Nonmonetary Perspectives on the Great Depression

Nonmonetary Perspectives on the Great Depression

October 16, 2016

Today, I want to give a little more support to the idea that monetary interpretations of the Great Depression have been mostly, perhaps entirely, created by the “small government free market” economists. Also, they became popular mostly after 1960, although some people held similar ideas during the 1930s itself. The primary interpretation, from 1930-1960, was a nonmonetary one, the Keynesian narrative of a self-reinforcing “decline in aggregate demand” related to a “loss of animal spirits” or something of that sort — basically, that people got the heebie-jeebies after the big stock market declines of 1929. We looked at the various “monetary interpretations” of the Great Depression thoughout this year:

October 2, 2016: The Interwar Period, 1914-1944
October 6, 2016: Team Gold Needs To Get Over The Great Depression

I’m going to focus on two books in particular: Did Monetary Forces Cause the Great Depression (1976), by Peter Temin, and Monetary Interpretations of the Great Depression (1995), by Frank Steindl. These two books were intended to be a survey of popular existing interpretations of their time. I’ll also make a few references to Golden Fetters: the Gold Standard and the Great Depression, 1919-1939 (1992), by Barry Eichengreen. It is a detailed Keynesian-type interpretation representative of its day, and I don’t think things have changed too much since then.

Here’s Temin:

It turns out that explanations of the Depression can be classified into two groups … The two classes of explanations of the Depression have different events at their cores. What I have called the “money hypothesis” asserts that the collapse of the banking system was the primary cause of the Depression, while the “spending hypothesis” assets that a fall in autonomous aggregate spending lay at the root of the decline. The following chapters represent an attempt to discriminate between the two factors. (p. 7)

It’s interesting here that Temin calls the “monetary interpretation” the assertion that “the collapse of the banking system was the primary cause of the Depression.” This is not actually monetary. It is the easiest thing in the world to imagine the failure of a single bank, without relying on a “monetary” explanation. The “collapse of the banking system” is just the collapse of many single banks. This does not necessarily have anything to do with the money. Deutschebank seems like it is in the process of failure right now; but this is not because of the euro. I would say that Milton Friedman’s arguments are exactly as Temin characterizes them — an observation of the contraction of the banking system, actually very much like Irving Fischer, with a lot of fluff and puffery implying that it was a monetary event, when it was not.

June 12, 2016: Milton Friedman Blames the Federal Reserve
June 5, 2016: Irving Fisher and “Debt Deflation”

Here is Temin giving a brief description of the “spending hypothesis,” the typical Keynesian interpretation of his time. Although 1976 was quite a while ago, it was nevertheless nearly fifty years after the start of the Great Depresison, and forty years after the publication of Keynes’ General Theory. So, these ideas had a long time to percolate. Let’s see what the best and brightest could come up with, after studying the topic for four decades:

According to the spending hypothesis, the Depression was generated by a fall in autonomous spending. At a given level of income, desired investment and consumption fell. Various reasons for this fall can be given, but the two most frequently cited focus on construction and the stock market. Construction–which was a substantial component of investment–fell because the housing stock exceeded the demand after 1925. And consumption fell sharply after 1929 in response to the stock-market crash. The fall in these components of autonomous spending then produced a fall in real income and prices by the multiplier process. The Depression was severe because the fall in autonomous spending was large and sustained. …

The money hypothesis leads to a rather different tale. In this story, a “normal,” short-lived depression was converted into a major continued downswing in income and prices by the collapse of the banking system. (p. 10)

Again, I find Temin’s version of the “monetary hypothesis” is oddly Keynesian. I’ve said that Friedman really made the argument that the bank credit contraction should have been addressed by some form of Federal Reserve expansion — expansion that would have necessitated a devaluation and floating fiat currency. Friedman dresses this up in a lot of tricky rhetoric to make it seem as if the Federal Reserve was not doing its job correctly. Actually, it was doing its job correctly — adhering to the gold standard quite successfully, in a difficult environment — but Friedman thought it should be doing another job, a job which was actually the same as that the Keynesians recommended. Temin also seems to sense this.

In the last chapter, Temin summarizes his conclusions:

For these two reasons, then, the proposition that monetary forces caused the Depression must be rejected. …


The economic history of the Depression, then, seems to have gone something like this: a recession started in 1929 due to some combination of factors which cannot be disentangled. Financial markets were tight as a result both of the expectations built up around the stock market boom and the efforts of the Federal Reserve to arrest that boom. There were a variety of imbalances in particular markets, of which the apparent oversupply of housing at current prices was the most obvious. These and other factors made for a drop in income, but they would not by themselves have led to a major depression.

To these forces, several other deflationary factors were added. The stock market crash¬† was the most dramatic of these, and it has been discussed most widely. … For all the discussion of the crash by historians looking back on the 1920s and 1930s, it does not seem to have altered people’s anticipations about the overall level of activity in the economy. … It was not until a year after the stock-market crash that observers in general saw that the Depression at hand was not the same as previous falls in income. … Investment fell in 1930, as it falls in all recessions, but it did not fall more than usual. The Depression was not caused by a dramatic collapse of investment. The large fall in consumption in 1930, deriving from a variety of diverse and as yet still incompletely delineated sources, prevented recovery in that year. (p. 171-172)

Temin doesn’t seem to find this explanation very convincing, although he choses it over the “monetary interpretations,” which were apparently even less convincing. Temin’s last words:

This study has shown that the spending hypothesis fits the observed data better than the money hypothesis, that is, that it is more plausible to believe that the Depression was the result of a drop in autonomous expenditures, particularly consumption, than the result of autonomous bank failures. This is of great interest. But, for the reasons just stated, the economist who uses this conclusion or any other conclusion about the Depression as a basis for economic policy recommendations essentially is performing an act of faith. (p. 178)

There you go. It is clear that, in 1976, a large portion of academic economists basically rejected the Monetarist view (which was then over ten years old). They didn’t see any monetary problem at all. I find it interesting that even “the monetarist interpretation” is here explicitly described as essentially a nonmonetary one, having to do with credit contraction with a currency that itself undergoes no particular change (i.e. linked to gold). I think people understood, in the 1930s and afterwards, that the currency was indeed unchanged; and unless you can posit some kind of major change in the value of gold, you really can’t derive any kind of “monetary deflation” hypothesis involving a rise in the value of currencies. This is exactly my conclusion, and I think it was hazily though broadly understood in the 1930-1960 period, although people didn’t really talk about it in those terms.

Rather, I think that the popularity of “monetary interpretations” after 1960 was in part enabled by the general deterioration of monetary understanding after WWII. People were so confused by that point, that the inconsistencies of the “monetary interpretations” didn’t bother them.

I have also been describing this popular Keynesian view as “the Great Depression appeared out of a blue sky.” I think Temin’s version shows that that characterization is not too far off the mark. Temin cites a few items lackadaisically — a supposed excess of housing construction, a stock market crash — and then says explicitly that these factors alone really do not amount to much of an explanation for such a dramatic event. The Keynesians relied on “multiplier effects” to turn rinky-dinky causes into big consequences. This raises the question: if rinky-dinky stuff can be “multiplied” into giant disasters, why didn’t this happen in the century previous? You would think it would happen all the time. By the end of the book, we find that Temin does not offer anything new in replacement, but rather a faint grumbling about a “variety of diverse and as yet still incompletely delineated sources,” which means, “I have no idea, and neither does anyone else.”

That was the state of things, after fifty years of academic research into the Great Depression. A big airball. But, people got paid and tenure was achieved, so what was the problem, really.

I threw in Temin’s last line about “an act of faith” mostly for fun, although I think it does show that at least some people felt there was a big vacuum here that really couldn’t serve as the basis of confident policy.

Given Temin’s lack of conviction for either the “monetary hypothesis” or the “spending hypothesis” in 1976, it is perhaps no surprise that by 1989, he became more of a Blame France guy. This gave him a little more enthusiasm; the title of his 1989 book Lessons from the Great Depression suggests that the caution expressed in the last line of his 1976 book had dissipated. Now there were lessons; and he intends to tell you what they were.

I argued in the first lecture that the First World War was the impulse that led to the Great Depression. This solved one problem at the cost of creating another. The shock in this view was commensurate with the effect. There is no need to hypothesize an instability so great as to destroy the world economy in response to a small shock. Offsetting this desirable attribute of the argument, however, is the necessity to explain why a shock in 1914-1918 produced a depression in 1929-1933. (p. 41)

This is wonderfully silly. He is giddy with delight that he found a cause supposedly big enough to explain the effects. That it makes no sense doesn’t bother him. He will wallpaper that over in a hurry. Here is what he means by blaming WWI:

The postwar gold standard spread the shock of the war in two ways, by imparting a deflationary bias to national economic policies of gold-standard countries in the late 1920s and by indicating that deflation was the appropriate remedy for the ills of the early 1930s. The first tendency created the conditions for the Depression throughout the 1920s. The second pattern directed national economic policies in ways that accentuated the economic decline. (p. 42)

Note that this is also a “monetary interpretation.” The return of several countries to their prewar gold parities after wartime devaluation — notably Britain — did impart a genuine “monetary deflation” during that time. But, it didn’t cause a Great Depression in the 1920s. I think this effect, though real, tends to be overblown. People tend to ascribe all economic effects to this one monetary factor, while ignoring the effects of tax policy. Not only did Britain retain its high wartime tax rates during the 1920s, but additional taxes were imposed to fund new welfare programs. In any case, we find that Temin’s “propogation” thesis amounts to “the first tendency created the conditions for the Depression throughout the 1920s”without actually creating a Great Depression. Economies in general were actually rather healthy in the 1920s, especially in the U.S. and France. Traditionally, the U.S. is blamed as the originating source of the Great Depression, not Britain. The U.S. economy of the 1920s was booming. It was “the Roarding Twenties.” The stock market told the tale, even at its peak trading at less than 20x trailing earnings.

January 31, 2016: Blame Benjamin Strong

As for the 1930s, he says that the 1920s experience “directed national economic policies … ” This is the avenue of “propogation.” People had some ideas. By this, he basically means that governments wanted to remain on the gold standard, rather than devaluing. The fact that Britain and 22 other countries actually did devalue at the relatively early date of 1931 apparently was not early or aggressive enough for him.

Even after all this, however, Temin was still basically a Keynesian — he saw devaluation as a way of dealing with economic problems that were nonmonetary in nature.

The decline that started in 1929 was due to a failure of aggregate demand, as documented in Lecture 1. (p. 60)

I think we see that, by 1989, Team Keynes was still basically following the idea that there was no monetary cause of the Great Depression, but that a devaluation could have helped to address the problem. Thirteen years later, Temin still doesn’t have any decent notion of what may have caused it, relying on “a failure of aggregate demand,” which doesn’t mean anything except: “there’s a recession.”

The idea that the Smoot-Hawley tariff was a major cause of the Depression is an enduring conviction. It was stated at the time, reiterated after the Second World War by Lewis (1949, pp. 59-61), and again more recently and more strongly by Meltzer (1976). It has found its way into popular discussion and general histories (Kennedy 1987, pp. 282-283). Despite its popularity, however, this argument fails on both theoretical and historical grounds.

A tariff, like a devaluation, is an expansionary policy. (p. 46)

The purpose of this is not so much to examine Temin’s personal views, but rather to use him as a representative of common academic thinking in 1976 and 1989.

We will have more on this topic soon.