J. Bradford DeLong (2004) "Comment on James Stock and Mark Watson (2003), 'Has the Business Cycle Changed?': Hoisted from the Archives
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More Great Depression Blogging

Anna J. Schwartz and Edward Nelson are considerably less coherent than I thought. Consider this passage:

'WHO WAS MILTON FRIEDMAN?' - The New York Review of Books: The 1930-1933 increase in the monetary base did not reflect official ease, as Krugman implies, but the general public's flight into currency in response to their distrust of banks. Only the currency component of the base rose; the bank reserves component declined.

Krugman contends that Friedman distorted the Monetary History in journalistic outlets, offering as evidence Friedman's statement that the Depression was "produced by government mismanagement." A comparable formulation was used by Bernanke, who noted that the Federal Reserve failed to execute its duty "to improve the management of banking panics." There was, in short, government mismanagement.

If Friedman's intention was to distort the Monetary History to noneconomist readers, then his 1973 Playboy interview offered an ideal opportunity. Yet Friedman told Playboy:

Just as banks all around the country were closing, the Fed raised the discount rate; that's the rate they charge for loans to banks. Bank failures consequently increased spectacularly. We might have had an economic downturn in the thirties anyway, but in the absence of the Federal Reserve System--with its enormous power to make a bad situation worse--it wouldn't have been anything like the scale we experienced.

Friedman clearly characterized the problem as Federal Reserve failure to support commercial banks. Friedman did not imply--as Krugman suggests--that "the Depression wouldn't have happened if only the government had kept out of the way.

With respect to the first paragraph, Schwartz and Nelson appear to have simply forgotten that what the Federal Reserve controls via its open-market operations is the sum of currency and bank reserves--that's why we call it the "monetary base"--and not each component individually. Banks can take their reserve deposits at the Fed and turn them into currency. Banks can take their currency and deposit it at the Fed in order to obtain reserve deposits. That one of these two is going up or down tells us nothing about Federal Reserve policy, which controls only the total and not the mix.

With respect to the second paragraph, there is a difference between Bernanke's formulation--that a Great Depression was coming and the Fed could have headed it off if it had properly-handled the banking panic--and Friedman's statement taht the Depression was produced by government mismanagement. There was government mismanagement, but Krugman would say--and I would agree--not that it caused but that it failed to head off the Great Depression.

With respect to the Playboy interview, Friedman appears to have forgotten that the absence of a Federal Reserve would not have produced a lower but a higher overnight bank-to-bank interest rate. The Federal Reserve raised the discount rate, yes, but it also loaned banks a lot of money at that discount rate. In the absence of the Federal Reserve--under a full-fledged automatic gold standard--money loaned to banks to boost their reserves would have had to have come in from England by ship in specie, and in the meanwhile the lack of liquidity would have caused the equivalent of the discount rate to have risen by much, much more than the Fed raised it.

It is true that you do not absolutely need a central bank to increase the money supply in a panic or a depression--a dominant financial oligarch can substitute and do so if other people are scared enough of him to accept what he decrees good as legal tender, as I note here that J.P. Morgan did in the Panic of 1907. But there was no such dominant oligarch in 1930-1933 who was blocked by the Fed from taking action.

In the absence of the Federal Reserve the quantity of bank reserves would have fallen by more, not less; the number of failing banks would have been greater, not lesser; the fall in the money stock would have been larger, not smaller; and the Great Depression would have been even greater.