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Both Ben S. Bernanke and Milton Friedman are economists who studied the Great Depression closely. Indeed, Bernanke admits that his intense interest in that event was inspired by reading Milton Friedman and Anna Jacobson Schwartz's Monetary History of the United States, 1867-1960 (1963). Bernanke agrees with Friedman that what made the Great Depression truly great rather than just a garden-variety depression was the series of banking panics that began nearly a year after the stock-market crash of October 1929. And both agree that the Federal Reserve (the Fed) was the primary culprit by failing to offset, if not by initiating, that economic cataclysm within the United States (Ip 2005). As Bernanke, while still only a member of the Fed's board of governors, said in an address at a ninetieth-birthday celebration for Friedman: "I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again" (2002b).
This seeming similarity, however, disguises significant differences in Friedman's and Bernanke's approaches to financial crises, differences that have played an enormous yet rarely noticed role in the recent financial crisis. Not only have those differences resulted in another Fed failure - not quite as serious as the one during the Great Depression, to be sure, yet serious enough - but they have also resulted in a dramatic transformation of the Fed's role in the economy. Bernanke has so expanded the Fed's discretionary actions beyond merely controlling the money stock that it has become a gigantic, financial central planner. In short, despite Bernanke's promise, the Fed did do it again.
Conflicting Lessons of the Great Depression
The banking panics associated with the Great Depression were not only the worst in the history of the United States, but also the largest in the history of the world. The differences between Bernanke and Friedman center on why those panics generated economic catastrophe. For Friedman and Schwartz, the causal mechanism was the resulting changes in the money stock and therefore in the equilibrium price level. The panics brought about a collapse of the broader measures of the money stock over the four years from 1929 to 1933: a one-third fall in M2 and a one-fourth fall...