The Great Depression Explained: The Monetarist Position

 One of the most enduring questions in economic history, which historians still debate today, is, “what caused the Great Depression?”  There are competing schools of thought regarding the Great Depression, and the two major views are the Keynesian theory, based on the views of British economist John Maynard Keynes, and the monetarist view, espoused by Milton Friedman and Anna Schwartz. 

In this blog post, I want to focus on the monetarist view, which Friedman and Schwartz outlined in their seminal work, A Monetary History of the United States, 1867-1960, which they published in 1963.

In his article, “The Macroeconomics of the Great Depression: A Comparative Approach,” Ben S. Bernanke explains Friedman and Schwartz’s monetarist position as follows: “in their classic study of U.S. monetary history, Friedman and Schwartz (1963) presented a monetarist interpretation of these observations, arguing that the main lines of causation ran from monetary contraction-the result of poor policy-making and continuing crisis in the banking system-to declining prices and outputs.”[1]

Chapter 7 of their book, “The Great Contraction, 1929-33,” is of particular importance when one considers the question of what caused the Great Depression.  In this chapter, Friedman and Schwartz outline their argument that the fall in the stock of money, (approximately August 1929-March 1933), caused many banks to suspend operations.[2] Additionally, they outline that, during the period from August 1929 to the October stock market crash, production, wholesale prices, and personal income all fell.  This, and the stock market crash spread an atmosphere which reduced the willingness of consumers and businesses to spend, which make the contraction worse, in their opinion.[3]

Friedman and Schwartz also point to the multitude of bank panics or failures during the years 1929-1933, as evidence of the Great Contraction.  They argue that these bank panics, in particular that of 1933, occurred again due to a fall in the stock of money.  Banks greatly reduced their government securities, which in turn caused people to want to withdraw their own accounts.  Furthermore, the Federal Reserve banks reduced their holdings in gold, which exacerbated this panic.[4]

This situation was even worse for the commercial banks, which had even less in reserve than the Federal banks.  Friedman and Schwartz contend that the Federal Reserve could have altered this situation through open market purchases which would have improved the capital positions of these commercial banks, and thereby raise market values. However, the Federal Reserve took no steps to do so until the Emergency Banking Act of March 9, 1933, late in the Depression.[5]

These bank failures and the contraction in money supply was in stark contrast to the rise in the supply of money present during the 1920s.  Most economists place the rise at just over 15 percent, while Milton Friedman and Anna Schwartz place this rise at 30 percent.[6]

An additional factor, in Friedman and Schwartz’s view, was the Federal Reserves intense focus on the gold standard, and in holding gold stock.  The Federal Reserve tightened money, which negatively impacted spending by consumers and businesses, prolonging and deepening the Great Depression.[7]

Friedman and Schwartz’ basic premise is that the Federal Reserve could have negated most of the impacts of the Great Depression through sound monetary policy, which would in turn stabilize the market.  Specifically, had the Federal Reserve enacted policies which would have opened the money stock market, it would have encouraged spending by consumers and businesses, and thereby negate (largely) the impacts of the Great Depression. 

 However, reliance or overreliance on the gold standard, and the lack of confidence in the market, combined with a decline in the available stock of money, led to the Great Contraction or Great Depression.  Had the Federal Reserve acted prior to 1933, perhaps they could have avoided the Great Depression altogether. 

Thus, one can see that Milton Friedman and Anna Schwartz’s book clearly outlines the challenges faced by the Federal Reserve during the Great Depression.  They argue that sound monetary policy may have had an influence on the market and curtailed or reversed the Great Contraction.  This is one of the two main schools of thought regarding causes of the Great Depression, and it is important for historians to understand. 


[1] Ben S. Bernanke, “The Macroeconomics of the Great Depression: A Comparative Approach,” Journal of Money, Credit and Banking, 27, no. 1 (Feb., 1995): 3, https://www.jstor.org/stable/2077848

[2] Milton Friedman and Anna Jacobson Schwartz, “The Great Contraction, 1929-33,” in A Monetary History of the United States, 1867-1960, 299, https://www.jstor.org/stable/j.ctt7s1vp.10

[3] Ibid, 306.

[4] Ibid, 326.

[5] Ibid, 330-331.

[6] Herman E. Krooss. “Review: Monetary History and Monetary Policy: A Review Article,” The Journal of Finance, 19, no 4 (Dec., 1964): 663, https://www.jstor.org/stable/2977119

[7][7] Ibid, 664.

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