Customer Reviews

The Great Contraction, 1929-1933: (New Edition) (Princeton Classic Editions)

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Friedman and Shwartz see two causes of the Great Contraction: 1) to a small extent bank failures; and 2) to a large extent a series of poor and inconsistent policies from the Federal Reserve System.

Popular belief is that the Stock Market crash of 1929 caused the Great Depression. From a statistical monetary analysis this is obviously false. For a year after the stock market crashed the economy experienced a recessionary business cycle but monetary factors remained relatively stable. After the bank panic of 1930 that all changed. The bank panics of 1931 and 1933 made matters far worse and at an accelerating rate. The United States caused the Great Depression which would later lead to an international depression.

If the Federal Reserve had followed a policy of monetary easing the bank panic of 1930 probably would not have happened. This would have required a very small amount, ~$80 million, in order to solve. The 1931 panic could have been prevented, even accounting for the 1930 panic with a ~$250 million injection of capital into banks. The 1933 crisis could have been prevented with ~$1 billion injection of capital. Instead the Federal Reserve decided to disregard conventional theory, which while not perfect would have solved the crisis, and submit to a deflationary set of policies. In the end it came down to the Federal Reserve System lacking internal leadership and acting in a fractured manner.

The Great Contraction only partially explains the monetary history of the Great Depression. I highly recommending Friedman and Shwartz's 'Monetary History of the U.S., 1867-1960' for those wishing to know more.

Unfortunately, Friedman and Shwartz's analysis only partially explains the Great Contraction and the subsequent Great Depression. From Gregory Mankiw's bestselling textbook 'Macroeconomics':

"This fact provides the motivation and support for what is called the money hypothesis, which places primary blame for the Depression on the Federal Reserve for allowing the money supply to fall by such a large amount. the best-known advocates of this interpretation are Milton Friedman and Anna Schwartz, who defend it in their treatise on U.S. monetary history...

Using the Is-LM model, we might interpret the money hypothesis as explaining the Depression by a contractionary shift in the LM curve. Seen in this way, however, the money hypothesis runs into two problems.

The first problem is the behavior of real money balances. Monetary policy leads to a contractionary shift in the LM curve only if real money balances fall. Yet from 1929 to 1931 real money balances rose slightly, because the fall in the money supply was accompanied by an even greater fall in the price level. Although monetary contraction may be responsible for the rise in unemployment from 1931 to 1933, when real money balances did fall, it cannot easily explain the initial downturn form 1929 to 1931.

The second problem for the money hypothesis is the behavior of interest rates. If a contractionary shift in the LM curve triggered the Depression, we should have observed higher interest rates. Yet nominal interest rates fell continuously form 1929 to 1933.

These two reasons appear sufficient to reject the view that the Depression was instigated by a contractionary shift in the LM curve. But was the fall in the money stock irrelevant? Next, we turn to another mechanism through which monetary policy might have been responsible for the severity of the Depression--the deflation of the 1930's."

(Mankiw then goes on to explain why Keynes' Paradox of Thrift was the leading cause of the Great Depression)

Friedman and Schwartz's chapter on the Great Contraction is a truly remarkable work in economics.

It is somewhat a morose sense of timing that a new edition of this book just came out. The authors write what is probably the definitive study of the monetary factors behind the great depression, and hopefully, provide enough information to avoid a repeat. As should be evident by the subject, a highly technical book, even for someone with a background in economics, not light bedtime reading, but well worth reading for someone with an interest in the subject.

I bought this book for my father for Christmas last year. While it is considered a classic text and does provide many insights about our current financial crisis, it is too arcane for the average reader. Don't buy it unless you have an extensive background in economics.

In these days, in which we are discussing and fighting over the issue of the financial crisis, nothing is better than this chapter of Milton Friedman "Banking History" which reviews carefully and seriously the causes resulting in The Great Contraction 1929-1933, and sent the world into the greatest depression of modern times. Men who do not know history are bound to repete the errors of the past. We hope it will not happen due to Dr. Friedman excelente study