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Abstract
Friedman and Schwartz have argued that the Great Depression was primarily caused by mistakes in monetary policy. This paper presents evidence supporting this view. Four percent money growth over the period 1929-1941 is found to prevent the Great Depression completely. Indeed, had such a policy been followed, real income would have grown nearly as rapidly in the 1930s as it grew in the 1920s.
JEL Codes: E58, E52, E42
Keywords: depression, money
I. Introduction
Because the Great Depression is the single most important macroeconomic event of the twentieth century, it has received the attention of many economists. With all this attention, a consensus should have emerged on what caused the Depression; it has yet to emerge.
Milton Friedman and Anna Jacobson Schwartz (1963) have advanced one widely accepted view. They argue that the Great Depression was primarily caused by terrible mistakes in monetary policy that permitted the money supply to fall by about 40 percent between 1929 and 1933. For them, the Great Depression stemmed from poor government policy, and the proper lesson to learn is that the government should be fettered by fairly detailed rules of conduct.
The other widely held view attributes the Great Depression to private decisions that led to insufficient aggregate demand.Government may have exacerbated the effects by resorting to trade wars, cutting government spending, raising taxes, and keeping interest rates too high. Nevertheless, even if the government had avoided all pitfalls, the Great Depression would have been severe. What was necessary to prevent it was positive action- devaluing the dollar, raising government spending and public employment, and lowering taxes and interest rates. See Charles Kindleberger (1973) for an example of such a view and Peter Temin (1976) for some supporting empirical evidence.
In this paper, I evaluate these views using a simple structural model fitted to monthly data spanning the period 1929-1941. The model imposes the minimal number of restrictions necessary for identification. Doing so allows money to influence the economy through many channels that are ruled out a priori in Keynesian models. As a result, the model does not bias the analysis against the monetary explanation. I find that the views of Friedman and Schwartz are consistent with the data and those of Kindleberger and...