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http://www.federalreserve.gov/boarddocs/speeches/2004/200403022/default.htm
Remarks by Governor Ben S. Bernanke
At the H. Parker Willis Lecture in Economic Policy, Washington and
Lee University, Lexington, Virginia
March 2, 2004
Money, Gold, and the Great Depression
I am pleased to be able to present the H. Parker Willis Lecture in
Economic Policy here at Washington and Lee University. As you may know,
Willis was an important figure in the early history of my current
employer, the Federal Reserve System. While he was a professor at
Washington and Lee, Willis advised Senator Carter Glass of Virginia, one
of the key legislators involved in the founding of the Federal Reserve.
Willis also served on the National Monetary Commission, which
recommended the creation of the Federal Reserve, and he went on to
become the research director at the Federal Reserve from 1918 to 1922.
At the Federal Reserve, Willis pushed for the development of new and
better economic statistics, facing the resistance of those who took the
view that too many facts only confuse the issue. Willis was also the
first editor of the
Federal Reserve Bulletin, the official publication of the Fed,
which in Willis's time as well as today provides a wealth of economic
statistics. As an illustration of the intellectual atmosphere in
Washington at the time he served, Willis reported that when the first
copy of the Bulletin was presented to the Secretary of the
Treasury, the esteemed Secretary replied, "This Government ain't going
into the newspaper business."
Like Parker Willis, I was a professor myself before coming to the
Federal Reserve Board. One topic of particular interest to me as a
researcher was the performance of the Federal Reserve in its early days,
particularly the part played by the young U.S. central bank in the Great
Depression of the 1930s.1
In honor of Willis's important contribution to the design and creation
of the Federal Reserve, I will speak today about the role of the Federal
Reserve and of monetary factors more generally in the origin and
propagation of the Great Depression. Let me offer two caveats before I
begin: First, as I mentioned, H. Parker Willis resigned from the Fed in
1922, to take a post at Columbia University; thus, he is not implicated
in any of the mistakes that the Federal Reserve made in the late 1920s
and early 1930s. Second, the views I will express today are my own and
are not necessarily those of my colleagues in the Federal Reserve
System.
The number of people with personal memory of the Great Depression is
fast shrinking with the years, and to most of us the Depression is
conveyed by grainy, black-and-white images of men in hats and long coats
standing in bread lines. However, although the Depression was long
ago--October this year will mark the seventy-fifth anniversary of the
famous 1929 stock market crash--its influence is still very much with
us. In particular, the experience of the Depression helped forge a
consensus that the government bears the important responsibility of
trying to stabilize the economy and the financial system, as well as of
assisting people affected by economic downturns. Dozens of our most
important government agencies and programs, ranging from social security
(to assist the elderly and disabled) to federal deposit insurance (to
eliminate banking panics) to the Securities and Exchange Commission (to
regulate financial activities) were created in the 1930s, each a legacy
of the Depression.
The impact that the experience of the Depression has had on views
about the role of the government in the economy is easily understood
when we recall the sheer magnitude of that economic downturn. During the
major contraction phase of the Depression, between 1929 and 1933, real
output in the United States fell nearly 30 percent. During the same
period, according to retrospective studies, the unemployment rate rose
from about 3 percent to nearly 25 percent, and many of those lucky
enough to have a job were able to work only part-time. For comparison,
between 1973 and 1975, in what was perhaps the most severe U.S.
recession of the World War II era, real output fell 3.4 percent and the
unemployment rate rose from about 4 percent to about 9 percent. Other
features of the 1929-33 decline included a sharp deflation--prices fell
at a rate of nearly 10 percent per year during the early 1930s--as well
as a plummeting stock market, widespread bank failures, and a rash of
defaults and bankruptcies by businesses and households. The economy
improved after Franklin D. Roosevelt's inauguration in March 1933, but
unemployment remained in the double digits for the rest of the decade,
full recovery arriving only with the advent of World War II. Moreover,
as I will discuss later, the Depression was international in scope,
affecting most countries around the world not only the United States.
What caused the Depression? This question is a difficult one, but
answering it is important if we are to draw the right lessons from the
experience for economic policy. Solving the puzzle of the Depression is
also crucial to the field of economics itself because of the light the
solution would shed on our basic understanding of how the economy works.
During the Depression years and for many decades afterward,
economists disagreed sharply on the sources of the economic and
financial collapse of the 1930s. In contrast, during the past twenty
years or so economic historians have come to a broad consensus about the
causes of the Depression. A widening of the geographic focus of
Depression research deserves much of the credit for this breakthrough.
Before the 1980s, research on the causes of the Depression had
considered primarily the experience of the United States. This attention
to the U.S. case was appropriate to some degree, as the U.S. economy was
then, as it is today, the world's largest; the decline in output and
employment in the United States during the 1930s was especially severe;
and many economists have argued that, to an important extent, the
worldwide Depression began in the United States, spreading from here to
other countries (Romer, 1993). However, in much the same way that a
medical researcher cannot reliably infer the causes of an illness by
studying one patient, diagnosing the causes of the Depression is easier
when we have more patients (in this case, more national economies) to
study. To explain the current consensus on the causes of the Depression,
I will first describe the debate as it existed before 1980, and then
discuss how the recent focus on international aspects of the Depression
and the comparative analysis of the experiences of different countries
have helped to resolve that debate.
I have already mentioned the sharp deflation of the price level that
occurred during the contraction phase of the Depression, by far the most
severe episode of deflation experienced in the United States before or
since. Deflation, like inflation, tends to be closely linked to changes
in the national money supply, defined as the sum of currency and bank
deposits outstanding, and such was the case in the Depression. Like real
output and prices, the U.S. money supply fell about one-third between
1929 and 1933, rising in subsequent years as output and prices rose.
While the fact that money, prices, and output all declined rapidly in
the early years of the Depression is undeniable, the interpretation of
that fact has been the subject of much controversy. Indeed,
historically, much of the debate on the causes of the Great Depression
has centered on the role of monetary factors, including both monetary
policy and other influences on the national money supply, such as the
condition of the banking system. Views have changed over time. During
the Depression itself, and in several decades following, most economists
argued that monetary factors were not an important cause of the
Depression. For example, many observers pointed to the fact that nominal
interest rates were close to zero during much of the Depression,
concluding that monetary policy had been about as easy as possible yet
had produced no tangible benefits to the economy. The attempt to use
monetary policy to extricate an economy from a deep depression was often
compared to "pushing on a string."
During the first decades after the Depression, most economists looked
to developments on the real side of the economy for explanations, rather
than to monetary factors. Some argued, for example, that overinvestment
and overbuilding had taken place during the ebullient 1920s, leading to
a crash when the returns on those investments proved to be less than
expected. Another once-popular theory was that a chronic problem of
"under-consumption"--the inability of households to purchase enough
goods and services to utilize the economy's productive capacity--had
precipitated the slump.
However, in 1963, Milton Friedman and Anna J. Schwartz transformed
the debate about the Great Depression. That year saw the publication of
their now-classic book, A Monetary History of the United States,
1867-1960. The Monetary History, the name by which the
book is instantly recognized by any macroeconomist, examined in great
detail the relationship between changes in the national money
stock--whether determined by conscious policy or by more impersonal
forces such as changes in the banking system--and changes in national
income and prices. The broader objective of the book was to understand
how monetary forces had influenced the U.S. economy over a nearly a
century. In the process of pursuing this general objective, however,
Friedman and Schwartz offered important new evidence and arguments about
the role of monetary factors in the Great Depression. In contradiction
to the prevalent view of the time, that money and monetary policy played
at most a purely passive role in the Depression, Friedman and Schwartz
argued that "the [economic] contraction is in fact a tragic testimonial
to the importance of monetary forces" (Friedman and Schwartz, 1963, p.
300).
To support their view that monetary forces caused the Great
Depression, Friedman and Schwartz revisited the historical record and
identified a series of errors--errors of both commission and
omission--made by the Federal Reserve in the late 1920s and early 1930s.
According to Friedman and Schwartz, each of these policy mistakes led to
an undesirable tightening of monetary policy, as reflected in sharp
declines in the money supply. Drawing on their historical evidence about
the effects of money on the economy, Friedman and Schwartz argued that
the declines in the money stock generated by Fed actions--or
inactions--could account for the drops in prices and output that
subsequently occurred.2
Friedman and Schwartz emphasized at least four major errors by U.S.
monetary policymakers. The Fed's first grave mistake, in their view, was
the tightening of monetary policy that began in the spring of 1928 and
continued until the stock market crash of October 1929 (see Hamilton,
1987, or Bernanke, 2002a, for further discussion). This tightening of
monetary policy in 1928 did not seem particularly justified by the
macroeconomic environment: The economy was only just emerging from a
recession, commodity prices were declining sharply, and there was little
hint of inflation. Why then did the Federal Reserve raise interest rates
in 1928? The principal reason was the Fed's ongoing concern about
speculation on Wall Street. Fed policymakers drew a sharp distinction
between "productive" (that is, good) and "speculative" (bad) uses of
credit, and they were concerned that bank lending to brokers and
investors was fueling a speculative wave in the stock market. When the
Fed's attempts to persuade banks not to lend for speculative purposes
proved ineffective, Fed officials decided to dissuade lending directly
by raising the policy interest rate.
The market crash of October 1929 showed, if anyone doubted it, that a
concerted effort by the Fed can bring down stock prices. But the cost of
this "victory" was very high. According to Friedman and Schwartz, the
Fed's tight-money policies led to the onset of a recession in August
1929, according to the official dating by the National Bureau of
Economic Research. The slowdown in economic activity, together with high
interest rates, was in all likelihood the most important source of the
stock market crash that followed in October. In other words, the market
crash, rather than being the cause of the Depression, as popular legend
has it, was in fact largely the result of an economic slowdown and the
inappropriate monetary policies that preceded it. Of course, the stock
market crash only worsened the economic situation, hurting consumer and
business confidence and contributing to a still deeper downturn in 1930.
The second monetary policy action identified by Friedman and Schwartz
occurred in September and October of 1931. At the time, as I will
discuss in more detail later, the United States and the great majority
of other nations were on the gold standard, a system in which the value
of each currency is expressed in terms of ounces of gold. Under the gold
standard, central banks stood ready to maintain the fixed values of
their currencies by offering to trade gold for money at the legally
determined rate of exchange.
The fact that, under the gold standard, the value of each currency
was fixed in terms of gold implied that the rate of exchange between any
two currencies within the gold standard system was likewise fixed. As
with any system of fixed exchange rates, the gold standard was subject
to speculative attack if investors doubted the ability of a country to
maintain the value of its currency at the legally specified parity. In
September 1931, following a period of financial upheaval in Europe that
created concerns about British investments on the Continent, speculators
attacked the British pound, presenting pounds to the Bank of England and
demanding gold in return. Faced with the heavy demands of speculators
for gold and a widespread loss of confidence in the pound, the Bank of
England quickly depleted its gold reserves. Unable to continue
supporting the pound at its official value, Great Britain was forced to
leave the gold standard, allowing the pound to float freely, its value
determined by market forces.
With the collapse of the pound, speculators turned their attention to
the U.S. dollar, which (given the economic difficulties the United
States was experiencing in the fall of 1931) looked to many to be the
next currency in line for devaluation. Central banks as well as private
investors converted a substantial quantity of dollar assets to gold in
September and October of 1931, reducing the Federal Reserve's gold
reserves. The speculative attack on the dollar also helped to create a
panic in the U.S. banking system. Fearing imminent devaluation of the
dollar, many foreign and domestic depositors withdrew their funds from
U.S. banks in order to convert them into gold or other assets. The
worsening economic situation also made depositors increasingly
distrustful of banks as a place to keep their savings. During this
period, deposit insurance was virtually nonexistent, so that the failure
of a bank might cause depositors to lose all or most of their savings.
Thus, depositors who feared that a bank might fail rushed to withdraw
their funds. Banking panics, if severe enough, could become
self-confirming prophecies. During the 1930s, thousands of U.S. banks
experienced runs by depositors and subsequently failed.
Long-established central banking practice required that the Fed
respond both to the speculative attack on the dollar and to the domestic
banking panics. However, the Fed decided to ignore the plight of the
banking system and to focus only on stopping the loss of gold reserves
to protect the dollar. To stabilize the dollar, the Fed once again
raised interest rates sharply, on the view that currency speculators
would be less willing to liquidate dollar assets if they could earn a
higher rate of return on them. The Fed's strategy worked, in that the
attack on the dollar subsided and the U.S. commitment to the gold
standard was successfully defended, at least for the moment. However,
once again the Fed had chosen to tighten monetary policy despite the
fact that macroeconomic conditions--including an accelerating decline in
output, prices, and the money supply--seemed to demand policy ease.
The third policy action highlighted by Friedman and Schwartz occurred
in 1932. By the spring of that year, the Depression was well advanced,
and Congress began to place considerable pressure on the Federal Reserve
to ease monetary policy. The Board was quite reluctant to comply, but in
response to the ongoing pressure the Board conducted open-market
operations between April and June of 1932 designed to increase the
national money supply and thus ease policy. These policy actions reduced
interest rates on government bonds and corporate debt and appeared to
arrest the decline in prices and economic activity. However, Fed
officials remained ambivalent about their policy of monetary expansion.
Some viewed the Depression as the necessary purging of financial
excesses built up during the 1920s; in this view, slowing the economic
collapse by easing monetary policy only delayed the inevitable
adjustment. Other officials, noting among other indicators the very low
level of nominal interest rates, concluded that monetary policy was in
fact already quite easy and that no more should be done. These
policymakers did not appear to appreciate that, even though nominal
interest rates were very low, the ongoing deflation meant that the real
cost of borrowing was very high because any loans would have to be
repaid in dollars of much greater value (Meltzer, 2003). Thus monetary
policy was not in fact easy at all, despite the very low level of
nominal interest rates. In any event, Fed officials convinced themselves
that the policy ease advocated by the Congress was not appropriate, and
so when the Congress adjourned in July 1932, the Fed reversed the
policy. By the latter part of the year, the economy had relapsed
dramatically.
The fourth and final policy mistake emphasized by Friedman and
Schwartz was the Fed's ongoing neglect of problems in the U.S. banking
sector. As I have already described, the banking sector faced enormous
pressure during the early 1930s. As depositor fears about the health of
banks grew, runs on banks became increasingly common. A series of
banking panics spread across the country, often affecting all the banks
in a major city or even an entire region of the country. Between
December 1930 and March 1933, when President Roosevelt declared a
"banking holiday" that shut down the entire U.S. banking system, about
half of U.S. banks either closed or merged with other banks. Surviving
banks, rather than expanding their deposits and loans to replace those
of the banks lost to panics, retrenched sharply.
The banking crisis had highly detrimental effects on the broader
economy. Friedman and Schwartz emphasized the effects of bank failures
on the money supply. Because bank deposits are a form of money, the
closing of many banks greatly exacerbated the decline in the money
supply. Moreover, afraid to leave their funds in banks, people hoarded
cash, for example by burying their savings in coffee cans in the back
yard. Hoarding effectively removed money from circulation, adding
further to the deflationary pressures. Moreover, as I emphasized in
early research of my own (Bernanke, 1983), the virtual shutting down of
the U.S. banking system also deprived the economy of an important source
of credit and other services normally provided by banks.
The Federal Reserve had the power at least to ameliorate the problems
of the banks. For example, the Fed could have been more aggressive in
lending cash to banks (taking their loans and other investments as
collateral), or it could have simply put more cash in circulation.
Either action would have made it easier for banks to obtain the cash
necessary to pay off depositors, which might have stopped bank runs
before they resulted in bank closings and failures. Indeed, a central
element of the Federal Reserve's original mission had been to provide
just this type of assistance to the banking system. The Fed's failure to
fulfill its mission was, again, largely the result of the economic
theories held by the Federal Reserve leadership. Many Fed officials
appeared to subscribe to the infamous "liquidationist" thesis of
Treasury Secretary Andrew Mellon, who argued that weeding out "weak"
banks was a harsh but necessary prerequisite to the recovery of the
banking system. Moreover, most of the failing banks were relatively
small and not members of the Federal Reserve System, making their fate
of less interest to the policymakers. In the end, Fed officials decided
not to intervene in the banking crisis, contributing once again to the
precipitous fall in the money supply.
Friedman and Schwartz discuss other episodes and policy actions as
well, such as the Federal Reserve's misguided tightening of policy in
1937-38 which contributed to a new recession in those years. However,
the four episodes I have described capture the gist of the Friedman and
Schwartz argument that, for a variety of reasons, monetary policy was
unnecessarily tight, both before the Depression began and during its
most dramatic downward phase. As I have mentioned, Friedman and Schwartz
had produced evidence from other historical periods that suggested that
contractionary monetary policies can lead to declining prices and
output. Friedman and Schwartz concluded therefore that they had found
the smoking gun, evidence that much of the severity of the Great
Depression could be attributed to monetary forces.
Friedman and Schwartz's arguments were highly influential but not
universally accepted. For several decades after the Monetary History
was published, a debate raged about the importance of monetary factors
in the Depression. Opponents made several objections to the Friedman and
Schwartz thesis that are worth highlighting here.
First, critics wondered whether the tightening of monetary policy
during 1928 and 1929, though perhaps ill advised, was large enough to
have led to such calamitous consequences.3
If the tightening of monetary policy before the stock market crash was
not sufficient to account for the violence of the economic downturn,
then other, possibly nonmonetary, factors may need to be considered as
well.
A second question is whether the large decline in the money supply
seen during the 1930s was primarily a cause or an effect of falling
output and prices. As we have seen, Friedman and Schwartz argued that
the decline in the money supply was causal. Suppose, though, for the
sake of argument, that the Depression was the result primarily of
nonmonetary factors, such as overspending and overinvestment during the
1920s. As incomes and spending decline, people need less money to carry
out daily transactions. In this scenario, critics pointed out, the Fed
would be justified in allowing the money supply to fall, because it
would only be accommodating a decline in the amount of money that people
want to hold. The decline in the money supply in this case would be a
response to, not a cause of, the decline in output and prices. To put
the question simply, we know that both the economy and the money stock
contracted rapidly during the early 1930s, but was the monetary dog
wagging the economic tail, or vice versa?
The focus of Friedman and Schwartz on the U.S. experience (by design,
of course) raised other questions about their monetary explanation of
the Depression. As I have mentioned, the Great Depression was a
worldwide phenomenon, not confined to the United States. Indeed, some
economies, such as that of Germany, began to decline before 1929.
Although few countries escaped the Depression entirely, the severity of
the episode varied widely across countries. The timing of recovery also
varied considerably, with some countries beginning their recovery as
early as 1931 or 1932, whereas others remained in the depths of
depression as late as 1935 or 1936. How does Friedman and Schwartz's
monetary thesis explain the worldwide nature of the onset of the
Depression, and the differences in severity and timing observed in
different countries?
That is where the debate stood around 1980. About that time, however,
economic historians began to broaden their focus, shifting from a heavy
emphasis on events in the United States during the 1930s to an increased
attention to developments around the world. Moreover, rather than
studying countries individually, this new scholarship took a comparative
approach, asking specifically why some countries fared better than
others in the 1930s. As I will explain, this research uncovered an
important role for international monetary forces, as well as domestic
monetary policies, in explaining the Depression. Specifically, the new
research found that a complete understanding of the Depression requires
attention to the operation of the international gold standard, the
international monetary system of the time.4
As I have already mentioned, the gold standard is a monetary system
in which each participating country defines its monetary unit in terms
of a certain amount of gold. The setting of each currency's value in
terms of gold defines a system of fixed exchange rates, in which the
relative value of (say) the U.S. dollar and the British pound are fixed
at a rate determined by the relative gold content of each currency. To
maintain the gold standard, central banks had to promise to exchange
actual gold for their paper currencies at the legal rate.
The gold standard appeared to be highly successful from about 1870 to
the beginning of World War I in 1914. During the so-called "classical"
gold standard period, international trade and capital flows expanded
markedly, and central banks experienced relatively few problems ensuring
that their currencies retained their legal value. The gold standard was
suspended during World War I, however, because of disruptions to trade
and international capital flows and because countries needed more
financial flexibility to finance their war efforts. (The United States
remained technically on the gold standard throughout the war, but with
many restrictions.)
After 1918, when the war ended, nations around the world made
extensive efforts to reconstitute the gold standard, believing that it
would be a key element in the return to normal functioning of the
international economic system. Great Britain was among the first of the
major countries to return to the gold standard, in 1925, and by 1929 the
great majority of the world's nations had done so.
Unlike the gold standard before World War I, however, the gold
standard as reconstituted in the 1920s proved to be both unstable and
destabilizing. Economic historians have identified a number of reasons
why the reconstituted gold standard was so much less successful than its
prewar counterpart. First, the war had left behind enormous economic
destruction and dislocation. Major financial problems also remained,
including both large government debts from the war and banking systems
whose solvency had been deeply compromised by the war and by the periods
of hyperinflation that followed in a number of countries. These
underlying problems created stresses for the gold standard that had not
existed to the same degree before the war.
Second, the new system lacked effective international leadership.
During the classical period, the Bank of England, in operation since
1694, provided sophisticated management of the international system,
with the cooperation of other major central banks. This leadership
helped the system adjust to imbalances and strains; for example, a
consortium of central banks might lend gold to one of their number that
was experiencing a shortage of reserves. After the war, with Great
Britain economically and financially depleted and the United States in
ascendance, leadership of the international system shifted by default to
the Federal Reserve. Unfortunately, the fledgling Federal Reserve, with
its decentralized structure and its inexperienced and domestically
focused leadership, did not prove up to the task of managing the
international gold standard, a task that lingering hatreds and disputes
from the war would have made difficult for even the most-sophisticated
institution. With the lack of effective international leadership, most
central banks of the 1920s and 1930s devoted little effort to supporting
the overall stability of the international system and focused instead on
conditions within their own countries.
Finally, the reconstituted gold standard lacked the credibility of
its prewar counterpart. Before the war, the ideology of the gold
standard was dominant, to the point that financial investors had no
doubt that central banks would find a way to maintain the gold values of
their currencies no matter what the circumstances. Because this
conviction was so firm, speculators had little incentive to attack a
major currency. After the war, in contrast, both economic views and the
political balance of power had shifted in ways that reduced the
influence of the gold standard ideology. For example, new
labor-dominated political parties were skeptical about the utility of
maintaining the gold standard if doing so increased unemployment.
Ironically, reduced political and ideological support for the gold
standard made it more difficult for central banks to maintain the gold
values of their currencies, as speculators understood that the
underlying commitment to adhere to the gold standard at all costs had
been weakened significantly. Thus, speculative attacks became much more
likely to succeed and hence more likely to occur.
With an international focus, and with particular attention to the
role of the gold standard in the world economy, scholars have now been
able to answer the questions regarding the monetary interpretation of
the Depression that I raised earlier.
First, the existence of the gold standard helps to explain why the
world economic decline was both deep and broadly international. Under
the gold standard, the need to maintain a fixed exchange rate among
currencies forces countries to adopt similar monetary policies. In
particular, a central bank with limited gold reserves has no option but
to raise its own interest rates when interest rates are being raised
abroad; if it did not do so, it would quickly lose gold reserves as
financial investors transferred their funds to countries where returns
were higher. Hence, when the Federal Reserve raised interest rates in
1928 to fight stock market speculation, it inadvertently forced
tightening of monetary policy in many other countries as well. This
tightening abroad weakened the global economy, with effects that fed
back to the U.S. economy and financial system.
Other countries' policies also contributed to a global monetary
tightening during 1928 and 1929. For example, after France returned to
the gold standard in 1928, it built up its gold reserves significantly,
at the expense of other countries. The outflows of gold to France forced
other countries to reduce their money supplies and to raise interest
rates. Speculative attacks on currencies also became frequent as the
Depression worsened, leading central banks to raise interest rates, much
like the Federal Reserve did in 1931. Leadership from the Federal
Reserve might possibly have produced better international cooperation
and a more appropriate set of monetary policies. However, in the absence
of that leadership, the worldwide monetary contraction proceeded apace.
The result was a global economic decline that reinforced the effects of
tight monetary policies in individual countries.
The transmission of monetary tightening through the gold standard
also addresses the question of whether changes in the money supply
helped cause the Depression or were simply a passive response to the
declines in income and prices. Countries on the gold standard were often
forced to contract their money supplies because of policy developments
in other countries, not because of domestic events. The fact that these
contractions in money supplies were invariably followed by declines in
output and prices suggests that money was more a cause than an effect of
the economic collapse in those countries.
Perhaps the most fascinating discovery arising from researchers'
broader international focus is that the extent to which a country
adhered to the gold standard and the severity of its depression were
closely linked. In particular, the longer that a country remained
committed to gold, the deeper its depression and the later its recovery
(Choudhri and Kochin, 1980; Eichengreen and Sachs, 1985).
The willingness or ability of countries to remain on the gold
standard despite the adverse developments of the 1930s varied quite a
bit. A few countries did not join the gold standard system at all; these
included Spain (which was embroiled in domestic political upheaval,
eventually leading to civil war) and China (which used a silver monetary
standard rather than a gold standard). A number of countries adopted the
gold standard in the 1920s but left or were forced off gold relatively
early, typically in 1931. Countries in this category included Great
Britain, Japan, and several Scandinavian countries. Some countries, such
as Italy and the United States, remained on the gold standard into 1932
or 1933. And a few diehards, notably the so-called gold bloc, led by
France and including Poland, Belgium, and Switzerland, remained on gold
into 1935 or 1936.
If declines in the money supply induced by adherence to the gold
standard were a principal reason for economic depression, then countries
leaving gold earlier should have been able to avoid the worst of the
Depression and begin an earlier process of recovery. The evidence
strongly supports this implication. For example, Great Britain and
Scandinavia, which left the gold standard in 1931, recovered much
earlier than France and Belgium, which stubbornly remained on gold. As
Friedman and Schwartz noted in their book, countries such as
China--which used a silver standard rather than a gold standard--avoided
the Depression almost entirely. The finding that the time at which a
country left the gold standard is the key determinant of the severity of
its depression and the timing of its recovery has been shown to hold for
literally dozens of countries, including developing countries. This
intriguing result not only provides additional evidence for the
importance of monetary factors in the Depression, it also explains why
the timing of recovery from the Depression differed across countries.
The finding that leaving the gold standard was the key to recovery
from the Great Depression was certainly confirmed by the U.S.
experience. One of the first actions of President Roosevelt was to
eliminate the constraint on U.S. monetary policy created by the gold
standard, first by allowing the dollar to float and then by resetting
its value at a significantly lower level. The new President also
addressed another major source of monetary contraction, the ongoing
banking crisis. Within days of his inauguration, Roosevelt declared a
"bank holiday," shutting down all the banks in the country. Banks were
allowed to reopen only when certified to be in sound financial
condition. Roosevelt pursued other measures to stabilize the banking
system as well, such as the creation of a deposit insurance program.
With the gold standard constraint removed and the banking system
stabilized, the money supply and the price level began to rise. Between
Roosevelt's coming to power in 1933 and the recession of 1937-38, the
economy grew strongly.
I have only scratched the surface of the fascinating literature on
the causes of the Great Depression, but it is time that I conclude.
Economists have made a great deal of progress in understanding the Great
Depression. Milton Friedman and Anna Schwartz deserve enormous credit
for bringing the role of monetary factors to the fore in their
Monetary History. However, expanding the research focus to include
the experiences of a wide range of countries has both provided
additional support for the role of monetary factors (including the
international gold standard) and enriched our understanding of the
causes of the Depression.
Some important lessons emerge from the story. One lesson is that
ideas are critical. The gold standard orthodoxy, the adherence of some
Federal Reserve policymakers to the liquidationist thesis, and the
incorrect view that low nominal interest rates necessarily signaled
monetary ease, all led policymakers astray, with disastrous
consequences. We should not underestimate the need for careful research
and analysis in guiding policy. Another lesson is that central banks and
other governmental agencies have an important responsibility to maintain
financial stability. The banking crises of the 1930s, both in the United
States and abroad, were a significant source of output declines, both
through their effects on money supplies and on credit supplies. Finally,
perhaps the most important lesson of all is that price stability should
be a key objective of monetary policy. By allowing persistent declines
in the money supply and in the price level, the Federal Reserve of the
late 1920s and 1930s greatly destabilized the U.S. economy and, through
the workings of the gold standard, the economies of many other nations
as well.
REFERENCES
Bernanke, Ben (1983). "Nonmonetary Effects of the Financial Crisis in
the Propagation of the Great Depression," American Economic Review,
73, (June) pp. 257-76.
Bernanke, Ben (2000). Essays on the Great Depression.
Princeton, N. J.: Princeton University Press.
Bernanke, Ben (2002a). "Asset-Price
'Bubbles' and Monetary Policy," before the New York chapter of the
National Association for Business Economics, New York, New York, October
15. Available at www.federalreserve.gov.
Bernanke, Ben (2002b). "On
Milton Friedman's Ninetieth Birthday," at the Conference to Honor
Milton Friedman, University of Chicago, Chicago, Illinois, November 8.
Available at www.federalreserve.gov.
Choudhri, Ehsan, and Levis Kochin (1980). "The Exchange Rate and the
International Transmission of Business Cycle Disturbances: Some Evidence
from the Great Depression," Journal of Money, Credit, and Banking,
12, pp. 565-74.
Eichengreen, Barry (1992). Golden Fetters: The Gold Standard and
the Great Depression, 1919-1939. Oxford: Oxford University Press.
Eichengreen, Barry (2002). "Still Fettered after All These Years,"
National Bureau of Economic Research working paper no. 9276 (October).
Eichengreen, Barry, and Jeffrey Sachs (1985). "Exchange Rates and
Economic Recovery in the 1930s," Journal of Economic History,
45, pp. 925-46.
Friedman, Milton, and Anna J. Schwartz (1963). A Monetary History
of the United States, 1867-1960. Princeton, N.J.: Princeton
University Press for NBER.
Hamilton, James (1987). "Monetary Factors in the Great Depression,"
Journal of Monetary Economics, 34, pp. 145-69.
Meltzer, Allan (2003). A History of the Federal Reserve, Volume
I: 1913-1951. Chicago: The University of Chicago Press.
Romer, Christina (1993). "The Nation in Depression," Journal of
Economic Perspectives, 7 (Spring), pp. 19-40.
Temin, Peter (1989). Lessons from the Great Depression.
Cambridge, Mass.: MIT Press.
Footnotes
1. My professional articles on the Depression are
collected in Bernanke (2000). Return
to text
2. Bernanke (2002b) gives a more detailed
discussion of the evidence presented by Friedman and Schwartz. Return
to text
3. There was less debate about the period 1931-33,
the most precipitous downward phase of the Depression, for which most
economists were inclined to ascribe an important role to monetary
factors. Return to text
4. Critical early research included Choudhri and
Kochin (1980) and Eichengreen and Sachs (1985). Eichengreen (1992, 2002)
provides the most extensive analysis of the role of the gold standard in
causing and propagating the Great Depression. Temin (1989) provides a
readable account with a slightly different perspective. Return
to text |
