Ben bernanke great depression pdf

This deflation increased debt burdens; distorted economic decision-making; reduced consumption; increased unemployment; and forced banks, firms, and individuals into bankruptcy. The deflation stemmed from the collapse of the banking system, as explained in the essay on the banking panics of and The Federal Reserve could have prevented deflation by preventing the collapse of the banking system or by counteracting the collapse with an expansion of the monetary base, but it failed to do so for several reasons.

The economic collapse was unforeseen and unprecedented. Decision makers lacked effective mechanisms for determining what went wrong and lacked the authority to take actions sufficient to cure the economy. Some decision makers misinterpreted signals about the state of the economy, such as the nominal interest rate, because of their adherence to the real bills philosophy. Others deemed defending the gold standard by raising interests and reducing the supply of money and credit to be better for the economy than aiding ailing banks with the opposite actions.

On several occasions, the Federal Reserve did implement policies that modern monetary scholars believe could have stemmed the contraction. In the spring of , the Federal Reserve began to expand the monetary base, but the expansion was insufficient to offset the deflationary effects of the banking crises.

In the spring of , after Congress provided the Federal Reserve with the necessary authority, the Federal Reserve expanded the monetary base aggressively.

The policy appeared effective initially, but after a few months the Federal Reserve changed course. A series of political and international shocks hit the economy, and the contraction resumed. Congress responded by reforming the Federal Reserve and the entire financial system. Under the Hoover administration, congressional reforms culminated in the Reconstruction Finance Corporation Act and the Banking Act of These agencies dominated monetary and banking policy until the s.

The creation of the modern intellectual framework underlying economic policy took longer and continues today. Bernanke, Ben. Essays on the Great Depression.

Princeton: Princeton University Press, Chandler, Lester V. American Monetary Policy, to New York: Harper and Row, New York: Harper Collins, Eichengreen, Barry. Friedman, Milton and Anna Schwartz. A Monetary History of the United States: Kindleberger, Charles P. Berkeley: University of California Press, Meltzer, Allan. A History of the Federal Reserve: Volume 1, to Chicago: University of Chicago Press, Romer, Christina D.

Temin, Peter. Cambridge: MIT Press, Marriner S. Eccles Governor. Eugene I. Meyer Governor [Chair]. Current Fed leaders. Classroom resources About this site Our authors Related resources. The Great Depression — The longest and deepest downturn in the history of the United States and the modern industrial economy lasted more than a decade, beginning in and ending during World War II in Men study the announcement of jobs at an employment agency during the Great Depression.

Bibliography Bernanke, Ben. Written as of November 22, See disclaimer. Related People Marriner S. The Fed's strategy worked, in that the attack on the dollar subsided and the U. However, once again the Fed had chosen to tighten monetary policy despite the fact that macroeconomic conditions--including an accelerating decline in output, prices, and the money supply--seemed to demand policy ease.

The third policy action highlighted by Friedman and Schwartz occurred in By the spring of that year, the Depression was well advanced, and Congress began to place considerable pressure on the Federal Reserve to ease monetary policy. The Board was quite reluctant to comply, but in response to the ongoing pressure the Board conducted open-market operations between April and June of designed to increase the national money supply and thus ease policy. These policy actions reduced interest rates on government bonds and corporate debt and appeared to arrest the decline in prices and economic activity.

However, Fed officials remained ambivalent about their policy of monetary expansion. Some viewed the Depression as the necessary purging of financial excesses built up during the s; in this view, slowing the economic collapse by easing monetary policy only delayed the inevitable adjustment.

Other officials, noting among other indicators the very low level of nominal interest rates, concluded that monetary policy was in fact already quite easy and that no more should be done. These policymakers did not appear to appreciate that, even though nominal interest rates were very low, the ongoing deflation meant that the real cost of borrowing was very high because any loans would have to be repaid in dollars of much greater value Meltzer, Thus monetary policy was not in fact easy at all, despite the very low level of nominal interest rates.

In any event, Fed officials convinced themselves that the policy ease advocated by the Congress was not appropriate, and so when the Congress adjourned in July , the Fed reversed the policy. By the latter part of the year, the economy had relapsed dramatically.

The fourth and final policy mistake emphasized by Friedman and Schwartz was the Fed's ongoing neglect of problems in the U. As I have already described, the banking sector faced enormous pressure during the early s. As depositor fears about the health of banks grew, runs on banks became increasingly common. A series of banking panics spread across the country, often affecting all the banks in a major city or even an entire region of the country.

Between December and March , when President Roosevelt declared a "banking holiday" that shut down the entire U. Surviving banks, rather than expanding their deposits and loans to replace those of the banks lost to panics, retrenched sharply. The banking crisis had highly detrimental effects on the broader economy. Friedman and Schwartz emphasized the effects of bank failures on the money supply. Because bank deposits are a form of money, the closing of many banks greatly exacerbated the decline in the money supply.

Moreover, afraid to leave their funds in banks, people hoarded cash, for example by burying their savings in coffee cans in the back yard. Hoarding effectively removed money from circulation, adding further to the deflationary pressures. Moreover, as I emphasized in early research of my own Bernanke, , the virtual shutting down of the U. The Federal Reserve had the power at least to ameliorate the problems of the banks.

For example, the Fed could have been more aggressive in lending cash to banks taking their loans and other investments as collateral , or it could have simply put more cash in circulation.

Either action would have made it easier for banks to obtain the cash necessary to pay off depositors, which might have stopped bank runs before they resulted in bank closings and failures. Indeed, a central element of the Federal Reserve's original mission had been to provide just this type of assistance to the banking system. The Fed's failure to fulfill its mission was, again, largely the result of the economic theories held by the Federal Reserve leadership.

Many Fed officials appeared to subscribe to the infamous "liquidationist" thesis of Treasury Secretary Andrew Mellon, who argued that weeding out "weak" banks was a harsh but necessary prerequisite to the recovery of the banking system. Moreover, most of the failing banks were relatively small and not members of the Federal Reserve System, making their fate of less interest to the policymakers.

In the end, Fed officials decided not to intervene in the banking crisis, contributing once again to the precipitous fall in the money supply. Friedman and Schwartz discuss other episodes and policy actions as well, such as the Federal Reserve's misguided tightening of policy in which contributed to a new recession in those years. However, the four episodes I have described capture the gist of the Friedman and Schwartz argument that, for a variety of reasons, monetary policy was unnecessarily tight, both before the Depression began and during its most dramatic downward phase.

As I have mentioned, Friedman and Schwartz had produced evidence from other historical periods that suggested that contractionary monetary policies can lead to declining prices and output. Friedman and Schwartz concluded therefore that they had found the smoking gun, evidence that much of the severity of the Great Depression could be attributed to monetary forces. Friedman and Schwartz's arguments were highly influential but not universally accepted.

For several decades after the Monetary History was published, a debate raged about the importance of monetary factors in the Depression. Opponents made several objections to the Friedman and Schwartz thesis that are worth highlighting here. First, critics wondered whether the tightening of monetary policy during and , though perhaps ill advised, was large enough to have led to such calamitous consequences.

A second question is whether the large decline in the money supply seen during the s was primarily a cause or an effect of falling output and prices. As we have seen, Friedman and Schwartz argued that the decline in the money supply was causal.

Suppose, though, for the sake of argument, that the Depression was the result primarily of nonmonetary factors, such as overspending and overinvestment during the s. As incomes and spending decline, people need less money to carry out daily transactions. In this scenario, critics pointed out, the Fed would be justified in allowing the money supply to fall, because it would only be accommodating a decline in the amount of money that people want to hold.

The decline in the money supply in this case would be a response to, not a cause of, the decline in output and prices. To put the question simply, we know that both the economy and the money stock contracted rapidly during the early s, but was the monetary dog wagging the economic tail, or vice versa?

The focus of Friedman and Schwartz on the U. As I have mentioned, the Great Depression was a worldwide phenomenon, not confined to the United States. Indeed, some economies, such as that of Germany, began to decline before Although few countries escaped the Depression entirely, the severity of the episode varied widely across countries.

The timing of recovery also varied considerably, with some countries beginning their recovery as early as or , whereas others remained in the depths of depression as late as or How does Friedman and Schwartz's monetary thesis explain the worldwide nature of the onset of the Depression, and the differences in severity and timing observed in different countries? That is where the debate stood around About that time, however, economic historians began to broaden their focus, shifting from a heavy emphasis on events in the United States during the s to an increased attention to developments around the world.

Moreover, rather than studying countries individually, this new scholarship took a comparative approach, asking specifically why some countries fared better than others in the s. As I will explain, this research uncovered an important role for international monetary forces, as well as domestic monetary policies, in explaining the Depression.

Specifically, the new research found that a complete understanding of the Depression requires attention to the operation of the international gold standard, the international monetary system of the time. As I have already mentioned, the gold standard is a monetary system in which each participating country defines its monetary unit in terms of a certain amount of gold.

The setting of each currency's value in terms of gold defines a system of fixed exchange rates, in which the relative value of say the U. To maintain the gold standard, central banks had to promise to exchange actual gold for their paper currencies at the legal rate.

The gold standard appeared to be highly successful from about to the beginning of World War I in During the so-called "classical" gold standard period, international trade and capital flows expanded markedly, and central banks experienced relatively few problems ensuring that their currencies retained their legal value. The gold standard was suspended during World War I, however, because of disruptions to trade and international capital flows and because countries needed more financial flexibility to finance their war efforts.

The United States remained technically on the gold standard throughout the war, but with many restrictions. After , when the war ended, nations around the world made extensive efforts to reconstitute the gold standard, believing that it would be a key element in the return to normal functioning of the international economic system. Great Britain was among the first of the major countries to return to the gold standard, in , and by the great majority of the world's nations had done so.

Unlike the gold standard before World War I, however, the gold standard as reconstituted in the s proved to be both unstable and destabilizing. Economic historians have identified a number of reasons why the reconstituted gold standard was so much less successful than its prewar counterpart.

First, the war had left behind enormous economic destruction and dislocation. Major financial problems also remained, including both large government debts from the war and banking systems whose solvency had been deeply compromised by the war and by the periods of hyperinflation that followed in a number of countries.

These underlying problems created stresses for the gold standard that had not existed to the same degree before the war. Second, the new system lacked effective international leadership. During the classical period, the Bank of England, in operation since , provided sophisticated management of the international system, with the cooperation of other major central banks.

This leadership helped the system adjust to imbalances and strains; for example, a consortium of central banks might lend gold to one of their number that was experiencing a shortage of reserves. After the war, with Great Britain economically and financially depleted and the United States in ascendance, leadership of the international system shifted by default to the Federal Reserve. Unfortunately, the fledgling Federal Reserve, with its decentralized structure and its inexperienced and domestically focused leadership, did not prove up to the task of managing the international gold standard, a task that lingering hatreds and disputes from the war would have made difficult for even the most-sophisticated institution.

With the lack of effective international leadership, most central banks of the s and s devoted little effort to supporting the overall stability of the international system and focused instead on conditions within their own countries. Finally, the reconstituted gold standard lacked the credibility of its prewar counterpart.

Before the war, the ideology of the gold standard was dominant, to the point that financial investors had no doubt that central banks would find a way to maintain the gold values of their currencies no matter what the circumstances. Because this conviction was so firm, speculators had little incentive to attack a major currency.

After the war, in contrast, both economic views and the political balance of power had shifted in ways that reduced the influence of the gold standard ideology.

For example, new labor-dominated political parties were skeptical about the utility of maintaining the gold standard if doing so increased unemployment. Ironically, reduced political and ideological support for the gold standard made it more difficult for central banks to maintain the gold values of their currencies, as speculators understood that the underlying commitment to adhere to the gold standard at all costs had been weakened significantly.

Thus, speculative attacks became much more likely to succeed and hence more likely to occur. With an international focus, and with particular attention to the role of the gold standard in the world economy, scholars have now been able to answer the questions regarding the monetary interpretation of the Depression that I raised earlier. First, the existence of the gold standard helps to explain why the world economic decline was both deep and broadly international.

Under the gold standard, the need to maintain a fixed exchange rate among currencies forces countries to adopt similar monetary policies. In particular, a central bank with limited gold reserves has no option but to raise its own interest rates when interest rates are being raised abroad; if it did not do so, it would quickly lose gold reserves as financial investors transferred their funds to countries where returns were higher.

Hence, when the Federal Reserve raised interest rates in to fight stock market speculation, it inadvertently forced tightening of monetary policy in many other countries as well. This tightening abroad weakened the global economy, with effects that fed back to the U.

Other countries' policies also contributed to a global monetary tightening during and For example, after France returned to the gold standard in , it built up its gold reserves significantly, at the expense of other countries. The outflows of gold to France forced other countries to reduce their money supplies and to raise interest rates. Speculative attacks on currencies also became frequent as the Depression worsened, leading central banks to raise interest rates, much like the Federal Reserve did in Leadership from the Federal Reserve might possibly have produced better international cooperation and a more appropriate set of monetary policies.

However, in the absence of that leadership, the worldwide monetary contraction proceeded apace. The result was a global economic decline that reinforced the effects of tight monetary policies in individual countries. The transmission of monetary tightening through the gold standard also addresses the question of whether changes in the money supply helped cause the Depression or were simply a passive response to the declines in income and prices.

Countries on the gold standard were often forced to contract their money supplies because of policy developments in other countries, not because of domestic events. The fact that these contractions in money supplies were invariably followed by declines in output and prices suggests that money was more a cause than an effect of the economic collapse in those countries.

Perhaps the most fascinating discovery arising from researchers' broader international focus is that the extent to which a country adhered to the gold standard and the severity of its depression were closely linked. In particular, the longer that a country remained committed to gold, the deeper its depression and the later its recovery Choudhri and Kochin, ; Eichengreen and Sachs, The willingness or ability of countries to remain on the gold standard despite the adverse developments of the s varied quite a bit.

A few countries did not join the gold standard system at all; these included Spain which was embroiled in domestic political upheaval, eventually leading to civil war and China which used a silver monetary standard rather than a gold standard. A number of countries adopted the gold standard in the s but left or were forced off gold relatively early, typically in Countries in this category included Great Britain, Japan, and several Scandinavian countries.

Some countries, such as Italy and the United States, remained on the gold standard into or And a few diehards, notably the so-called gold bloc, led by France and including Poland, Belgium, and Switzerland, remained on gold into or If declines in the money supply induced by adherence to the gold standard were a principal reason for economic depression, then countries leaving gold earlier should have been able to avoid the worst of the Depression and begin an earlier process of recovery.

The evidence strongly supports this implication. For example, Great Britain and Scandinavia, which left the gold standard in , recovered much earlier than France and Belgium, which stubbornly remained on gold. As Friedman and Schwartz noted in their book, countries such as China--which used a silver standard rather than a gold standard--avoided the Depression almost entirely.

The finding that the time at which a country left the gold standard is the key determinant of the severity of its depression and the timing of its recovery has been shown to hold for literally dozens of countries, including developing countries. This intriguing result not only provides additional evidence for the importance of monetary factors in the Depression, it also explains why the timing of recovery from the Depression differed across countries.

The finding that leaving the gold standard was the key to recovery from the Great Depression was certainly confirmed by the U. One of the first actions of President Roosevelt was to eliminate the constraint on U. The new President also addressed another major source of monetary contraction, the ongoing banking crisis.

Within days of his inauguration, Roosevelt declared a "bank holiday," shutting down all the banks in the country. Banks were allowed to reopen only when certified to be in sound financial condition. Roosevelt pursued other measures to stabilize the banking system as well, such as the creation of a deposit insurance program. With the gold standard constraint removed and the banking system stabilized, the money supply and the price level began to rise. Between Roosevelt's coming to power in and the recession of , the economy grew strongly.

I have only scratched the surface of the fascinating literature on the causes of the Great Depression, but it is time that I conclude. Economists have made a great deal of progress in understanding the Great Depression. Milton Friedman and Anna Schwartz deserve enormous credit for bringing the role of monetary factors to the fore in their Monetary History. However, expanding the research focus to include the experiences of a wide range of countries has both provided additional support for the role of monetary factors including the international gold standard and enriched our understanding of the causes of the Depression.

Some important lessons emerge from the story.