The Economics of the Depression - causes and remedies
For the historical sequence of the events referred to, with links to accounts of those events, see the timelines subpage.
For definitions of the terms shown in italics see the glossary on the Related Articles subpage.
- For a summary of the statistics of the Great Depression in the United States, go to Great Depression in the United States/Tutorials.
The economic doctrines of the 1920s and 1930s
The prevailing attitude to recessions in the 1920s was the teaching of the Austrian School led by Friederich Hayek in London, and supported by eminent American economists. Recessions occur because consumption is mal-adapted to production. The cure therefore is not to stimulate consumption through inflationary policies because that just perpetuates "artificial" demand and delays any "real" cure. The only real cure is allowing the system to correct itself over time. Hayek wrote,
- "... still more difficult to see what lasting good effects can come from credit expansion. The thing which is most needed to secure healthy conditions is the most speedy and complete adaptation possible of the structure of production. If the proportion as determined by the voluntary decisions of individuals is distorted by the creation of artificial demand resources [then the economy is] again led into a wrong direction and a definite and lasting adjustment is again postponed. The only way permanently to 'mobilise' all available resources is, therefore to leave it to time to effect a permanent cure by the slow process of adapting the structure of production ...."
- and Harvard's Joseph Schumpeter argued that there was:
- " a presumption against remedial measures which work through money and credit. Policies of this class are particularly apt to produce additional trouble for the future;"
- and that:
- "depressions are not simply evils, which we might attempt to suppress, but forms of something which has to be done, namely, adjustment to change."
That was the view of United States Secretary of the Treasury Andrew Mellon (who has been quoted as advising President Hoover that the depression would "purge the rottenness out of the system") and it was shared by Britain's Chancellor Philip Snowden. They agreed that expansionary monetary and fiscal policies should be avoided because they would reduce investor confidence and hinder the process of liquidation, reallocation, and the resumption of private investment.
The Real Bills doctrine
Monetary theory in the 1920s was largely governed by the doctrine propounded by Adam Smith in his "Wealth of Nations":
- "When a bank discounts to a merchant a real bill of exchange, drawn by a real creditor upon a real debtor, and which, as soon as it becomes due, is really paid by that debtor ; it only advances to him part of the value which he would otherwise be obliged to keep by him unemployed and in ready money, for answering occasional demands. The payment of the bill, when it becomes due, replaces to the bank the value of what it had advanced, together with the interest." .
- which was interpreted to mean that money issued against commercial paper cannot be inflationary because it merely responds passively to the needs of commerce.
Despite its disproof by David Ricardo and others , the real bills doctrine was so widely held that it was incorporated in the Federal Reserve Act 1913 . It was also the basis of the Reichsbank’s policy of issuing astronomical sums of money to satisfy the needs of trade at ever-rising prices during the German hyperinflation of 1922-1923.
The gold standard imperative
- (for an account of the history and effects of the gold standard see the article on that subject)
By the 1920s, the gold standard had been endowed with an importance that went beyond any appreciation of its merits as a means of stabilising trade flows. According to Peter Bernstein its control over the affairs had "never been so absolute" and he quotes Joseph Schumpeter as calling it "a symbol of sound practice and a badge of honor and dignity" , and Peter Temin quotes Benjamin, the Governor of the New York Federal Reserve Bank as saying (about the need for Britain to return to the gold standard, after the first word war) that "failure to resume gold payments...would be followed by a long period of unsettled conditions, too serious really to contemplate... - and incentives to governments ...to undertake various types of paper money experiments and inflation" . Its only important opponent was John Maynard Keynes, who argued in a tract on monetary reform  that price stability should take priority over exchange stability.
The balanced budget mantra
A (sometimes ethical) belief in the case for a balanced budget has played a powerful part in the conduct of the politics of the United States from its inception to the present day. Thomas Jefferson believed that deficit spending is "swindling futurity" , Herbert Hoover campaigned for a return to a balanced budget in 1931 , and among Franklin D Roosevelt's election promises was an undertaking to maintain a balanced budget except in emergencies . Roosevelt's adoption of deficit spending in 1933 raised fierce controversy in the country, and his wish to return to a balanced budget as soon as practicable has been held to account for the fiscal tightening that his administration introduced in 1936.
The need for economic planning
Among politicians of the time, the ideas of Professor Rexford Tugwell of the Economics Department of Columbia University had a significant influence upon thinking about economic policy in America of the 1930s. He argued that the cause of the Great Depression had been the uncoordinated activities of businessmen under conditions of unregulated competition, which had led to overproduction and underconsumption. To put matters right, their activities would have to be coordinated by government agencies. He envisaged the creation of planning boards in which employers, employees, and consumers would work out plans for production, prices, division of markets, and working conditions in each industry which they would pass to a central planning board representing the various industries and the government. That board would then act as a "mediating and integrating body," which would co-ordinate the various industrial plans into a national planning programme, and would supervise capital investment and control prices .
The aftermath of war
The first world war had an intense and lasting disruptive effect, leaving the international economy in an unusually fragile condition. There had been an unprecedented loss of life and productive manpower in Europe, 8 million men having been killed and 15 million incapacitated. The financial consequences had also been severe: budget deficits had multiplied, gold stocks had been depleted, onerseas assets had been sold, and the wartime allies owed nearly $2 billion to the United States (which, must be considered to have been a large sum, bearing in mind that prices are now about 20 times, and US output about 100 times what is was then), and productive capacity had suffered a considerable setback . Writing in 1919, John Maynard Keynes presented a graphic picture of the poverty and deprivation, and of a gloomy prospect for the years to come, remarking that
- "We are thus faced in Europe with the spectacle of an extra-ordinary weakness on the part of the great capitalist class, which has emerged from the industrial triumphs of the nineteenth century, and seemed a very few years ago our all-powerful master" .
The gold standard
A further increase in the fragility of the international economy was created by the return to the gold standard after its wartime suspension. The United States returned in 1919, and most other countries between 1924 and 1927 . A substantial disruption was caused by Britain's 1925 decision to return at the pre-war exchange rate of $4.86 (a decision that had been opposed by Keynes, who warned that it could lead to an international depression ). The hope that the gold standard would exert a stabilising influence as it had before the war was soon disappointed . It was a system with an inbuilt tendency to deflation. As explained by Peter Temin and others ., that was because, whereas countries with balance of payments deficits were forced to reduce deflate in order to preserve their gold reserves, surplus countries were free to "sterilise" gold inflows and so prevent any increase in their money supply. According to James Hamilton  such sterilisation was, in fact practised from time to time by the two major surplus countries, the United States and France (that between them came to hold 60 per cent of the world's gold reserves). Countries with small gold reserves were especially vulnerable to gold outflows and the general strike of 1926 has been attributed to deflationary policies that were forced on the British government by its determination to stay on the gold standard .
In 1927, the Federal Reserve increased the United States money supply by a reduction in interest rates and by vigorous open market operations . It did so partly in order to fend off what appeared to be an impending recession, and partly in response to a British request for help to stem the outflow of gold from Britain to the United States .
(the following has been summarised from Ben Bernanke's speech to the Conference to Honor Milton Friedman, November 8, 2002  )
In the spring of 1928 there was a significant tightening of monetary policy by the Federal Reserve Board that continued until the stock market crash of October 1929. The Board's reason for that action was not concern about inflation - which hardly existed at the time - but concern about speculation on Wall Street, prompted by the increases stock market prices and in bank loans to brokers. As Friedman and Schwartz noted ., "by July, the discount rate had been raised in New York to 5 per cent, the highest since 1921, and the System's holdings of government securities had been reduced to a level of over $600 million at the end of 1927 to $210 million by August 1928, despite an outflow of gold." Strong reservations about that policy had been expressed by one of the Board's members, Benjamin Strong, the influential Governor of the Federal Reserve Bank of New York, but Strong died in October and the policy was supported by his successor, George Harrison, and the discount rate was raised a further point to 6 per cent in the following year. That move was followed by a period of falling prices and weaker economic activity. According to Friedman and Schwartz "During the two months from the cyclical peak in August 1929 to the crash, production, wholesale prices, and personal income fell at annual rates of 20 per cent, 7-1/2 per cent, and 5 per cent, respectively." and after the stock market crash, economic decline became even more precipitous. (James Hamilton  has shown that the Board's desire to slow outflows of gold to France had then resulted in massive flows of gold from abroad and a further tightening of monetary policy.)
In September 1931 there was another tightening of monetary policy, following the UK's sterling crisis. A wave of speculative attacks on the pound had forced Britain to leave the gold standard and, anticipating that the United States might the next to do so, speculators turned their attention from the pound to the dollar. Central banks and private investors converted a substantial quantity of dollar assets to gold in September and October of 1931. The resulting outflow of gold reserves also put pressure on the U.S. banking system as foreigners liquidated dollar deposits and domestic depositors withdrew cash in anticipation of additional bank failures. According to Friedman and Schwarz: , "The Federal Reserve System reacted vigorously and promptly to the external drain. . . . On October 9, the Reserve Bank of New York raised its rediscount rate to 2-1/2 per cent, and on October 16, to 3-1/2 per cent--the sharpest rise within so brief a period in the whole history of the System, before or since (p. 317)." This action stemmed the outflow of gold but contributed to an increase in bank failures and bank runs, with 522 commercial banks closing their doors in October alone. The policy tightening and the ongoing collapse of the banking system caused a steep fall in the money supply and the declines in output and prices became even more precipitous.
In April 1932, when the Congress pressed the Board to ease monetary policy, and between April and June 1932, it made substantial open market purchases, which slowed the decline in the stock of money and reduced the yields on bonds and commercial paper. By August there were rises in wholesale prices and industrial production and there were other indications of increasing activity. However, the Board members did not favour a continuation of that policy and, when the Congress adjourned in July, they abandoned it. A sharp fall in economic activity followed towards the end of the year.
There was one more monetary tightening in early 1933. Fearing that the new President would abandon the gold standard, investors began to convert dollars to gold, putting pressure on both the banking system and the gold reserves of the Federal Reserve System. Bank failures and action to resist the gold drain further reduced the stock of money and there was another sharp reduction in economic activity. That tightening ended after President Roosevelt's March declaration of a national bank holiday and his abandonment of the gold standard; and there was then a renewed expansion of money, prices, and output.
The stock market boom and crash
As noted in the article on the crash of 1929, the stock market crash marked the end of a period of eight increasingly prosperous years, known as the "roaring twenties": a period of above-average growth of national income, exceptionally rapid growth in corporate earnings, and even more rapid growth in stock exchange prices. That trend intensified in the latter years, with stock prices rising from about 10 times corporate earnings in 1928 to 15 times or more in 1929. Then, in the June of 1929, industrial activity began a decline  that continued throughout the rest of the year, and, in a few days in the autumn of 1929, the average share price on the New York stock exchange dropped by a staggering 30 per cent.
It is now clear that the stock market crash could not have contributed to the initiation of the downturn, because the downturn was already under way at the time of the crash. However the tightening of monetary policy in 1928 and 1929 was prompted by the belief by the staff of the Federal Reserve Bank that the preceding boom in stock prices was a speculative "bubble", and their wish to restrain it in order to achieve a soft landing". As a result of an analysis by McGrattan and Prescott , endorsed by Bernanke , there is now a consensus that their belief had been mistaken, and that market prices before the downturn in activity had been well justified by the real value of the companies concerned.
The financial crisis
- (This paragraph is based mainly upon chapter 2 of Bernanke (2000)
Many American financial enterprises went out of business early in the depression, and their failures had the effect of increasing its depth and duration . Some mutual savings banks and insurance companies ran into trouble, and there were widespread failures among the savings and loans associations; but it was the collapse of the commercial banking system that did the most damage. Banking crises had long been more common in the United States than in Europe, possibly because its banking system was more fragmented, but the crises of the early 1930s were more serious than anything that had gone before. By the time the system had to be closed down in 1933, the survivors numbered little more than half of those operating in 1929, and most of them had suffered heavy losses. There was an exceptional incidence of banking runs, and they were more damaging than previously because (according to Friedman and Schwartz) the practice of dealing with them by stopping withdrawals had been abandoned in 1913 with the advent of the Federal Reserve Bank. The results of the banking failures and the tribulations of the survivors were what is now called a "credit crunch", during which householders, farmers and small businesses found credit to be expensive and hard to get, and a widespread loss of confidence in the country's financial institutions.
The financial system was further disrupted by widespread defaults among mortgage holders and by insolvencies among small firms. There had been a large increase in the volumes of personal and commercial debt in the 1920s, with rises in the number of mortgaged homes and in the volume of hire-purchase debt, all of which had increased the vulnerability of the economy to economic shocks.
The Smoot-Hawley Tariff
The Smoot-Hawley Tariff Act of June 1930 raised U.S. tariffs to historically high levels. In his election campaign, Herbert Hoover had only promised to increase tariffs on agricultural products, but industrial lobbying persuaded Congress to raise tariffs on some 20,000 products, covering all sectors of the economy (contrary to the advice of many economists at the time  ) , and raising the average tariff rate on United States imports from 26% to 50%. . Following retaliation by 25 of America's trading partners, its exports fell by over 60% during the following two years . In dollar terms, American exports declined from about $5.2 billion in 1929 to $1.7 billion in 1933; but prices also fell, so the physical volume of exports only fell in half. Hardest hit were farm commodities such as wheat, cotton, tobacco, and lumber. Many American farms had been heavily mortgaged as farmers bought overpriced land in the bubble of 1919-20, and defaulted.
Many economists at the time argued that the sharp decline in international trade after 1930 helped to worsen the depression, especially for countries dependent on foreign trade. Most historians and economists assign the American Smoot-Hawley Tariff Act of 1930 part of the blame for worsening the depression by reducing international trade and causing retaliation. Foreign trade was a small part of overall economic activity in the United States; it was a much larger factor in most other countries. The average rate of duties on dutiable imports for 1921-1925 was 26% but under the new tariff it jumped to 50% in 1931-1935. Nevertheless Barry Eichengreen has argued that, relative to the Depression, the direct macroeconomic effects of the Smoot-Hawley tariff upon the American economy had been small, but that it may have had indirect significant effects, as a result of its impact on the stability of the international monetary system and the efficiency of the international capital market. 
- (Irving Fisher (1867-1947) was an American economist, statistician and commentator on public events, and was Professor of Political Economy at Yale from 1898 to 1935. An influential economist in the early 20th century, he is now best known for his forecast that there would be no stock market crash - that he made immediately before it happened , (although in his defence he has pointed out that only he had predicted the inevitability of a depression, although he had seriously underestimated its severity ).
Fisher's explanation of the depression was that an economy with a high level of debt had suffered a shock that had led to a loss of confidence which had prompted the widespread liquidation of debts by "distress selling", causing a sharp fall in share prices and a contraction in bank deposits; and that this had triggered a deflation which increased the stock of debt in real terms. What had followed had been a perverse cycle of further price reductions which led to further pressure to liquidate debts, which led to further price falls, and so on, which he called "debt deflation" . . Fisher maintained throughout the 1930s that a financial crash need not affect the real economy provided that there was a sufficient expansion of the money supply . The shock to which Fisher attributed the onset of the depression was the sudden reversal of the Federal Reserve Bank's monetary policy referred to above.
- I believe some of the crash was inevitable because of over-indebtedness, but the depression was not inevitable. The reason is that the deflation which went with the over-indebtedness was not necessary. We can always control the price level. 
- (Lionel Robbins (1898-1984) was Professor of Political Economy at the London School of Economics from 1929 to 1961. He was at first an influential proponent of the theories of the Austrian School of economics, but he subsequently adopted Keynesianism).)
Writing in 1934, Lionel Robbins argued that the expansionary action taken by Federal Reserve Bank in 1927 had set off a speculative boom, the inevitable consequences of which were the later downturns of stock prices, consumers' expenditure and economic activity. The conclusion of his analysis was that:
- " ... it was ...deliberate "reflation" on the part of the Federal Reserve authorities, which produced the worst phase of this stupendous fluctuation. ...."
Although he thus assigned a single cause to the initial downturn in economic activity, he attributed its continued severity to multiple influences, including political uncertainties, trade protection, bad banking policies, fraud, and "...the cartelisation of industry, the growth of the strength of trade unions [and] the multiplication of state controls"; but particularly to the failure of wage rates to adjust to the fall in prices - which he called "the by-product of unemployment insurance".
He was later to decide that he had been mistaken, and to have said of his book, "The Great Depression", that: "this is a work I should now wish not to have written" .
Friedrich Hayek and the Austrian School
- (Friedrich Hayek (1899-1992) was a British economist of the Austrian School, winner of the 1974 Nobel Prize in Economics , founder of the Institute for Economic Affairs, and author of "The Road to Serfdom ".)
According to the theory of business cycles, first propounded by Ludwig von Mises and subsequently developed by Hayek , the artificial lowering of interest rates and creation of excess credit causes investors to believe that economic conditions are better than in fact they are, and the resulting speculative tendencies are reinforced by the big increases in the prices of property and of financial assets, generating a process that leads in the end to a collapse of prices and output. Hayek's work was drawn upon by Robbins in writing "The Great Depression", and his analysis of the great depression may be assumed to have been similar to that of Robbins.
Hayek is well known to have been one of the few economists to have predicted the recession, and he is often quoted as later saying that
- "Up to 1927 I should have expected that the subsequent depression would be very mild. But in that year an entirely unprecedented action was taken by the American monetary authorities [who] succeeded, by means of an easy-money policy, inaugurated as soon as the symptoms of an impending reaction were noticed, in prolonging the boom for two years beyond what would otherwise have been its natural end. And when the crisis finally occurred, deliberate attempts were made to prevent, by all conceivable means, the normal process of liquidation." 
The Austrian School analysis of the great depression has since been extensively developed by Murray Rothbard .
Keynes and the Keynesians
- (John Maynard Keynes (1883-1946) was a Fellow of King's College, Cambridge, 1930-89 and author of The General Theory of Employment, Interest and Money  and was the founder of macroeconomics.
An entirely different view of the situation was taken at the time by John Maynard Keynes. In an article to an English magazine in late 1930, he argued that the depression had been the result of a downturn in investment because the plans of savers had diverged from the plans of investors , and in a 1931 Chicago lecture, he explained that, in his view, that had been due to high interest rates, tight Federal Reserve monetary policies and diminishing returns to investment; and in his Treatise on Money he said that:
- "The boom of 1928-29 and the slump of 1929-30 in the United States correspond respectively to an excess and a deficiency of investment",
- "I attribute the slump of 1930 primarily to the deterrent effect upon investment of the long period of dear money which preceded the stock market collapse, and only secondarily to the collapse itself, but the collapse having occurred, it greatly aggravated matters, especially in the United States, by causing a disinvestment in working capital" .
Later, in his 1936 General Theory , he attributed less importance to interest rates, arguing that the marginal efficiency of capital had fallen because of the large volume of previous investment.
The subsequent development of the Keynesian explanation, taking account of the banking crisis, - as described by Peter Temin in 1976  - was on the following lines.
- The fall in spending produced a fall in real income and prices by the multiplier process  and that led to a decrease in the demand for money. The monetary base (high powered money) continued to increase (except, briefly, in 1930)  but the banking panics reduced the amount of money that the monetary base could support , helping to bring the supply of money into line with demand (but equilibrium would have been reached by other means if there had been no banking crisis). The international collapse further reduced activity by reducing US exports.
- (The contribution of John Maynard Keynes to the debate is further described below, under the heading of "Remedies".)
Milton Friedman and the Chicago School
- (Milton Friedman (1912-2006) was the winner of the 1976 Nobel Prize in Economics and leader of the Chicago School of Economics and was the founder of modern monetarism.)
The monetarists of the Chicago School are best known for the association that they established between inflation and expansion of the money supply. In their book on The Monetary History of The United States  , they established an association between contractions in output and contractions in the money supply during the Great Depression, and argued that the direction of causation had been mainly from the money supply to output. The money supply data that they used were -
1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 Money supply M1 ($billions) 25.9 25.9 26.2 26.4 25.4 23.6 20.5 19.4 21.5 25.5 29.2 30.3
- and they contended that a mild and potentially short-term downturn in output brought about by the 1929/30 money supply downturn had been converted into a violent depression by the sharper money supply downturn of 1931/32. They attributed that sharper downturn to a policy mistake by the Federal Reserve Bank and to a banking panic which had led to an increase in the banks' reserves and a consequent further fall in the supply of money.The depression had then been intensified by a further reduction in the money supply brought about by the restrictive monetary policies that were adopted in order to counter international pressure on the dollar. They attributed the Bank's adoption of those policies to its officials' belief in "liquidationism" and to the fact that they were not considered to have any duty towards banks that were not members of the Federal Reserve System.
- (Peter Temin (1937 - ) is a Professor of Economics at the Massachusetts Institute of Technology and was formerly head of its economics department. He has written widely as an economist and economic historian.)
In the last chapter of his 1976 book, entitled "Did Monetary Forces Cause the Great Depression?" , Peter Temin concluded that Milton Friedman's explanation of the cause of the initial downturn must be rejected - but not necessarily his explanation of subsequent developments. However, Temin considered the direction of causation to have been principally from output downturn to money supply downturn rather than principally from money supply to output as contended by Friedman and Schwartz. He attributed the start of the recession in 1929 to "some combination of factors that cannot be disentangled", including the Federal Reserve's monetary policy and an oversupply of housing.
In a later book, Temin argued  that World War 1 had been the impulse that led to the depression; and that, because of its deflationary bias , the gold standard was the mechanism by which a 1914-18 shock was made to lead a 1929 crisis. He considers the primary propagating mechanism of the depression itself to have been the late-1930 failure of the Bank of the United States, resulting from its reckless behaviour in the 1920s. He assigned a secondary role to the 1929 stock exchange crash, arguing that it had reduced private wealth by only 10 per cent, which would not have had a sufficient effect on consumers' expenditure to account for the very sharp fall that occurred in 1930. He also argues that the effect of retaliation against the Smoot-Hawley tariff must have been small - on the grounds that, with exports only 15 per cent of GDP, their fall by 1.5 per cent of 1929 GDP could not have had more than a small effect upon the US economy.
- (Barry Eichengreen (1952 - ) has been Professor of Economics and Political Science at the University of California, Berkeley since 1987, and was Senior Policy Adviser to the International Monetary Fund from 1997 to 1998.)'
In a joint paper with Kris Michener, Barry Eichengreen produces evidence from the Great Depression in support of the von Mises theory of business cycles, which could be roughly summarised as:
- Higher property and securities prices encourage investment activity. But, as lending expands, increasingly risky investments are undertaken. , especially if yields on safe investments are low.
- Eventually, signs of inflationary pressure appear, prompting the central bank to tighten monetary policy. The bubble bursts and its legacy of excessive debt and troubled banks adds to the subsequent downturn .
- but argue that the evidence does not exclude the possibility that other mechanisms were also at work.
In one of a series of contributions on the subject, Barry Eichengreen considers the gold standard to have been the mechanism by which the great depression came to infect countries outside the United States . He found that countries that stayed longest on the exchange rates, (such as Switzerland and Poland), had high real wages and low output, whereas those that abandoned it early (such as Japan, Australia, New Zealand and Argentina) had lower real wages and higher output by the mid-30s . In a joint paper with his colleague Jeffrey Sachs, he argues that, although the currency devaluations of countries that left the gold standard may have been intended as beggar—thy—neighbour actions, they benefited the system as a whole and would have hastened recovery from the great depression had they been adopted more widely . (For the purpose of their analysis, they developed an influential two-country model of the operation of the gold standard, that has since been extended by Temin  and others.) In an examination, in collaboration with Peter Temin, of a counterfactual scenario in which policy makers are unwilling to choose deflation in preference to devaluation , he envisaged a world in which recovery from the 1929 downturn would have been comparatively rapid,as result of which there would, perhaps, have been no acquisition of power by the Nazi party in Germany.
- (Charles Kindleberger (1910-2003) was Professor of Economics at the Massachusetts Institute of Technology from 1951 to 1976 and had previously served as an economist at the Federal Reserve Bank of New York and the Bank for International Settlements.)
Charles Kindleberger's has provided an explanation of the fact that the gold standard operated successfully before the first world war, but had a destabilising influence thereafter. His contention is that the gold exchange system had also been unstable unless action was taken to stabilise it, as Britain had until 1913. After the war Britain had lacked the necessary resources, and when the need arose in the 1930s, the United States had refused to do so. The result had been that every country took whatever action appeared to serve its own national interests, and the result had been collective disaster .
- (Ben Bernanke (1953 - ), now Chairman of the Board of Governors of the Federal Reserve System was previously Professor of Economics and Public Affairs and Chair of the Economics Department at Princeton University from 1996 to 2002.)
Ben Bernanke has described the discovery of the causes of the great depression as the "Holy Grail of macroeconomics". He has written extensively on the subject, drawing upon evidence of its incidence outside the United States to test and evaluate the rival theories. He has concluded that the evidence gives "much support for the monetary view" as put forward by Friedman and Schwartz, but that it does not provide a complete explanation for the depth and, especially, the duration of the downturn.
His own extension of their findings is advanced in the second chapter of his book of essays, under the title of "Nonmonetary Effects of the Financial Crisis and the Propagation of the Great Depression". He argues that, in addition to its effects via the money supply, the financial crisis had raised, what he terms the "cost of credit intermediation", which exerted a further downward pressure on economic activity. He notes that the duration of a credit crunch depends upon the time it takes to both revive the channels of credit flow, and rehabilitate insolvent debtors - and that, since those are slow processes, they supplement the monetary explanation with a plausible reason for the unusual persistence of the depression.
Retrenchment versus expansion
- [THIS PARAGRAPH IS INCOMPLETE]
Hayek's comment on expansionary policies has been quoted as:
- "..still more difficult to see what lasting good effects can come from credit expansion. The thing which is most needed to secure healthy conditions is the most speedy and complete adaptation possible of the structure of production.If the proportion as determined by the voluntary decisions of individuals is distorted by the creation of artificial demand resources [are] again led into a wrong direction and a definite and lasting adjustment is again postponed.The only way permanently to 'mobilise' all available resources is, therefore to leave it to time to effect a permanent cure by the slow process of adapting the structure of production..." 
The New Deal
Shortly after taking office in 1933, President Roosevelt announced the suspension of the convertibility of the dollar into gold - an action that was followed by a 30 per cent fall in its exchange rate with the pound. That action facilitated expansion by relieving the pressure on the Federal Exchange to defend the dollar by means of restrictive monetary actions. It was followed later in the year by the mix of policy actions known as the New Deal that involved a substantial fiscal expansion, amounting in most years to between 2.5 and 3 per cent of GDP.
Having despaired of any prospect of effective action by the Hoover administration
- "Nothing could be a greater advantage to the world than that the United States should solve her own domestic problems, and, by solving them, provide the stimulus and the example to other countries. But observing from a distance, -- a nearer view of the prospect might modify my pessimism, -- I am unable to imagine a course of events which could restore health to American industry in the near future. I even fancy that, so far from the United States giving the example, she will herself have to wait for stimulus from outside." ,
- Keynes reacted favourably to the announcement New Deal, describing it as "turning the tide in the direction of better activity  - but, later in 1933, he expressed acute disappointment with what he considered to be the inadequacy of the President's fiscal expansion plans:
- "The set-back which American recovery experienced this autumn was the predictable consequence of the failure of your administration to organise any material increase in new Loan expenditure during your first six months of office. The position six months hence will entirely depend on whether you have been laying the foundations for larger expenditures in the near future."
He warned against exclusive reliance upon monetary policy
- "... in a slump governmental loan expenditure is the only sure means of securing quickly a rising output at rising prices...";
- "Rising output and rising incomes will suffer a set-back sooner or later if the quantity of money is rigidly fixed. Some people seem to infer from this that output and income can be raised by increasing the quantity of money. But this is like trying to get fat by buying a larger belt. In the United States to-day your belt is plenty big enough for your belly."
- but in a later paragraph he added that having given first place to fiscal expansion he would advise giving:
- "...second place to the maintenance of cheap and abundant credit and in particular the reduction of the long-term rates of interest...the Federal Reserve System [should] replace its present holdings of short-dated Treasury issues by purchasing long-dated issues in exchange... Such a policy might become effective in the course of a few months, and I attach great importance to it."
- (Open letter to the President October 1933)
Keynes visited the White House in 1934 in a further attempt to persuade the President to take more vigorous fiscal action, but it the attempt was a failure. The President is reported to have commented afterward that Keynes "must be a mathematician rather than a political economist." and Keynes to have said that he had "supposed the President was more literate, economically speaking." .
It subsequently became evident that, because of the importance that he attached to the achievement of a balanced budget, President Roosevelt considered the fiscal consequences of the New Deal to be its regrettable by-product, not its intention
The leading monetarist economist of the Chicago School of the time had been a proponent of the contracyclical control of the money supply to stabilise the economy, but was strongly opposed to Roosevelt's public spending experiments . Later Chicago monetarists under the leadership of Milton Friedmam were also opponents of the regulatory use of public spending and were also advocates of the control of the money supply (but by the continuously maintaining its non-inflationary growth rather than by its contracyclical manipulation.)
Roosevelt's New Deal had significant features apart from the fiscal stimulus that it applied - notably its effect upon confidence - but the current consensus among economists is that a fiscal stimulus of 3 per cent of GDP - although substantial in modern terms - would have been too small in comparison with the Great Depression's 30 per cent fall in GDP to have had a significant influence upon the course of events . Monetarists in particular, consider more important factors to have been his rescue of what remained of the banking system, and the reversal of monetary policy that followed his suspension of the gold standard with the consequent removal of the policy constraints that it had imposed.
The principle influence upon Roosevelt's policies in the 1930s was not the economic thinking of John Maynard Keynes, nor that of Milton Friedman's predecessors, but that of Professor Rexford Tugwell of the Economics Department of Columbia University. Tugwell became the leading member of the unofficial group of academics that were known at the time as Roosevelt's "Brains Trust", and upon which he mainly relied for the formulation of the policies of the New Deal . The National Recovery Administration, devised mainly by Tugwell, was described by Roosevelt as "a supreme effort to stabilize for all time the many factors which make for the prosperity of the nation and the preservation of American standards." One of the consequences of the operations of the National Recovery Administration and its successor under the Wagner Act, was an increase of 30 per cent in real wages between 1933 and 1937 which, according to one study , delayed the return to full employment.
- Bradford J. DeLong, "Friedrich A. von Hayek," quoting Hayek from an unnamed source (University of California, Berkeley).
- Joseph A. Schumpeter, Essays on Entrepreneurs, Innovations, Business Cycles, and the Evolution of Capitalism (Transaction Publishers, 1989), 117.
- Paul Kugman: The Conscience of a Liberal, New York Times November 7 2007
- Adam Smith: Wealth of Nations, Book II, Chapter 2
- Thomas Humphrey: The Real Bills Doctrine, Federal Reserve Bank of Richmond Economic Review, 1982
- Allan Meltzer: A History Of The Federal Reserve, Volume I: 1913–51, University Of Chicago Press, 2003
- Peter Bernstein: The Power of Gold, page 239, John Wiley, 2000
- Peter Temin: Lessons from the Great Depression, page 14, MIT Press, 1989
- John Maynard Keynes: A Tract on Monetary Reform, Macmillan, 1924.
- Thomas Jefferson: "Letter to John Taylor" 1816
- Herbert Hoover: Address to the American Legion September 1931
- Allan Meltzer and Alan Greenspan A History of the Federal Reserve: 1913-1951, University of Chicago Press, 2003
- Rexford Tugwell: The Industrial Discipline and the Governmental Arts Columbia University Press 1933
- Giulio Gallarotti: The Anatomy of an International Monetary Regime: The Classical Gold Standard, Oxford University Press, 1995 (quoted by Peter Bernstein op cit p285)
- John Maynard Keynes: The Economic Consequences of the Peace, Macmillan 1919
- For the dates at which countries returned to the gold standards see the table on page 74 of Ben Bernanke: Essays on the Great Depression, Princeton University Press 2004
- John Maynard Keynes: The Economic Consequences of Mr Churchill, Hogarth Press 1925
- Natalia Chernyshoff, David Jacks and Alan Taylor: Stuck on Gold: Real Exchange Rate Volatility and the Rise and Fall of the Gold Standard NBER Working Papers 11795 November 2005.
- Peter Temin: Lessons from the Great Depression MIT Press
- Ben Bernanke and Harold James: "The Gold Standard, Deflation and Financial Crisis in the Great Depression" in Ben Bernanke: Essays on the Great Depression, Princeton University Press 2004
- James Hamilton: "Monetary Factors in the Great Depression", Journal of Monetary Economics XIX 1987
- Taylor: The 1926 General Strike Society Today, Economics and Social Science Research Association, August 2007
- Minutes of the Meetings of the Open Market Investment Committee, May 9 and July 1927  []
- . Michael Bordo, Owen Humpage and Anna Schwartz; Historical Origins of US Exchange Market Intervention Policy, NBER Working Paper 12662, 2006
- Milton Friedman and Anna Schwartz A Monetary History of the United States 1867-1960 (p. 289), Princeton University Press for NBER, 1963
- James Hamilton: Monetary Factors in the Great Depression, Journal of Monetary Economics, 1987
- Geoffrey Moore and Julius Sishkin Indicators of Business Contractions and Expansions page 25 National Bureau of Economic Research Occasional Paper 103, 1967 
- Ellen McGrattan and Edward Prescott: The Stock Market Crash of 1929: Irving Fisher Was Right!, Federal Reserve Bank of Minneapolis, Research Department Staff Report 294, December 2001[]
- Ben Bernanke Asset-Price "Bubbles" and Monetary Policy, Speech to the New York Chapter of the National Association for Business Economics, October 15, 2002
- Ben Bernanke: "Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression", in Essays on the Great Depression, Princeton University Press, 2000
- For an explanation of the effect of a banking crisis on the money supply, see the Tutorials subpage of the article on banking []
- Smoot-Hawley Tariff US State Department
- "The Battle of Smoot-Hawley" The Economist, December 18 2008
- "Shades of Smoot-Hawley", Time, October 7 1985
- Charles Kindleberger: The World in Recession, 1929-39, Chapter 14, "An Explanation of the 1929 Depression," University of California Press, 1973
- Barry Eichengreen: The Political Economy of the Smoot-Hawley Tariff Barry Eichengreen NBER Working Paper No. 2001 August 1986
- Irving Fisher is widely reported to have said " stock prices have reached what looks like a permanently high plateau" in September 1929
- Discussion by Professor Irving Fisher
- Irving Fisher : The Debt-Deflation Theory of Great Depressions, Econometrica 1933
- Giovanni Pavanelli: The Great Depression in Irving Fisher's Thought December 2001
- Irving Fisher. Discussion by Professor Irving Fisher (On the causes of the Great Depression)
- Lionel Robbins The Great Depression 1934
- Lionel Robbins: Autobiography of an Economist, Macmillan, 1971
- Friedrich Hayek: Monetary Theory and the Trade Cycle, 1933 (reprinted by von Mises Institute 2008)
- Quoted in Bradford DeLong: The Economic History of the Twentieth Century Chapter XIV, 1997
- Murray Rothbard: America's Great Depression, von Mises Institute, 1963
- John Maynard Keynes: The General Theory of Employment, Interest and Money" 1936
- John Maynard Keynes: The Great Slump of 1930, The Nation & Athenæum, December 1930
- John Maynard Keynes: Treatise on Money, Harcourt Brace 1930
- Peter Temin: Did Monetary Forces Cause the Great Depression?, W W Norton & Co 1976
- See the article on Keynesianism
- See the money supply table at paragraph 4 of the tutorials subpage of the article on the great depression in the United States 
- See the tutorials subpage of the article on banking 
- Discussion with Anna Schwartz and others at the Book Forum Friday, November 21, 2003 Cato Institute, 2003
- See the above paragraph on "the paragraph on the aftermath of war"
- Barry Eichengreen and Kris Mitchener: The Great Depression as a Credit Boom Gone Wrong August 2003 
- For example: Barry Eichengreen: Lessons from the Great Depression" The MIT Press 1989
- For an examination of its mechanism, see the Tutorials subpage of article on the gold standard []
- Barry Eichengreen: Golden Fetters. Oxford University Press 1996
- Barry Eichengreen and Jeffrey Sachs: Exchange Rates and Economic Recovery in the 1930s, NBER Working Paper No. 1498 1984
- Barry Eichengreen and Peter Temin: Counterfactual Histories of the Great Depression October 2001
- Schifferes, Steve. Lesson for G20 from 1933 London summit, BBC News, British Broadcasting Corporation, 23 March 2009. Retrieved on 22 April 2014.
- Charles Kindleberger: The World in Depression, 1929-39, Chapter 14, University of California Press, 1973
- Ben Bernanke Essays on the Great Depression Princeton University Press, 2000
- John Maynard Keynes: The World's Economic Outlook, The Atlantic Monthly,May 1932
- John Maynard Keynes: Letter to N V Phillips, August 1933, Archives of King's College Cambridge
- John Maynard Keynes An Open Letter to President Roosevelt
- John Kenneth Galbraith: The Age of Uncertainty BBC 1977
- Henry Simons: Positive Program for Laissez Faire: Some proposals for a liberal economic policy Public Policy Pamphlet, University of Chicago Press 1934
- Carey Brown: Fiscal Policy in the Thirties: A Reappraisal, American Economic Review, December 1956
- Bernard Sternsher: Rexford Tugwell and the New Deal, Rutgers University Press, 1964
- Harold L. Cole: New Deal Policies and the Persistence of the Great Depression: A General Equilibrium Analysis, Federal Reserve Bank of Minneapolis Research Department Staff Report XXX, February 2003