Bob Murphy was kind enough to review my recent book on the Great Depression, in the Quarterly Journal of Austrian Economics. Here are the concluding two paragraphs:

Putting aside the detailed statistics, I will end this review with a simple question: How can it be that the classical gold standard is largely responsible for the Great Depression, when the classical gold standard was operating during several previous financial panics and depressions (small “d”)? To blame the Great Depression on the gold standard is akin to blaming a particular plane crash on gravity.

In contrast, the Rothbardian analysis at least has a shot at being satisfactory. After all, Herbert Hoover in his memoirs tried to defend his legacy by assuring his readers (truthfully) that his administration had taken unprecedented measures in battling the Depression, meddling in the economy in ways that no president during peacetime had done before. That’s the place to start, when we ponder why Herbert Hoover suffered from a worse downturn than any president before.

I don’t recall ever saying precisely that the classical gold standard was largely responsible for the Great Depression. If I did, it was an error. My actual belief (which explains the original title of my book—The Midas Curse) is slightly different—that the initial phase of the Great Depression was caused by massive gold hoarding during 1929-33 (under the interwar gold standard), especially by central banks. This gold hoarding sharply reduced prices and NGDP, and since nominal wages were sticky it also led to mass unemployment. The unusual duration of the Great Depression (including an 8 year recovery after a 3 1/2 year contraction) is partly explained by FDR’s high wage policies.

I believe that the gravity metaphor better applies to Bob’s explanation for high unemployment—sticky wages. In my view, sticky wages and prices are just one aspect of reality, something that policymakers must account for, just as airplane designers must account for gravity. Thus monetary policy should aim for stable growth in NGDP, so that sticky wages don’t become a problem.

In fairness to Bob, there is a grain of truth in his attempt to blame wage stickiness. He points to the fact that Hoover pressured firms not to cut wages after 1929, whereas during the severe 1920-21 price deflation, wages were allowed to adjust downwards. But I don’t think this proves as much as Bob assumes. Even without any government interference, wages would be sticky in the short run, and the 1921 depression was also quite steep. The difference in 1929-33 was that the deflation continued for 3 and 1/2 years, whereas after 1921 prices started rising again. So the monetary shock was far worse in 1929-33, which largely explains why the latter contraction was longer and deeper.

Having said that, I do agree with Bob that Hoover’s high wage policy was also a significant factor, and explains part of the greater severity of the 1929-33 slump. I also agree with the Murphy/Rothbard view that other Hoover policies were also destructive, such as the Smoot-Hawley tariff and the sharp increase in marginal income tax rates.

However, Adam Smith was right when he said there’s a great deal of ruin in a nation. During 1964-73, Johnson and Nixon did lots of things that led to greater government spending and regulation, as well as higher taxes. The net effect of these on measured economic efficiency was negative (aside from civil rights laws). And yet the economy boomed. It didn’t boom because supply-side factors don’t matter, it boomed because in the short run demand shocks are the primary determinant of output and employment. Hoover’s policies were quite counterproductive, but nowhere near important enough to explain the Great Contraction. It was tight money that did it.

When I wrote the book, I consciously tried to avoid monocausal explanations that pinned “blame” on a single policy or political figure. The Great Depression was very complex, and my book makes it quite clear that if during the 1930s the gold standard had been operated according to the “rules of the game”, there might well have been no Great Depression (we can’t be sure either way). That’s why I say it’s an oversimplification to say I “blamed” the gold standard for the Great Depression, especially the claim that I blamed the “classical gold standard”, which usually refers to the pre-WWI system (where central bank intervention was milder and hence the rules of the game were more closely followed).

On the other hand I’m quite comfortable saying that I think we would have been better off if the gold standard had been replaced by fiat money after WWI. Even that new system would have probably performed poorly by the standards of the 1990s, but it would have done less poorly than the actual result that we got under the interwar gold standard.

One other point. I think Bob makes too much of the fact that I was unable to explain the stock market crash of 1929. I explained as much of it as I could (which is far more than what anyone has been able to do for the similar 1987 crash) but freely acknowledged that I fell well short. It remains something of a mystery. At the beginning of the book I indicated that I believe I was able to do a much better job of explaining stock market movements in 1930-38, as compared to 1929. A reviewer certainly should point out that I fell somewhat short of explaining 1929 (although I still think I did better than others) but the greatest weakness in the book (in my view) is that I had almost nothing interesting to say about the rapid recovery of 1940-41.

But then that’s where I’d guess a Keynesian reviewer would take me to task, not Bob Murphy. 🙂

Despite these quibbles, I appreciate Murphy’s review, which did have some positive things to say as well.


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