the lessons of the great depression is our topic today. you are an expert on that subject. By all accounts, that is one of the reasons Barack Obama asked him to join his cabinet in the fall of 2008. How well did economists understand the toll the 2008 financial crisis would have on the American economy? while preparing to preside over the white cabinet? council of the house of economic advisers?
In the midst of the financial crisis, it was difficult to estimate how much damage had already been done to the economy and how widespread the impacts would be. But what economists certainly understood from the story was that the crisis could be absolutely devastating if policymakers didn’t take action to stop it and mitigate the damage.
You are reading: Books about great depression
Right-wing websites are littered with references to the “obama depression.” I know partisan economists and bloggers use the word “depression” differently. When economists use the word, what exactly are they referring to?
The word “depression” doesn’t really have a well-defined meaning, unlike the words “recession” and “expansion.” The National Bureau of Economic Research defines a recession, for example, as a time when economic activity is declining. Often what economists mean by a depression is what other people mean: a really bad and exceptionally long recession. More importantly, as bad as the current recession has been, it has been much less severe and prolonged than the episode that we all agree was a depression, the great depression of the 1930s. An indicator, in 2009 the US unemployment rate peaked at 10%. in the early 1930s it reached 25%.
let’s go to your books. the first three are about what caused the great depression, and the last two are about what ended it. Your first choice is A Monetary History of the United States by Milton Friedman and Anna Schwartz. please give us a summary of the book and explain how it changed the debate about the causes of the great depression.
I frequently tell students: if you buy only one economics book, it should be a monetary history. the book is obviously important to our understanding of the great depression, but its impact goes much further. Friedman and Schwartz show us that monetary events and monetary policy have affected real output throughout American history.
That’s a fundamentally important finding. it tells us that a monetary development that affects aggregate demand has an impact on the things that matter to us, such as employment, unemployment, and how much we produce in the economy. The other thing Friedman and Schwartz do is show us how to use historical evidence about the motivation and thinking of policymakers to help establish a causal relationship between money and production.
“The strains on the US economy in 2008 were much greater than they were in 1930. So why has this recession, as bad as it has been, not been a second Great Depression or even worse?”
When you asked me for my list of books, I debated whether to include John Maynard Keynes’s General Theory on the list. The General Theory is an incredibly important book, but it’s basically a theoretical explanation of how aggregate demand might affect output. It was Friedman and Schwartz who provided the empirical evidence supporting the theory. that’s why a money history was at the top of my list.
Regarding the Great Depression specifically, Friedman and Schwartz show that there were large drops in the money supply associated with repeated waves of bank runs. they also provide compelling evidence that bad economic ideas and a dysfunctional organizational structure were the key reasons the Fed did so little to stop the panic.
The book was published nearly 50 years ago. Do your explanations hold up or have they been superseded by other research?
One of the reasons the monetary story remains a classic is that it has endured to a remarkable degree.
The essence of Friedman and Schwartz’s approach was very different from what modern economists do. modern economists get data. They do regressions. it’s all statistical work. Friedman and Schwartz understood that even if you have all the data you could ever want on the supply and production of money, it will still be very difficult to identify the causal relationship between the two because money changes for many reasons. sometimes it changes because production is changing, and changes in production affect how much banks lend and the money multiplier. other times, the money supply changes because the Federal Reserve makes a mistake or there is deliberate political action unrelated to the state of the economy.
The brilliance of this book is that friedman and schwartz use a lot of non-statistical or narrative evidence. They read the diaries of the people who ran the Federal Reserve in the 1930s and reviewed the records of the policy-making process. they were able to identify times when the money supply moved for relatively independent or exogenous reasons, not in anticipation of what was going to happen to output or because of other things happening in the economy. what they found was that after these relatively exogenous movements in the money supply, output moved strongly in the same direction.
A monetary history greatly affected the type of research I’ve done in my career. There have been many times when I have had to go back and read the same main documents that Friedman and Schwartz read. what almost always strikes me is how successful they were. this book is an example of exceptional scholarship. they examined the documentary evidence carefully and honestly, and arrived at an interpretation that has stood the test of time. That’s why it remains such an important book for our understanding of macroeconomics and the Great Depression.
Nobel Prize-winning economist Robert Solow quipped: “Everything reminds Milton of the money supply. well, it all reminds me of sex, but I keep it out of the paper.” what was solow referring to?
milton friedman deeply believed that monetary forces had a major impact on the economy, and he never missed an opportunity to remind people of that.
in the 1960s there was a struggle between monetarists like friedman and schwartz, who thought that monetary forces were very important, and keynesians like [paul anthony] samuelson and solow, who tended to focus on the impact of changes in public spending and taxes. modern economists tend to see monetarists and Keynesians as being on the same side. both believe, based on strong empirical evidence, that changes that affect the demand side of the economy (taxes, currency changes, or government purchases) affect output and employment.
your second pick is barry eichengreen’s golden fetters. How did this book contribute to our understanding of the Great Depression?
is important to help answer the question, why was the depression such a worldwide phenomenon? Friedman and Schwartz and other studies have shown that what caused the depression here in the United States was largely internal disturbances: a terrible stock market crash and a series of uncontrolled banking crises. But if that’s the case, why was the depression so terrible in Britain, France, and basically all over the world? Golden Shackles, by my colleague Barry Eichengreen, provides a definitive account of the role the gold standard played in transmitting shocks centered in the United States to many other countries.
The basic story is that if something were to happen in the US. uu. that would drive up our interest rates or lower our prices would attract gold from other countries to the us. uu. In the depression, other countries were concerned about their gold reserves and did not want gold flowing into the United States. so basically they had to have a monetary contraction as well. you saw countries that deliberately raised interest rates to try to prevent gold from flowing out of their economies. golden shackles explains that due to the gold standard, a monetary shock in the united states led to a global monetary contraction.
eichengreen demonstrates that a bad economic idea can have devastating consequences. The fact that policymakers around the world were determined to stay on the gold standard led them to follow the United States into the Great Depression.
At the time of the great depression, did economists understand the downsides of the gold standard and warn against it? Or did people only come to understand it in hindsight?
there were some who understood and warned about the downsides, but their failings were largely realized in hindsight. the gold standard is a bit like the euro today. It worked pretty well during the good old days of the late 19th and early 20th centuries, just as the euro worked pretty well before the financial crisis. policymakers tended to think it would always work well.
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eichengreen argues that the gold standard worked well in its heyday because countries followed the rules and the bank of england was an effective global steward of the system. But after the gold standard collapsed during World War I, economists and policymakers were slow to realize when they tried to restore it that it might not work so well, especially in the face of huge shocks in the United States.
Do you think there is something similar to the gold standard today? by which I mean bad economic policy ideas that history will judge to be causing or exacerbating our economic problems?
absolutely. the most important is the notion that fiscal contractions (reducing the budget deficit immediately) can be expansionary. Some policymakers have convinced themselves that cutting spending and raising taxes will be so good for confidence that it will increase jobs and growth rather than decrease it. this is a very bad idea that is contradicted by strong empirical evidence.
this mistaken belief in expansionary fiscal contractions has taken hold especially in europe. it is a big part of why europe is in the mess it is in. Countries with serious problems, such as Greece and Spain, have been forced to adopt severe fiscal austerity in order to receive help from other European countries and the IMF. And other countries, like the UK and Germany, have gone into austerity because they bought into the idea that it would be good for their growth. but the result has not been good. Growth has slowed across Europe, and the eurozone has almost certainly entered another recession. countries like spain and greece that have adopted extreme austerity measures have seen unemployment rise dramatically. this rise in unemployment makes it even more difficult for them to really control their budget deficits.
there are much wiser policies for europe and the united states. fiscal problems are very real but must be dealt with gradually. it would be much better to approve the plans now, but not make the actual spending cuts and tax increases until the economies are healthier. policies designed to stimulate growth would be much more humane and ultimately better for the fiscal situation. without growth and full employment, it is very difficult to really control the budget deficit.
the gold standard is back in the news as the campaign politics of one of the republicans running for president, ron paul. what do you say to the people calling for a return to the gold standard today?
read the book by barry eichengreen. Not only is the gold standard not a cure for our current ills, it could make things worse.
Her next book is a collection of essays by current Federal Reserve Chairman Ben Bernanke, who was formerly an economics professor at Princeton University. Explain how this book, and in particular the article “Nonmonetary Effects of the Financial Crisis on the Spread of the Great Depression,” has added to our understanding of financial recessions.
President Bernanke has written several important articles on the Great Depression. the one that really stands out is the role you mentioned. Friedman and Schwartz showed that bank runs caused a decrease in the money supply, which probably depressed output by raising real interest rates. Bernanke argued that a financial crisis also has negative effects that act directly through the decrease in the availability of credit. When a financial panic causes banks to fail or become unwilling to lend, that can have an impact on the economy beyond any effect on the money supply. He found evidence from the Great Depression that such nonmonetary effects of a banking crisis could be very large.
bernanke’s focus on the nonmonetary effects of financial crises turned out to be incredibly important. he started a whole literature on how credit matters, beyond what is reflected in interest rates. he changed our view of how monetary policy affects the economy.
How did Bernanke’s theories impact the understanding and management of the 2008 crisis?
His work and the subsequent research it inspired made us realize how important it is in a financial crisis to not only keep the money supply from falling, but also to make sure that credit keeps flowing. we learned from the great depression that when credit dries up it has devastating consequences.
that idea had a big impact on the behavior of the federal reserve in the most recent crisis. In response to the financial crisis of the fall of 2008, the Federal Reserve not only followed the conventional central bank remedy of flooding the system with liquidity and making sure enough money was available, but also took extraordinary steps to keep credit flowing. . When they saw that credit markets weren’t working, the Fed was incredibly creative in finding ways to make sure businesses could get credit. For example, many companies issue commercial paper to cover payroll and finance day-to-day operations. when that market stopped working and no one was willing to buy commercial paper, the fed said, we’ll buy it.
This is not the type of action that the public has historically associated with central banks. Has monetary policy evolved much? what is it?
Conventionally, monetary policy refers to the Federal Reserve’s decisions about setting interest rates. we’re used to the fed saying it’s going to raise or lower the fed funds rate. but this crisis was so extreme that the federal government had to be much more aggressive and creative. In addition to reducing the funds rate to zero, the Fed has taken a number of steps to keep credit flowing and reduce interest rates other than the funds rate. whether you call that monetary policy or credit policy or quantitative easing is somewhat arbitrary. Since all policies are carried out by the central bank, I tend to group them under the broad term of monetary policy.
many people have questioned the obama administration’s fiscal policy response to the “great recession”. would you mind questioning the monetary policy response?
We often think that the financial crisis began with the collapse of Lehman Brothers, but there was real stress in the financial markets beginning in late 2007 with the collapse of subprime mortgages. The Fed worked very hard throughout 2008 to mitigate the fallout from falling house prices and the credit crunch. they were very proactive. then, when the crisis hit in the fall of 2008, the federal reserve was essential in helping to prevent a much more catastrophic collapse. they prevented the financial crisis from being much worse than it otherwise would have been. it’s hard to question them on that part of their answer.
Where I think you can question them is once we get past the immediate crisis. by the fall of 2009, the financial system had stabilized, but the rest of the economy was still recovering from the fallout, and unemployment was headed for 10%. Instead of more aggressive steps to encourage a faster recovery, like more quantitative easing or bold communication policy, the Fed essentially took a breather. that was a mistake.
Let’s talk about the role of fiscal policy, from the perspective of Lester Chandler’s America’s Greatest Depression. please tell us about the book.
This book provides an excellent overview of what happened during the Great Depression. it is especially strong when describing the political response. it was published in 1970, but it is still the book I go to when I want to know about the actions that were taken in the new deal [economic programs]. gives you an idea of all the things that were made in the 1930s.
one of the things you learn about chandler is that president roosevelt tried everything. In the 1930s, policymakers didn’t know much about what monetary and fiscal policy could do. So they tried all kinds of things: housing policy, agricultural policy, various credit policies, even allowing industries to collude to raise prices. however, many of these policies were not very successful. and the successful ones were often not pushed far enough.
This is especially the case for fiscal policy. Chandler’s book reminds us of something often forgotten, that the fiscal response to the Great Depression was not very great. In fact, under Hoover’s presidency, it actually went in the wrong direction. When the deficit increased because tax revenues fell due to high unemployment, Hoover’s response was a large tax increase: that was the Revenue Act of 1932. This deliberate and misguided tax contraction was another reason the economy kept falling. and the depression was as terrible as it was.
even under roosevelt, fiscal expansion was modest. when we think of the new deal, we tend to think of things like the wpa [works progress management assistance program], which built dams and bridges, and the civil conservation corps, which built so many buildings in our national parks. these programs left lasting legacies, so we often think that the new deal’s fiscal policy response was big and aggressive. But what Chandler points out, drawing on a classic article by Cary Brown, is that the fiscal response to the Great Depression was actually quite small, not as big as the American Recovery and Reinvestment Act of 2009. Even when Roosevelt raised the rate federal deficit in the mid-1930s, a move toward budget surpluses by state and local governments meant that the net fiscal stimulus was much smaller.
Brown’s famous conclusion, repeated in Chandler’s book, is: “Fiscal policy, then, appears to have been a failed recovery device in the 1930s, not because it didn’t work, but because it wasn’t tried.”
How did this book affect how you thought about responding to the great recession of the late 2000s?
Understanding the history of fiscal policy in the Great Depression certainly made me a strong advocate for truly bold fiscal stimulus in early 2009. It also made me acutely aware of the counteracting role that state and local governments can play. in trouble. the obama administration convinced congress to use some of the funds in the recovery act to help state and local governments maintain services and not raise taxes. which turned out to be incredibly useful.
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In hindsight, it would have been nice if the recovery law had been even bigger. But as it was, it was the largest countercyclical fiscal stimulus in US history, not just in dollar terms, but relative to the size of the economy. as we got more evidence on how it worked, it’s clear that it helped a lot. the recovery act is part of the reason why, despite the terrible shocks that hit the US economy in 2008, this recession, as severe as it was, was not a second great depression. the political response was much more effective and much more aggressive than in the early 1930s.
another part of the great depression that chandler talks about that had a big impact on my thinking is what happened in 1937. basically, the monetary and fiscal policy makers got tired of all the exceptional things that were going on. doing to help the economy, and tightening policy too soon. the result was a “depression within a depression,” a major recession that sent unemployment skyrocketing again when we were far from fully recovering.
That episode was very much on my mind when we learned during the first half of 2009 that the recession was much worse than almost anyone had expected and that the recovery would likely be slow. It was a big reason why I argued that it would be a terrible mistake to withdraw support from the economy too soon and that, in fact, we needed to do more, not less, to help the economy.
Your final choice is an article by Peter Temin and Barry Wigmore in the journal Explorations in Economic History. what makes “the end of a great deflation” so essential to understanding the end of the great depression?
an important fact about the depression that will resonate with people interested in modern economics is that in 1934 interest rates in the united states economy were reduced to zero, what economists call the zero lower bound. At that point, the Federal Reserve does not have the option of more conventional monetary policy, such as lowering interest rates further. that’s exactly the same situation we’ve been facing since the end of 2008.
A big question in economics is: can monetary policy continue to be useful once the official interest rate is at zero? this article by temin and wigmore suggests so.
One of the ways that monetary actions can have an impact when we are at the zero lower bound is by affecting expectations. If politics makes people expect faster output growth or higher inflation, that can increase demand and output today. For example, if I have a business and I see the government taking aggressive measures, I might decide to invest today because I expect my sales to increase in the future.
temin and wigmore show that abandoning the gold standard was a very powerful signal that US monetary policy was going to be more accommodative in the future. it appears to have had the effect of raising growth and inflation expectations. they find that spending and production responded very quickly to that decision. For example, truck sales took off shortly after the US. uu. abandon the gold standard.
You wrote one of the most cited articles on the Great Depression, called “What Ended the Great Depression?” we would be remiss if we did not include it in this discussion. please describe it briefly.
that particular article focused on how we got out of the great depression. One of the points he made goes back to what we talked about in Chandler’s book: he provided some empirical evidence that changes in fiscal policy were quite small during the Great Depression. So, in terms of accounting for what helped end the Great Depression, the fiscal response mattered, but it wasn’t very important because it was so small.
What I showed in the article was that there was a very aggressive monetary response, not only coming off the gold standard, as temin and wigmore discuss, but followed by a large monetary expansion. It was probably the only time in US history that we had a monetary expansion orchestrated by the executive branch rather than the Federal Reserve. In the mid-1930s, a large amount of gold was flowing into the United States due to political tensions in Europe. Because we returned to the gold standard (but at a lower price per dollar), the Treasury Department had the ability to convert the inflow of gold into increases in the money supply. As a result, the money supply grew rapidly after 1934. You can think of this as a very early version of quantitative easing, which economists describe as increasing the money supply even when interest rates are already at zero.
I showed that this monetary expansion affected real interest rates by ending expectations of deflation. In the data, interest-sensitive spending, such as business investment and consumer purchases of durable goods, responds to this drop in real interest rates. interest-sensitive spending was a major driver that pulled us out of the great depression.
My study was one of the first papers to talk about whether monetary policy can be useful at the zero lower bound. I argued that it absolutely could be. I think the Great Depression provides the best evidence we have that tighter monetary policy can help us recover faster, even in a world with very low nominal interest rates.
how common is it for an economy to run at the zero lower bound?
many countries are at the zero lower bound today, but it’s not very common at all. the other main time it happened in various countries was in the great depression. The other key episode was Japan after its Great Recession, which began in the early 1990s. Japan, for the most part, has remained in the zero lower bound since the mid-1990s and has never recovered for complete. The important thing about the great depression in the United States is that it is a case where we were at the zero lower bound and we managed to get out of it.
what does your article and temin and wigmore tell us about what can be done today? Has any country figured out how to have effective monetary policy once interest rates have fallen to zero?
what we learned from temin and wigmore’s article is that one way to get out of a recession at the zero lower bound is to change expectations. To do that, what is often needed is a very strong change in policy, something economists call “regime change.” The most effective way to get an economy out of a terrible recession when we are at the zero lower bound is an aggressive change in policy that makes people wake up, say “this is a new day” and change their expectations. what the fed has done since early 2009 is much more of an incremental change.
I think what the fed needs is regime change. Several economists have suggested that the Federal Reserve adopt a new framework for monetary policy, such as setting a path for nominal GDP. If the Fed were to adopt such a nominal GDP target, it would start in some normal year before the crisis and say that nominal GDP should have grown steadily since then. Compared to that baseline, nominal GDP is dramatically lower today. Committing to returning to the pre-crisis path for nominal GDP would commit the Fed to a much more aggressive policy, perhaps more quantitative easing and deliberate actions to coax the dollar. such a strong change in the policy framework could have a dramatic effect on the expectations and therefore on the behavior of consumers and companies.
Has the economy changed in important ways that require us to update our thinking about the roots and remedies of long-term recessions?
Of course, the economy has changed over time. our economic institutions have evolved and the composition of what we produce has changed. but the great depression is still relevant, because the economy is not fundamentally different. When I teach my undergraduate course on macroeconomic policy, I make a strong argument that the Great Depression is a sensible place to start. the world was similar enough in the 1930s that many of the lessons we learned then still apply today.
One of the things we’ve learned from the Great Recession is that modern economies remain vulnerable to terrible downturns. even very aggressive monetary and fiscal policy cannot fully offset the incredibly large shocks to household wealth and credit. that fact should make us anxious to avoid the kind of bubble-bust period we just went through.
What did your time in the Obama administration teach you about the ability of lawmakers to influence economic conditions?
that a good policy is absolutely important. The shocks that hit the US economy in 2008 were huge, in terms of destroying wealth and freezing our financial system. I firmly believe that the stresses on the US economy in 2008 were much greater than those in 1929 and 1930. So why hasn’t this recession, as bad as it been, not been a second Great Depression or even worse? I think the answer is a much better political response.
but this episode has also shown that politics is very difficult to get right. the policy response is inherently based on forecasts, which are subject to great uncertainty. and the political process often puts restrictions on what can be done. furthermore, the political response is limited by our understanding of how politics works and our view of possible options.
The bottom line is that the Great Recession showed us that we have effective tools to fight a terrible recession. but we also have a lot to learn about how to use those tools more successfully.
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