How would monetarism have fared against the Great Depression?

Paul Krugman has covered this topic a few times lately, most recently here.  For instance he writes:

The main point, however, is that we are a very long way from classic monetarism, of the form that says that the central bank can control broad monetary aggregates like M2 at will, and in turn that these broad monetary aggregates determine the course of the economy. That’s not at all true when you’re up against the zero lower bound — which is why Friedman’s analysis of the Great Depression was wrong…

I view Friedman’s position differently and in general I find this discussion would proceed on better terms with more direct quotations from primary sources.  On the question of what Friedman actually thought, I will reproduce part of an earlier post of my own:

When it comes to 1929-1931, Friedman favored the Fed a) buying up a lot more bonds, and b) serving as a lender of last resort to failing banks. They are separable but Friedman favored both.

In the Monetary History, Friedman and Schwartz approvingly quote Walter Bagehot about the need to do whatever is required, however bold or desperate, to stop a banking panic.  Part of the passage runs like this:

“The way in which the panic of 1825 was stopped by advancing money has been described in so broad and graphic a way that the passage has become classical. “We lent it,” said Mr. Harman [one of the Bank’s more senior directors] on behalf of the Bank of England, “by every possible means and in modes we have never adopted before;…”

Here is Charles Goodhart quoting Friedman on why the Fed should have been a lender of last resort to troubled banks.  Or see p.269 of the Monetary History, where Friedman and Schwartz explain how it was too difficult for banks to borrow from the Fed at favorable rates in the early 1930s.  Or read this Friedman interview.

In other words, had the U.S. followed Friedman’s (later) advice, matters would have gone far, far better.  We’re talking about lender of last resort aid to banks, not just printing currency, and we are talking about a time period before the U.S. economy hit a zero lower bound.  (In any case LLR functions still work at a zero lower bound.)  The money supply would not have fallen by one third or anything close to that.

Now, given 2008 and the like, one can readily argue that Friedman’s proposed actions for 1929-1931 would not have been enough to stave off a major recession.  One might also, if only from tone, argue that Friedman did not sufficiently appreciate this point, or that he failed to realize interest rates might have fallen to near-zero anyway.  I can’t prove those claims with textual evidence, but I think there is a good chance they are true.

That said, it is incorrect to suggest that monetarism had an impotent, currency-printing, Pigou effect-relying approach to the Great Depression.  Had we followed Friedman’s advice, things would have been much, much better, all the more so for the broader world at large.  If you doubt this, take a look at Sweden, the country which in the 1930s perhaps came closest to Friedmanesque policy, including no gold standard and floating exchange rates (pdf, and by the way read Bernanke’s FN1: “The original diagnosis of the Depression as a monetary phenomenon was of course made in Friedman and Schwartz (1963). We find the more recent work, though focusing to a greater degree on international aspects of the problem, to be essentially
complementary to the Friedman-Schwartz analysis.”), combined with a less deflationary monetary policy.  Their Great Depression was much milder than in most other parts of the West.

In other words, against the Great Depression monetarism would have fared pretty well.  Not perfectly, but pretty well.

Addendum: Here is Friedman’s classic 1968 essay on what monetary policy can and cannot do (pdf).  And I don’t wish to pick through the various other authors on Friedman vs. Keynes, rather I will refer you to what Friedman actually wrote on the topic when debating a variety of Keynesians and addressing precisely this issue (jstor pdf, maybe this is a better link).


I'm inclined to agree that Friedman supports the recent monetary programme in spirit, but the collapse of the system is in tension with this quote:

"A liquidity crisis involving such runs on a widespread scale is now almost inconceivable. The need for rediscounting in order for the Reserve System to serve as a ‘lender of last resort’ has therefore become obsolete, not because the function has been taken by someone else but because it no longer needs to be performed."

Granted, it would not be an egregious extension of his support for emergency liquidity relief during the Depression to believe he agrees broadly with our actions today.

By the way, I think the last link leads to a GMU portal that won't work for most of us. This is (probably) the jstor link you were looking for (Comments on the Critics – 1972):

This is wrong Ashok. And also in one interesting way makes a larger Friedman point.

You are talking about Friedman after Federal Deposit Insurance. And this was long before mind boggling trillions in shadow banking.

BUT, you are correct Friedman should have noted that eventually the biggest banks would also take advantage of the implicit guarantee of lender of last resort.

Essentially, they are not the types to pay insurance without ever filing claims. And when EACH and EVERYONE of them expects to get back all or more of the insurance paid, well thats not insurance is it?

Morgan, that's exactly my point. That he thought FDIC made LLR obsolete predated the boom in shadow banking, and I can't hold that against him. Therefore I noted he may support our bailouts in spirit.

But I do not know that he would have. It's a whole different ball game.

The bigger issue is that Friedman would propose GI CYB to solve unemployment immediately, thus removing 80% of the politics, and since we wouldn't need this unemployment target, the long term real function of monetarism is LITERALLY to keep the state from growing, in fact under NGDPLT, in would outright shrink.

Ultimately NGDPLT bakes the very best anti-govt. Uncle Milty into MP.

"BUT, you are correct Friedman should have noted that eventually the biggest banks would also take advantage of the implicit guarantee of lender of last resort."

When money market fund managers and advocates, including Friedman, claimed investors in money market funds would never ever assume that the money market funds would be as safe as banks and would never ever expect them to be bailed out by the government, and would never ever expect to cash out on demand for any reason, because the individuals and businesses would understand the money market funds are risky investments with no guarantees, so a money market fund panic is impossible and frozen money market funds would not disrupt the economy.

I remember the opposition to money market fund restrictions like delays in receiving cash after requesting withdrawal, restriction on withdrawal frequency to once a month, the ability of fund managers to freeze or limit withdrawals being SOP, total prohibition of anything like checking or bill paying, all based on these being end runs around Regulation Q which served to divide demand deposits from safe long term investments, and risky investments.

By 2008, money market funds were assumed to be like banks in the 20s, or maybe even S&Ls in 1990.

When was the implicit government backing of money market funds made, and who made the government the lender of last resort for money market funds?

My attention to this debate was drawn by Friedman's columns, and he never convinced me, even before I read a Monetary History. Even in my teens I had grown to appreciate the tension between corporations and the people who acted collectively through government and other institutions to the bad natures that drove some big corporations contrary to the interests of society. It was pretty clear that the free lunches promised by the money market fund managers would come at a high cost in the end.

"I find this discussion would proceed on better terms with more direct quotations from primary sources" ... well it is a blog debate #DreamOn

What bugs me is why the Friedman bashing now? (Is he in the running for the Fed Chair too?) I appreciate a good economics history lesson -- for instance I just listened recently to a talk about 90+ years of research staff at the Board, it's amazing how much the approach to and support of monetary policy has changed over time -- and yet, I suspect this blog debate is about something else. Maybe the actual debate Is monetary policy (monetarism or other unconventional flavors) at the zero lower bound sufficient? I like how this post pivots to Bagehot and the lender of last resort. It seems financial system stability has come back into favor and the understanding that 'do what it takes' is the minmum level. But the Bagehot point is distinct from the out-of-financial-crisis monetary policy.

I also think you allude to an important fact in the case of Sweden: the policy response is a constellation of actions -- interaction effects can be quite important, so a monetarist money supply may not be enough if other policy offset or clog transmission channels. Oh and I like the reference to inflation expectations (in Krugman's post) ... he should thank Friedman for that: the drivers to long and variable lags in monetary policy didn't just magically appear. In any case, Krugman's initial post on Friedman, "the extended footnote," on Friday was pure trolling, but the follow-on discussion has been more interesting.

"...why the Friedman bashing now?"

Friedman is a hero of libertarianism, therefore in the Krugman world-view he is a crypto-fascist (yes, I know that doesn't make sense; libertarianism is as far from fascism as possible, but hey, this is Krugman after all) and must be pushed down the memory hole as quickly as possible.

Well, how about because, not so much Friedman, but those who make arguments citing Friedman, argue that all that is required to create jobs, wealth, etc is the right monetary policy and just making government smaller and irrelevant.

The argument is made that Obama has been crushing the economy with oppressive taxes, yet the Federal tax burden has never exceeded the lowest tax burden when Reagan was president, that tax rates are so high they crush job creation, even while rates are lower than when Reagan was president, that raising taxes and spending is the wrong thing, even though the economy turned around when Reagan became a tax and spender by doubling the gas tax and authorizing increased spending on transportation infrastructure.

Friedman gets cited all too often by those who reject most of what Friedman argued for. Negative income tax is bad because the working poor aren't paying taxes. Free markets and trade is bad because commies would live better and black and brown people would compete with the beer companies with their pot growing operation and with drug companies by importing coca and opium and selling those. And lower wages will create jobs and the minimum wage prevents that, except the real minimum wage is lower today than while Reagan was president, and Friedman argued for a minimum income regardless of being an individual or a family with or without children.

Friedman was not that black and white on issues in my reading of his words, at least through the 80s, so it seems to me that Friedman would be modifying his theory of policy if he were in his 40s and 50s today.

As opposed to what? Borrow more money? Monetary policy right now is enabling more borrowing by government and individuals. The 'recovery' that everyone is looking for is that everyone starts borrowing more money again. There is no difference between Keynesian or Monetarist or any of the various macro schools of thought. More borrowing, the only difference is who can borrow easiest.

Friedmanism & the Chicago-School represent 'Keynesianism-Lite'.

Krugman naturally disdains such timid adherence to Lord Keynes.

Like his Keynesian comrades, Friedman favored absolute central government control over macro areas of the economy... to manipulate it for social ends. But Friedman mistakenly believed that the micro economic world could still remain free; he (... & Keynesians) grant the vital macro sphere to statism -- as the supposedly necessary foundation for the micro-freedom of the free market.

In reality, the economic macro & micro spheres are thoroughly integrated and enmeshed.
It is impossible to concede the macro sphere to the government... and still retain freedom on the
micro level.

Lost macro-freedom = lost micro-freedom = serfdom.

Bageho said "lend a punative rates against good collateral".

In 1907, JPMorgan's people could walk into the vault of a failing bank and walk out with good collateral, leaving behind a loan.

In 2008, there were no shortage of people willing to lend against good collateral--- today, we'd call it repo. The problem was, the banks had very little good collateral to pledge--- they were "well run" and had pledged it already.

So, the central bank loaned at low rates against dodgy collateral.

You may think that was wise, but it has little to do with Bagehot's maxim.

there were haircuts in the recent episode and policy at least rhymed with Bagehot ... of course, details change over time. here's an overview of the Fed's recent programs since the crisis:

What qualifies as bank such that the Fed should act as a LLR? Citibank? Goldman Sachs? Lehman?

What actions, if any, should be taken to insure the Fed is not inappropriately bailing out shareholders, bondholders and management?

The more important question is why anyone thought money market funds were just like savings and even checking accounts, and not high risk investments that could in an instant become totally illiquid?

Should every business that depended on money market fund deposits being always liquid and available to make payroll and accounts payable have been forced to file for bankruptcy protection until it could liquidate its money market holdings to pay creditors?

A different mechanism for monetary policy that would be more likely to work in deperate conditions.

1. Every citizen has an account with the Fed.
2. Every short time period, say 2 weeks, the Fed prints some money and puts the same amount into every account.
3. This amount is small - say, $10. So every citizen gets $240 a year in "assured income" from the Fed every year.
4. When times are normal, that's all you get.
5. In times of crises, the Fed announces, "Instead of $10 every two weeks every citizen will get $100 every two weeks, for the next N years" and then does that. Various arguments about people's future planning functions get tested.

The key point is to INJECT CASH DIRECTLY INTO THE HANDS OF HOUSEHOLDS on an ongoing reliable basis. It's very flat nature means it will naturally favor the lower classes. Since it's explicilty printed money, it will have some ability to forstall deflation or create inflation.

Yes, it is an explicit side run around the formal and shadow banking systems.

I like it!

When do I get my check?

Hayek repeatedly endorsed Friedman's empirical work on the Great Depression and repeatedly endorsed going even further than Friedman in acting to counter the pathological secondary deflation of the 1930s in the U.S. -- Hayek endorsed public & pre-announced support by whatever means necessary for a stable total income stream target -- something like Scott Sumner's NGDP targeting.

Indeed, as early as 1931 Hayek endorsed Keynes' new ideas for fighting the post-bust secondary deflation -- and insisted that a post-bust pathological secondary deflation must not be allowed to spin into a downward cycle.

What Hayek believed in the case of Britain is that empirically by 1932 it was well passed the point where any counter to Churchill's pathological government induced deflation of 1925 made any sense -- the British economy was well on the way to re-coordinating at the new par, especially is government labor privileges were reformed.

What Hayek believed in the case of America changed radically after he read Friedman's Monetary History -- after reading Friedman he believed the US was in a serious and severely pathological secondary deflation that required Federal Reserve action. Unfortunately, in the 1930s, when Hayek was undertaking a massive personal theoretical and editorial and teaching work load, Hayek seemed no to have any clue about the facts on the ground in America. He admitted as much by fully endorsing the data as discovered, socially constructed and published by Friedman and Schwartz.

Sixteen years after the creation of the Federal Reserve and the unprecedented explosion of industry and agriculture (fuel for the Great War according to Garrett and Churchill), by a remarkable coincidence the greatest depression in history struck. Yet we still speak of curing the disease from the same metric that got us there. Forrests and trees.

Nice post, Tyler. By the way, Krugman took your advice about primary sourcing:

"Had we followed Friedman’s advice, things would have been much, much better, all the more so for the broader world at large. If you doubt this, take a look at Sweden, the country which in the 1930s perhaps came closest to Friedmanesque policy".

Yes, Sweden came through the Great Depression better than most other countries. But the reader should know that Sweden followed a strongly expansionary fiscal policy in the years 1931 through 1936. Whether this was the main reason - or even a partial reason - for Swedens economic performance during the 1930s or not is open to interpretation of course, but this fact needs to be included in the narrative.

Source (in Danish): Jørgen S. Dich: "Arbejdsløshedsproblemet i Danmark 1930-38." Socialministeriets økonomisk-statistiske undersøgelser nr. 4, København 1939, pp. 149-53
Source (in Swedish): Lars Jonung: "Från guldmyntfot till inflationsmål – svensk stabiliseringspolitik under det 20:e seklet"

What more should the Fed have done under Marriner Eccles who was a strong advocate of monetizing pretty much all debt, especially the Treasury debt?

When the Congress did a huge helicopter drop of something like a trillion dollars in less than two years, and the Fed monetized it all, and then Congress reacted to the spike in deficit and embraced austerity, with businesses cutting back as the helicopter drop of cash was spent up, what should the Fed have done? Was the Fed wrong to increase reserve requirements as banks were flooded with the cash from Congress' helicopter drop? Should the Fed sought to encourage banks to become insolvent again in 1937?

FDR was opposed to the helicopter drop, the Bonus Payments, which occurred over his multiple vetoes, because FDR believed the way to put money in people's pocket is by putting them to work, and if business wouldn't put them to work, then he would. And his solution to business complaining the unemployed didn't know how to work was to take all the inexperienced unemployed people and put them to work for a couple of years serving the public making things.

FDR's favorite program was the CCC which took young adults without job prospects and put them to work in conservation work for a couple of years. But other programs employed the others who were unemployed.

Today we hear a lot about job training which seems to be teach people how to work in a classroom, on a computer, without giving them any work experience. Employers wanted experienced workers, and those put through job training prove they have no job experience too often for employers to hire the graduates of job training that is not run under the direction of the employer according to the employer's standards requiring actual work, but paid for by taxpayers. In other words, taxpayers pay people to work for a corporation with the corporation getting the benefits.

Meanwhile lots of problems that can only be solved by work are not being done. For example the lack of 30s style CCC conservation work resulted in flash floods that killed a number of people this weekend. And washing away soil from the hills and mountains is going to delay them returning to stability from well established growth.

Yes, very good post, and thanks for the links.

Liquidity traps are only real if you assume central banks can’t inflate, and fiscal expansion assumes levels of gov’t efficiency Friedman would have found amusing. Plus, Friedman understood that tight money could lead to low rates. All of this should have been made very, very obvious by now but the right is scared of monetization and the left wants fiscal expansion instead.

It’s not like the Fed couldn’t change their long-term target, or even tried very hard to inflate. Easy to forget the Fed statements at the time of the crisis were still worrying more about inflation than the oncoming fall in NGDP — the first since TGD. They’ve really dropped the ball, while the debate seems largely to be over which kind of oil they should be using on their hands.

I think people aren't really paying enough to what QE is. The right screams "moneyprinting!" The left shouts "ineffective at ZLB!" But the long-term Fed target is an implicit promise to roll QE back...

From the essay: "Paradoxically, the monetary authority could assure low nominal rates of interest-but to do so it would have to start out in what seems like the opposite direction, by engaging in a deflationary monetary policy."

“A fourth effect, when and if it becomes operative, will go even farther, and definitely mean that a higher rate of monetary expansion will correspond to a higher, not lower, level of interest rates than would otherwise have prevailed. Let the higher rate of monetary growth produce rising prices, and let the public come to expect that prices will continue to rise. Borrowers will then be willing to pay and lenders will then demand higher interest rates-as Irving Fisher pointed out decades ago. This price expectation effect is slow to develop and also slow to disappear. Fisher estimated that it took several decades for a full ad- justment and more recent work is consistent with his estimates.”

That’s the inverse of what's been happening, of course.

"But what I did was a little different from what the MMs have done this time around: I set out to prove my instincts right with a little model, a minimal thing that included actual intertemporal decisions instead of using the quasi-static IS-LM framework. [If you have no idea what I'm talking about, you have only yourself to blame -- I warned you in the headline]. And to my considerable surprise, the model told me the opposite of my preconception: there was no Pigou effect. Consumption was tied down in the current period by the Euler equation, so if you couldn’t move the real interest rate, nothing happened.

One way to say this — which Waldmann sort of says — is that even a helicopter drop of money has no effect in a world of Ricardian equivalence, since you know that the government will eventually have to tax the windfall away. Of course, you can invoke various kinds of imperfection to soften this result, but in that case it depends very much who gets the windfall and who pays the taxes, and we’re basically talking about fiscal rather than monetary policy. And it remains true that monetary expansion carried out through open-market operations does nothing at all."

OK, I understand that Krugman's post came with the "Double-super-special-wonkish" warning label. I also get that Krugman has a Nobel Prize, and that Robert Waldmann is a top ranked economist (even though he is super duper flakey). But I don't follow this argument at all, and I consider myself slightly smarter than the average bear.

What on earth does Ricardean Equivalence have to do with helicopter drops of money?!?

Here's my simple take on this in IS-LM terms.

The Investment Savings (IS) Curve is a function of income, the real long interest rate, the real exchange rate and real wealth.

To believe that monetary policy can have no effect at all on the IS Curve (and therefore is completely impotent when the IS curve intersects the LM curve on its horizontal portion) is to believe that:

1) Monetary policy cannot affect real long interest rates and/or real long interest rates have absolutely no effect on nonresidential investment, residential investment or durable goods

2) Monetary policy cannot affect the real exchange rate and therefore cannot affect exports

3) Monetary policy cannot affect income expectations and/or current real wealth and therefore cannot affect investment and consumption

Does anyone really believe all of those things? (Really?!?)

Furthermore I've noticed that Krugman is getting extra super cocky in his declarations that monetarism is dead, Friedman is irrelevant and monetary policy is totally ineffective lately. And I've noticed an enormous pushback from on at least the first two points from people who normally are in full agreement with him.

In my opinion when someone repeatedly declares victory in battle with such swagger it usually means that they've lost the war.

You should read Friedman's essay, delivered to the AEA in 1968' as linked by TC.

Not only have I read it many times, it's an assigned reading in my class on Topics in Monetary Policy.

If I had to suggest people read any one thing by Friedman it is precisely that.

Well, regarding your statement in 1), you must disagree with Friedman's comments on page 11, where he says that the monetary authorities can only peg nominal quantitative, not real ones.

On page 11 Friedman says:

"Monetary policy cannot peg these real magnitudes at predetermined levels."

Which I totally agree with and which in no way contradicts the fact that monetary policy can always affect real long interest rates and that real long interest rates have an effect on nonresidential investment, residential investment and durable goods, *in the short run*. (You do understand the meaning of the word "peg", don't you?)

Moreover Friedman says the following immediately afterwards:

"But monetary policy can and does have important effects on these real magnitudes. The one is in no way inconsistent with the other."

If you don't believe that, then you clearly don't agree with Friedman.

And he called it fiscal policy, too. A fiscal helicopter drop? What?

Are we to the point where the federal government is contemplating literal helicopter drops of money? :)

I have no idea what Krugman is talking about. His article says "Friedman’s analysis of the Great Depression was wrong" - I wish he was a bit more precise, because the Friedman wrote a huge amount of analysis about the Great Depression, and it is very difficult for me to figure out what Krugman is arguing.

Krugman would be far more effective if he stopped using people's names, and instead concentrated on the precise theories and data.

"That said, it is incorrect to suggest that monetarism had an impotent, currency-printing, Pigou effect-relying approach to the Great Depression. Had we followed Friedman’s advice, things would have been much, much better, all the more so for the broader world at large. If you doubt this, take a look at Sweden, the country which in the 1930s perhaps came closest to Friedmanesque policy, including no gold standard and floating exchange rates....We find the more recent work, though focusing to a greater degree on international aspects of the problem, to be essentially
complementary to the Friedman-Schwartz analysis.”), combined with a less deflationary monetary policy. Their Great Depression was much milder than in most other parts of the West."

Knut Wicksell's norm of price stabilization and Swedish monetary policy in the 1930's
Lars Jonung
October 1979

"This paper examines the conduct and the effects of Swedish monetary policy in the 1930's. Three major conclusions emerge from the study: (1) The conduct of monetary policy specifically the devaluation of the Swedish currency in 1931 and the subsequent program of price stabilization, had a major effect on the aggregative behavior of the Swedish economy in the 1930's. (2) The impact of the new fiscal policy was insignificant compared to the effects of monetary measures and international developments. (3) The framing of Swedish monetary policy in the 1930's was strongly influenced by Wicksell's norm of price stabilization and the recommendations of the old generation of monetary economists represented by Gustav Cassel and Eli Heckscher."

This episode is particularly interesting because it is the first and only known example of a country adopting price level targeting, which is closely related to nominal GDP level targeting, as its monetary policy. Lars Jonung has another paper devoted to a more detailed discussion of this aspect of Swedish monetary policy during this period:

Are we misunderstanding Paul Krugman, because it is hard to believe that he is not aware if Friedman’s position on this which is pretty well known?

Usually times they're combined with tribal tattoos to create a extra revolutionary tattoo. Egyptians at the moment were believed to use tattoos as a technique to mark the slaves and the peasants. They are able to as well indicate people carry dried up hues and in actual fact blend his or her inks as opposed to purchasing pre-made tattoo inks.

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