 337-57.

Flacco, Paul R. and Randall E. Parker. “Income Uncertainty and the Onset of the Great Depression.” Economic Inquiry 30, no. 1 (1992): 154-71.

Friedman, Milton and Anna J. Schwartz. A Monetary History of the United States, 1867–1960. Princeton, NJ: Princeton University Press, 1963.

Gordon, Robert J. Macroeconomics, seventh edition. New York: Addison Wesley, 1998.

Hamilton, James D. “Monetary Factors in the Great Depression.” Journal of Monetary Economics 13 (1987): 1-25.

Hamilton, James D. “Role of the International Gold Standard in Propagating the Great Depression.” Contemporary Policy Issues 6, no. 2 (1988): 67-89.

Hamilton, James D. “Was the Deflation during the Great Depression Anticipated? Evidence from the Commodity Futures Market.” American Economic Review 82, no. 1 (1992): 157-78.

Hayek, Friedrich A. von. Monetary Theory and the Trade Cycle. New

York: A. M. Kelley, 1967 (originally published in 1929).

Hayek, Friedrich A. von, Prices and Production. New York: A. M.

Kelley, 1966 (originally published in 1931).

Hoover, Herbert. The Memoirs of Herbert Hoover: The Great Depression, 1929–1941. New York: Macmillan, 1952.

Keynes, John M. The General Theory of Employment, Interest, and Money. London: Macmillan, 1936.

Kindleberger, Charles P. The World in Depression, 1929–1939. Berkeley: University of California Press, 1973.

Laidler, David. Fabricating the Keynesian Revolution. Cambridge: Cambridge University Press, 1999.

McCallum, Bennett T. “Could a Monetary Base Rule Have Prevented the Great Depression?” Journal of Monetary Economics 26 (1990): 3-26.

Meltzer, Allan H. “Monetary and Other Explanations of the Start of the Great Depression.” Journal of Monetary Economics 2 (1976): 455-71.

Mishkin, Frederick S. “The Household Balance Sheet and the Great Depression.” Journal of Economic History 38, no. 4 (1978): 918-37.

Nelson, Daniel B. “Was the Deflation of 1929–1930 Anticipated? The Monetary Regime as Viewed by the Business Press.” Research in Economic History 13 (1991): 1-65.

Peppers, Larry. “Full Employment Surplus Analysis and Structural Change: The 1930s.” Explorations in Economic History 10 (1973): 197-210..

Persons, Charles E. “Credit Expansion, 1920 to 1929, and Its Lessons.” Quarterly Journal of Economics 45, no. 1 (1930): 94-130.

Polenberg, Richard. The Era of Franklin D. Roosevelt, 1933–1945: A Brief History with Documents. Boston: Bedford/St. Martin’s, 2000.

Raynold, Prosper, W. Douglas McMillin and Thomas R. Beard. “The Impact of Federal Government Expenditures in the 1930s.” Southern Economic Journal 58, no. 1 (1991): 15-28.

Romer, Christina D. “World War I and the Postwar Depression: A Reappraisal Based on Alternative Estimates of GNP.” Journal of Monetary Economics 22, no. 1 (1988): 91-115.

Romer, Christina D. “The Great Crash and the Onset of the Great Depression.” Quarterly Journal of Economics 105, no. 3 (1990): 597-624.

Romer, Christina D. “The Nation in Depression.” Journal of Economic Perspectives 7, no. 2 (1993): 19-39.

Snowdon, Brian and Howard R. Vane. Conversations with Leading Economists: Interpreting Modern Macroeconomics, Cheltenham, UK: Edward Elgar, 1999.

Soule, George H. Prosperity Decade, From War to Depression: 1917–1929. New York: Rinehart, 1947.

Temin, Peter. Did Monetary Forces Cause the Great Depression? New York: W.W. Norton, 1976.

Temin, Peter. Lessons from the Great Depression. Cambridge, MA: MIT Press, 1989.

White, Eugene N. “The Stock Market Boom and Crash of 1929 Revisited.” Journal of Economic Perspectives 4, no. 2 (1990): 67-83.

Wicker, Elmus. “Federal Reserve Monetary Policy, 1922–33: A Reinterpretation.” Journal of Political Economy 73, no. 4 (1965): 325-43.

1 Bankers’ acceptances are explained at

2 Liquidity is the ease of converting an asset into money.

3 The monetary base is measured as the sum of currency in the hands of the public plus reserves in the banking system. It is also called high-powered money since the monetary base is the quantity that gets multiplied into greater amounts of money supply as banks make loans and people spend and thereby create new bank deposits.

4 The money multiplier equals [D/R*(1 + D/C)]/(D/R + D/C + D/E), where

D = deposits, R = reserves, C = currency and E = excess reserves in the

banking system.

5 The real interest rate adjusts the observed (nominal) interest rate for inflation or deflation. Ex post refers to the real interest rate after the actual change in prices has been observed; ex ante refers to the real interest rate that is expected at the time the lending occurs.

6 See note 3.

Citation: Parker, Randall. “An Overview of the Great Depression”. EH.Net Encyclopedia, edited by Robert Whaples. March 16, 2008. URL

Fighting Foreclosure: The Blaisdell Case, the Contract Clause, and the Great Depression

Author(s):Fliter, John A.
Hoff, Derek S.
Reviewer(s):Wheelock, David C.

Published by EH.Net (January 2013)

John A. Fliter and Derek S. Hoff, Fighting Foreclosure: The Blaisdell Case, the Contract Clause, and the Great Depression. Lawrence, KS: University Press of Kansas, 2012. x + 222 pp. $20 (paperback), ISBN: 978-0-7006-1872-9.

Reviewed for EH.Net by David C. Wheelock, Federal Reserve Bank of St. Louis.

John A. Fliter and Derek S. Hoff, professors of political science and history, respectively, at Kansas State University, have written an engaging history of mortgage foreclosures during the Great Depression ? Fighting Foreclosure: The Blaisdell Case, the Contract Clause, and the Great Depression.? The focus of Fighting Foreclosure is on the Minnesota Mortgage Moratorium Act of 1933 and its adjudication in state and federal courts, all the way through to the U.S. Supreme Court decision that deemed the act constitutional. That decision, Home Building and Loan Association v. Blaisdell (1934), was precedent setting and, the authors argue, revealed the Court?s ?increased willingness to uphold state efforts to respond to the Great Depression and augured the Court?s complete acceptance of the New Deal?; that acceptance would culminate in the Court?s later and more famous decisions, West Coast Hotel v. Parrish (1937) and NLRB v. Jones and Laughlin Steel (1937).

Twenty-seven states enacted mortgage foreclosure moratoriums during 1933-34 after a collapse of incomes and property values had caused farm and residential mortgage delinquencies and foreclosures to soar. Mortgage lenders argued that state foreclosure moratoriums violated the Contract Clause (Article 1, Section 10) of the U.S. Constitution. However, in the Blaisdell case, the U.S. Supreme Court ruled that temporary moratoriums, enacted in national emergencies, did not violate the Clause.

The book?s first two chapters discuss the origins of the Contract Clause and its legal history prior to the Great Depression. Although states sometimes enacted debtor-relief laws during economic crises, Fliter and Hoff argue that the courts generally limited state interference in private contracts until the Great Depression. The authors point to the 90-year precedent set by Bronson v. Kinzie (1843), in which the Supreme Court struck down two Illinois laws that restricted mortgages and extended redemption periods as violations of the Contract Clause.

Chapters 3 through 5 review the farm protest movement of the Great Depression, the legislative history of the Minnesota Mortgage Moratorium Act of 1933, and its adjudication in Minnesota state courts. Most of the remainder of the book focuses on the consideration of the Blaisdell case by the U.S. Supreme Court. Chapter 6 describes the views of the individual members of the Supreme Court, particularly views related to the Contract Clause, private property, and state police powers. Chapter 7 focuses on the oral and written arguments by each side in the Blaisdell case and the Court?s decision.

The sharply divided Supreme Court upheld the Minnesota foreclosure moratorium in a 5-to-4 decision, written by Chief Justice Charles Evans Hughes. Hughes argued that the ambiguities of the Contract Clause allowed for states to exercise their implied police powers to alter the terms of contracts in emergency situations. Hughes concluded that the Minnesota law was constitutional in that 1) an emergency existed that provided an occasion for the use of government police powers; 2) the foreclosure moratorium was in the public interest and did not privilege a particular group; 3) the relief to mortgagors by the act was commensurate with the scale of the emergency; 4) the provisions of the act were reasonable; and 5) the act was temporary and limited to the existing emergency. Fliter and Hoff show that Hughes? published opinion had been influenced by the Court?s liberals, especially Benjamin Cardozo, who argued for interpreting the Constitution ?in light of our whole experience and not merely what was said a hundred years ago.?

The dissenting opinion in the Blaisdell case, written by George Sutherland, argued that the ?meaning of constitutional provisions is changeless? and noted that the authors of the Constitution inserted the Contract Clause precisely to prevent governments from relieving debtors of their obligations, especially during times of distress. Clearly, the Blaisdell case struck at the heart of the long-standing debate over whether the Constitution should be interpreted literally, with considerable emphasis on the framers? intent, or with flexibility and less reliance on the framers? intent than on current circumstances.

The book?s final chapters discuss the immediate reaction to the Blaisdell decision and consider whether that decision and subsequent rulings have meant the death of the Contract Clause. The authors note that the clause has been ?on life support? since the Blaisdell decision and that the Supreme Court has not decided a Contract Clause case in some thirty years.

The book includes a postscript about the mortgage crisis that began in 2007. The responses of federal and state governments to the home mortgage crisis of 2007-08 differed from those during the Great Depression. To a much greater extent, resolution of the recent crisis was left to market forces, including protracted foreclosures. Relatively few delinquent mortgages were resolved under any of the federal programs created to ease the crisis, and though some states considered imposing moratoriums on foreclosures, only a few states adopted them. Fliter and Hoff attribute the comparatively tepid response of states and the federal government to the recent mortgage crisis to a long-ongoing ideological shift in which ?conservatives have set the terms of the nation?s major policy discussions, especially those regarding the economy.?

Many economic historians will find this conclusion either inaccurate or too simplistic an explanation for the comparatively weaker responses of states and the federal government to the recent mortgage crisis. Fliter and Hoff acknowledge that ?conservative? economists and historians have shown that state interventions in credit markets, including the foreclosure moratoriums of the Great Depression, impose real costs by reducing the supply of credit. Further, they note the presence of other forms of social insurance, such as unemployment benefits, that did not exist during the Depression. Indeed, perhaps the comparison of the recent crisis with the Great Depression has been overplayed and the comparatively limited response of governments has been less due to shifting ideology than to the fact that the recent mortgage crisis and recession, though severe, pale in comparison with the Great Depression. Despite some quibbles about the book?s interpretation of recent events, I recommend Fighting Foreclosure to economic historians of property rights and institutions, as well as those who study mortgage markets and the Great Depression. The book is highly readable and informative.

David C. Wheelock is vice president and deputy director of research at the Federal Reserve Bank of St. Louis ( His research interests include U.S. monetary and financial history, the Great Depression, banking, and monetary policy (
Copyright (c) 2013 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator ( Published by EH.Net (January 2013). All EH.Net reviews are archived at

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Government, Law and Regulation, Public Finance
Geographic Area(s):North America
Time Period(s):20th Century: Pre WWII

America?s First Great Depression: Economic Crisis and Political Disorder after the Panic of 1837

Author(s):Roberts, Alasdair
Reviewer(s):Rousseau, Peter L.

Published by EH.Net (September 2012)

Alasdair Roberts, America?s First Great Depression: Economic Crisis and Political Disorder after the Panic of 1837. Ithaca, NY: Cornell University Press, 2012. vii + 255 pp. $26 (hardcover), ISBN: 978-0-8014-5033-4.

Reviewed for EH.Net by Peter L. Rousseau, Department of Economics, Vanderbilt University.

In this entertaining monograph, Alasdair Roberts of Suffolk University?s Law School casts a long shadow on economic events near the end of the Jackson presidency. And while it is safe to say that the form of populism defined by Jackson influenced the nation?s course well beyond his term as President, it is challenging to build a model in which economic events of 1837 continued to drive domestic and international decisions a decade later. But Roberts makes the argument in a straightforward manner: hard times and repudiation of state debts heightened the level of rhetoric across the Atlantic and exacerbated territorial tensions between the United States and Britain. The United States, portrayed as being in no position to wage war directly with Britain, though it had been down that path several times before, responded to the apparent attack on national honor by starting the 1846-48 war with Mexico over Texas. Along the way, hard times produced civil unrest in Northeastern cities and in upstate New York, the former over voting rights and the latter over archaic land use policies. The ?long shadow? hypothesis goes beyond the standard economic analysis of the period that views the recession as turning around in 1843. This is thought provoking, but carrying the narrative forward through the Polk administration also requires moving from data to anecdote to speculation on causes and effects.

Roberts also intends to relate disturbances in the 1840s to current events in the United States and abroad. This is understandable. If hard times in the 1840s were driven by irresponsible excesses in state spending and an inability of the Federal government to broker a solution, parallels with the current U.S. crisis in personal debt and sovereign crises across the Eurozone seem almost immediate. Yet as economic historians we must be circumspect in viewing history as a simple series of repeating events devoid of learning in the interim.??

Using contemporary accounts to build a theory of the 1840s frees the author from standard economic analysis, which would rely strongly on empirical evidence to support its claims. Indeed, any economic motivation provided is conventional, drawing heavily but with little attribution from a number of important and more recent secondary works. Avoiding long-standing debates on the domestic and international causes of the financial panics of the 1830s, Roberts focuses on a narrative that places non-economic British headlines at the center of civil unrest and a rising nationalism in the United States. This Anglo-slanted view attributes the state bond defaults to bad investment decisions and rogue banking within the United States. British creditors are seen as indignant victims of U.S. actions, and the fact that British capital dried up well before the defaults is not considered as a possible cause of abandoned projects and debt repudiations. Rather, the United States is characterized as a federal state paralyzed by the realities of the world economic order and rife with the same types of reckless actors that many view as responsible for the 2008 recession.

Whether I agree with the emphasis applied in this interpretation or not, the book has led me to reconsider my priors about several important figures in the 1840s. For example, many financial historians think of the Tyler administration as both inept and ineffective. Tyler?s dismissal by his own party and veto of central bank legislation no doubt influence these views. But was the emergence from the recession just a cyclical rebound or the result of a strong nationalistic impulse and crackdown on civil disobedience set into motion by Tyler? Roberts makes an intriguing case that Tyler was actually a shrewd administrator who used the resources at hand to undo the unrest that came as direct consequences of actions by his predecessors.

The book gets a bit sidetracked as the Tyler administration closes and the narrative turns to territorial disputes taken up by President Polk. This is not to say that the stories are uninteresting! But linking them to the panics and state debt defaults is speculative at best. After all, to say that disparaging public statements by influential British creditors in the early 1840s caused the United States to lay claim to territory that seemed naturally within its domain reaches well beyond basic economics. And to say that the hard times of the 1840s were the reason why individuals in Philadelphia, Providence and upstate New York turned to violent protests and other unlawful acts is again not obvious. Indeed it seems just as likely that people who felt disenfranchised by the political process would rise against an unsustainable status quo recession or not.

At the same time, economists are sometimes too closely bound by the discipline of rigorous theories and the scanty data that often represent the only evidence available for testing them. If a narrative theory can be put forward that relies on anecdotal and contextual evidence, why worry that the argument is something less than airtight? In this respect Roberts does students of the period a service by thinking outside of the normal constraints to conjure a broad and international view of the decade that followed the Jackson presidency.

Peter L. Rousseau is Professor of Economics at Vanderbilt University and Secretary-Treasurer of the American Economic Association. He is author of ?Jacksonian Monetary Policy, Specie Flows, and the Panic of 1837,? Journal of Economic History 62:2 (2002), 457-88.
Copyright (c) 2012 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator ( Published by EH.Net (September 2012). All EH.Net reviews are archived at

Subject(s):Economic Planning and Policy
Government, Law and Regulation, Public Finance
Macroeconomics and Fluctuations
Geographic Area(s):North America
Time Period(s):19th Century

Birth of a Market: The U.S. Treasury Securities Market from the Great War to the Great Depression

Author(s):Garbade, Kenneth D.
Reviewer(s):Noll, Franklin

Published by EH.Net (May 2012)

Kenneth D. Garbade, Birth of a Market: The U.S. Treasury Securities Market from the Great War to the Great Depression.? Cambridge, MA: MIT Press, 2012.? xii + 393 pp. $50 (hardcover), ISBN: 978-0-262-01637-7.

Reviewed for EH.Net by Franklin Noll, Noll Historical Consulting.

Kenneth Garbade has been doing path-breaking work for years in what I like to call the mechanics of Treasury finance.? In various case studies and articles, Garbade, Senior Vice President at the Federal Reserve Bank of New York, has charted the origins of the sometimes revolutionary developments in Treasury financing that we now take for granted, including book-entry securities and Treasury auctions.? In Birth of a Market, he applies his special insight to the changes in Treasury financing methods during the interwar period. Attention to this topic is long overdue as sixty years have passed since the last detailed examination of Treasury debt management in the mid-twentieth century.

In his book, Garbade argues that between 1917 and 1939 the Treasury undertook four initiatives that made possible the familiar post-World War II primary securities market: the revival of auction sales, the linkage of Treasury cash and debt management, the loosening of Congressional constraints on Treasury management of the debt, and the start of offering securities on a regular, consistent schedule.? These developments, in turn, were caused by the Treasury?s reaction to the new reality of a large, permanent public debt created during the period.

At the start of World War I, most securities were being sold at auction.? This changed with the U.S. entry into the war.? Aiming to expand the market for the Liberty Loan bonds beyond large New York banks and to build popular support for the war, the Treasury promoted fixed-price subscription sales to appeal to less sophisticated investors.? This sales approach took hold in the Treasury after the war.? The road back to auctions began with a new instrument called a Treasury bill.? As an initiative to integrate Treasury cash and debt management, bills were introduced in 1929 as short-term funding instruments.? Their sale by auction provided flexibility in both the timing and amount of issuance, which was next to impossible with subscription sales.

The interwar period also marked a transition in Congressional and Treasury views of the nature of debt offerings and the public debt.? Prior to the 1920s, Garbade argues, debt was issued for a specific purpose such as to finance a war or to accomplish a particular task.? However, after World War I, the public debt increasingly came to be seen as something permanent that needed to be managed.? By 1939, Congress had ceded to the Treasury all debt management responsibilities, maintaining only the right to set a debt limit ceiling.? Managing a continual debt forced the Treasury to think in terms of ?issuance programs? that would provide for the ongoing need to refinance maturing securities.? This realization was the start of the ?regular and predictable? offerings that are now a fundamental Treasury strategy.?

In presenting his points, Garbade needs to be hailed for his explanations of the workings of Treasury securities? issuance and management.? His discussion of pre-World War I issues is revelatory, explaining how various factors merged to create a specific issue and method of issuance.? His descriptions of the rationales behind the various wartime Liberty Loan bonds and notes are probably the most concise and informative written.? He also delves into the long ignored subjects of the operation of New Deal program funding, the challenges of subscription issuance, and the interconnections between National Bank Notes and Treasury debt in the 1930s.

The weakness of Garbade?s interpretation, which he shares with his predecessors, is an overly narrow conception of causation for changes in Treasury actions, focusing almost exclusively on pressures arising from Treasury financial imperatives and the reactions of financial markets.? No doubt much of the reason for this stems from dependence by researchers on official Treasury reports and the financial press for a majority of their evidence.

Garbade fails to factor in the ideological and political forces of the thrift movement and efforts toward the democratization of investment.? (Before, during, and after World War I, the federal government made repeated attempts to bypass financial institutions and sell debt instruments directly to the general public.)? As a result, Garbade overlooks that the period saw a running battle between the government and the (ultimately victorious) financial industry for the souls and money of the average investor.? What we see during the period ? with the sole exception of Savings Bonds ? is the active exclusion of small and medium investors from the primary market that would continue until the establishment of the Treasury Direct system at the end of the twentieth century.

Also missing from Garbade?s analysis is the growth of the buyers? side of the bond market.? After all, it takes two to make a market.? Though Garbade often talks about the market?s response to Treasury issues and discusses ?free riders,? one discovers little of the development of the market makers in Treasury securities.?? And, it is hard to believe that the influence of the bond dealers on the Treasury?s actions was limited to their enthusiasm, or lack thereof, to a bond issue.? The growing size and sophistication of the market as well as the Treasury?s increasing dependence on it no doubt gave the advantage to the bond dealers.? To what extent did the buyers rather than the seller give birth to the modern market?

More questions arise if we consider the other major player during the period ? the brand new Federal Reserve System.? As the Treasury?s fiscal agent, how was the market affected by the new systems it established to facilitate Treasury security transactions?? How did the Fed shape the market as it pressured banks to buy securities during World War I and set up its own portfolio of Treasury securities as it began open market operations?

The fact that Garbade?s account prompts all these questions attests not to the weakness of his analysis, but the degree of insight and clarity he brings to a long-neglected topic.? By clearing away the miasma surrounding the study of Treasury debt management, he lets us take long, hard looks at the subjects.? One can only hope that Garbade will build upon this work and continue to break new ground, giving us the story of the United States Treasury securities market in the late twentieth century.

Franklin Noll is president of Noll Historical Consulting and historical consultant to the U.S. Bureau of Engraving and Printing.? He is the author of ?The United States Monopolization of Bank Note Production: Politics, Government, and the Greenback, 1862-1878,? in American Nineteenth Century History (forthcoming) and is currently studying the post-Civil War debt crisis.

Copyright (c) 2012 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator ( Published by EH.Net (May 2012). All EH.Net reviews are archived at

Subject(s):Government, Law and Regulation, Public Finance
Geographic Area(s):North America
Time Period(s):20th Century: Pre WWII