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