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).


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