What Made the Great Depression so Great? Part One of Two

 The Great Depression was the longest and greatest depression experienced by the Western industrialized world. The Great Depression was much more severe than a recession but how did it become so great?

In this blog post, I will discuss Friedman & Schwartz's theory on the Great Depression.

Friedman & Schwartz's Take on the Great Depression

Friedman's theory was an alternative to the Keynesian explanation.

Friedman & Schwartz identified the monetary policies of the Federal Reserve as the main cause. According to them, they believed that the events that took place were a result of the complete abdication of the Fed’s main responsibilities. For example, they have stated that they believe that the Fed did little to prevent the bank runs which deepened the Depression.

Bank runs came about in the 1930's and spread like wildfire throughout the country. These bank runs caused the money supply to decline.This caused banks to fail and the number increased substantially in December 1930, and in that month, 352 banks had failed. Friedman and Schwartz stated that the banks runs were a "contagion of fear."

One of their main criticisms of the Fed was its failure to act as a lender of last resort. They did not provide liquidity through loans and instead banks began to fail. The Fed could have prevented several failed banks by purchasing bonds but they did not. They believe the Fed did not act appropriately as they were not aware of the consequences if the banks were to fail. One consequence was that money supply declined by 27% between 1929 and 1933.

 The Fed’s mistakes were evident once Roosevelt came into office as  the economy began to recover. When Roosevelt was inaugurated, he declared a bank holiday two days later. The previous president, Hoover had a well-known reputation of being laissez – faire. The bank holiday lasted ten days and Friedman and Schwartz notes that during this time the attitudes of the banks changed, they began holding safe and liquid investments rather than providing loans.

In 2002, Ben Bernanke stated in honour of Friedman’s 90^th birthday, that regarding the Great Depression the Federal Reserve were wrong and apologised on behalf of the Federal Reserve.

However, Bernanke also had criticisms of this theory. He,like others, believe that impact of non monetary forces were missing in their theory. Other economists have challenged Friedman and Schwartz's theory. In particular some economists have argued against Friedman and Schwartz's emphasis on monetary shocks. In my final blog post I will be looking further into the criticisms of their theory and look more into Bernanke's take on the Great Depression.