Download The Great Depression: Monetarist and Keynesian Interpretations - Prof. Moore and more Study notes Development Economics in PDF only on Docsity! Amelie Turcotte ECON 2200 4/19/11 Chapter 23 Notes, Part II: The Great Depression I. How do economic historians explain the Great Depression? (two major theories) A. The Monetarist Interpretation: Friedman & Schwartz, A Monetary History of the US (1963) This interpretation focuses on events between 1929 and 1933. Primary cause: Decline in M (Table 23.2) o Bank failures/panics → Surviving banks increase reserve holdings Loans decreased – in early 1930s, total bank deposits decreased (as runs occurred) and reserves holdings of surviving banks increased M decreased – (Column 1 of Table 23.2) Y decreased - (Column 2 of Table 23.2) 1. As real output went down, unemployment increased (income of households & firms decreased) causing loans to decrease Note Column 3 of Table 23.2: Ratio of M to Y increased, which causes people to say that there was enough money for the real output, but Monetarists view this as evidence that the money supply was not circulating due to people hoarding Federal Reserve’s role: Monetarists claim that the Fed’s failure to exercise basic central bank functions increased the depth and duration of the recession that became the Great Depression. Monetary policy tended to be procyclical rather than countercyclical, especially between 1929-1932 Failure of Fed to 1) act as lender of last resort, and 2) exercise expansionary monetary policy (and instead, exercised contractionary monetary policy) Changes in Discount Rate 1. Recall that a decrease in the discount rate causes a decrease in the money supply 2. In Aug. 1929, Fed ↑the DR Effort to decrease bank loans for speculation in stock 3. Nov. 1931, Fed ↑ DR England left the gold standard 4. Mar. 1933, the Fed ↑ DR Early 1933 was 3rd and worst banking crisis ***Note: All of these increases in DR only further encouraged ↓ in money supply and led banks to increase their holdings of reserves Open Market Operations Fed buying (expansionary) and selling (contractionary) of Treasury bonds 1. Fed made modest purchases of bonds in Oct 1929, Dec. 1930, and Aug. 1931 insignificant impact of M because it wasn’t enough and they tended to hold the money supply 2. Aug. 1932: Fed purchased $1.1 billion in Treasury bonds 1. Friedman & Schwartz: “Too little, too late.” What was the Fed thinking? Page 1 Amelie Turcotte ECON 2200 4/19/11 o Fed failed to grasp magnitude of the crisis; focused on nominal (rather than real) interest rate (Table 23.2, last two columns) 1. Deflation was causing the real interest rate to increase while the nominal interest rate was decreasing 2. The Fed seems to have felt that and increase in the money supply wasn’t necessary because the nominal interest rate was low and falling. However, it should have been looking at the real interest rate o 1928 death of Benjamin Strong (President of NY Fed District Bank) 1. Leadership void at Board of Directors 3 different chairmen between 1927-1934 o Power struggle between NY Fed District Bank and Fed Board of Directors (now known as the Board of Governors) 1. There were Fed officials (especially from NY District Bank) who argued for expansionary open market operations. However, they did not typically win the Board votes in the early 1930s o 1932 Federal Reserve Annual Report indicates that Fed Board of Directors was: Concerned that buying bonds would drain Fed’s gold reserves Related to concerns about maintaining the Fed’s own solvency and to concerns that the US would be forced off the gold standard Concerned that buying bonds would reduce borrowing by commercial banks at the Fed’s discount window Somewhat concerned that ↑M would create inflation B. The Keynesian Interpretation: Keynes, The General Theory (1936); more recently Temin, Did Monetary Forces Cause the Great Depression? (1976) This interpretation focuses on events in 1929 and 1930. Primary cause: sudden decline in C (&/or I) o Stock market crash → decreased wealth → decreased C Firm output & profits decrease Unemployment increase Income decrease (household and firm income) Defaults on bank loans increase (individuals & firms) banks failed M decrease o Keynesians view decline in M as a symptom rather than a cause of the Great Depression. Temin (rep for Keynesians) and Keynesians acknowledge that M declined, but they further believe that the decrease in M demand was greater than the decrease in M 1. Table 23.2 Economic Insight 23.1: Temin’s Critique of Monetarists Page 2
