Published by EH.NET (February 2003)
Gene Smiley, Rethinking the Great Depression. Chicago, IL: Ivan R. Dee,
2002. xii + 179 pp $24.95 (hardcover), ISBN: 1-56663-472-5.
Reviewed for EH.NET by David C. Wheelock, Federal Reserve Bank of St. Louis.
Despite being less than 200 pages, Gene Smiley’s Rethinking the Great
Depression is a fairly comprehensive, as well as highly readable, account
of the origins, depth and legacy of the Great Depression. The book is intended
for a non-specialist audience, and would be appropriate reading for
undergraduate courses in American economic history or macroeconomics.
The book’s first two chapters focus on the causes of the Great Depression and
why the Depression was especially severe in the United States. Smiley
attributes the world wide Depression to a breakdown of the international gold
standard. He describes how countries that had undervalued currencies, e.g., the
United States and France, prevented gold inflows from equilibrating national
money supplies and price levels during the 1920s. Tight monetary policy, Smiley
argues, largely explains the unusual severity of the Depression in the United
States. The Federal Reserve adopted a tight monetary policy in 1928 to stem
gold outflows and contain stock market speculation. The Fed remained tight
after the stock market crash in 1929 because of continued gold losses and
because Fed officials mistakenly interpreted low market interest rates and
little discount window borrowing as signaling that monetary policy was in fact
loose.
In addition to monetary forces, Smiley argues that rising real wage rates also
contributed to the severity of the Great Depression in the United States.
Previous economic downturns had been relatively short, he contends, because
nominal wage rates had declined when the price level fell to keep real wages
relatively constant. Consequently, output and employment fell less than during
the Great Depression, and recovery came sooner. Smiley attributes the changed
behavior of real wages during the Depression to President Hoover’s lobbying of
large corporations to not cut money wage rates in the hope of preventing large
declines in consumer spending.
The book’s next two chapters focus on the recovery phase of the Depression,
with emphasis on the New Deal. Smiley describes the slow, halting pace of
recovery, which he attributes to misguided government policies. He argues that
the principal policies of the “first” New Deal, including the Agricultural
Adjustment Act (AAA) and the National Industrial Recovery Act (NIRA), were
aimed as much or more at reform than at economic recovery. Roosevelt’s main
economic advisors had little confidence in capitalism or free markets, Smiley
contends, and favored industrial planning and cooperation between business,
labor and government. The spirit of both the AAA and NIRA reflected the view
that deflation was caused by excessive competition and too much production. The
AAA sought to raise farm prices by cutting output, permitting cooperative
marketing, and through government purchases of commodities at target prices.
The NIRA had a similar objective for the price of manufactured output, and led
to the creation of industrial codes that limited competition and production, as
well as instituting labor market reforms. Smiley explains that “the NRA was
attuned to discourage recovery, that is exactly what it did” (p. 100).
Next Smiley discusses the depression of 1937-38. National output grew strongly
in 1935-36, after the “shackles of the NRA” had been removed (p. 106). The
money stock grew rapidly during these years, primarily because of gold inflows
from abroad. The “golden avalanche” allowed banks to build up substantial
excess reserves, which caught the attention of the Federal Reserve Board. Fed
officials worried about the inflationary potential of excess reserves and
increased reserve requirements three times during 1936-37 to reduce them.
Although policymakers viewed excess reserves as being redundant, Smiley argues
that banks held excess reserves as precautionary balances and thus responded to
the Fed’s actions by reducing loans and selling securities, which increased
interest rates. The policy was thus contractionary. Higher taxes on business
associated with a new tax on undistributed corporate profits and the
introduction of Social Security, further contributed to the contraction,
according to Smiley.
The final chapter of the book focuses on the apparent return to full employment
and high output growth during World War II, and the legacy of the Great
Depression for postwar economic policy. Smiley first addresses the
macroeconomic effects of the war. He describes the return to full employment
and rapid output growth, but argues economic conditions (and data) were highly
distorted by the military build up, price controls and rationing. Nevertheless,
the war years were widely seen as providing evidence that fiscal policy could
maintain high employment, and helped bring Keynesian macroeconomics to the fore
among economists and policymakers.
Smiley traces the origins of major postwar government social programs,
regulations, and economic stabilization policies to the Great Depression and
World War II. He also describes how the Bretton Woods System, which
reconstituted the international gold standard after the war, was incompatible
with the Keynesian-influenced monetary and fiscal policies U.S. officials
pursued during the 1960s. In the quest for high employment, these policies
resulted in rising inflation that ultimately forced the breakdown of fixed
exchange rates and dollar convertibility.
Smiley’s interpretations of the origins and effects of the Great Depression are
orthodox. He largely ignores other explanations, such as the possibility that
rising income or wealth inequality, or financial speculation, helped bring
about the Depression. Although many economists would accept Smiley’s
explanations about the causes of the Great Depression, the alternative
explanations are widely believed, especially among non-economists. Hence, the
book might have been enhanced by a discussion of some alternative explanations
and their weaknesses. Similarly, Smiley’s interpretation of New Deal policies
on economic recovery are almost uniformly negative. Although he is careful to
identify how some policies benefited labor and other groups, the book could do
more to distinguish between the effects of New Deal policies on economic growth
and their other effects — for example, on infrastructure, rural
electrification, etc. Moreover, in arguing that New Deal policies retarded
economic recovery, Smiley focuses on disruptions to institutions that defined
property rights. It has been argued, however, that Roosevelt’s policies
stimulated recovery by giving consumers and firms confidence that recovery was
possible. Such effects are hard to quantify, but worth considering. Despite
these quibbles, I recommend this book as a widely accessible and clearly
written summary of the main causes of the Great Depression and its legacy for
economic policy.
David C. Wheelock is Assistant Vice President and Economist, Federal Reserve
Bank of St. Louis. He is author of The Strategy and Consistency of Federal
Reserve Monetary Policy, 1924-1933 (Cambridge, 1991) and numerous articles
on financial and monetary history.