All Commentary
Sunday, August 1, 1999

The Great Depression: An International Disaster of Perverse Economic Policies

Macroeconomics Alone Cannot Explain Historical Events

Thomas Hall and J. David Ferguson state two purposes in writing this book. Their first is to apply macroeconomic theory to an actual event, “the greatest macroeconomic disaster in U.S. history.” Their second aim is historical. They seek to tell the story of how powerful officials in several countries “committed an incredible sequence of policy errors that generated a cataclysmic event reaching around the entire globe.” The authors succeed admirably in their first objective, but do less well in their second. As economists relying on macroeconomics to explain the decision-making processes that culminated in and sustained the Depression, they demonstrate the limits of macroeconomics alone in analyzing and explaining historical events.

Nonetheless, The Great Depression is a valuable book. It is well written and the authors carefully explain many obscure practices of the interwar financial world, such as the Federal Reserve’s real bills doctrine. Moreover, they ably marshal the secondary literature in economics to answer such questions as: why the depression was so severe, why it lasted so long, and why it was a global phenomenon.

Their answers to those questions reflect a monetarist consensus that synthesizes the work of Milton Friedman and Anna Schwartz, which focuses on the domestic sources of the depression found in Fed policy, and that of Peter Temin and Barry Eichengreen, whose work indicts the pursuit of the interwar gold standard for making the depression an international phenomenon. Although the authors do not include the analysis of Austrian economists, they rightly point to the role of the Hoover and Roosevelt administrations in perpetuating the Depression. Indeed, the authors reach the conclusion of Murray Rothbard and other Austrians: government intervention made conditions worse.

In applying macroeconomic criteria as the test of policy outcomes, the authors also applaud several federal policies that constituted unprecedented economic intervention. Accepting the idea that a central role of the government in monetary policy is essential, they approve of the banking and financial laws of the 1930s that established federal deposit insurance, and strengthened the power of the Fed. Similarly, given Fed failures, they view the Reconstruction Finance Corporation as a useful alternative lending institution. They also endorse the questionable idea that heavy federal defense spending ended the Depression. As Robert Higgs has argued, the war masked the Depression by putting people back to work, but did not end it in terms of restoring material well-being.

The book also fails to demonstrate the authors’ main contention that it was policy errors of well-intentioned officials who were “grossly ignorant about the goals, tools, and impact of economic policy” that caused the Depression. They suggest that had policymakers just known better, they wouldn’t have enacted the series of misguided policies that created “an absolute disaster.” The historical literature leads to a rather different conclusion. For instance, as Herbert Stein has shown, New Deal officials were cognizant of monetary policy as a tool, but simply regarded it as ineffective. Holding dim views of financiers and bankers as a class and eager to demonstrate the capability of the federal government in restoring prosperity, they instead developed fiscal policy as a tool to manage the economy. The problem was not so much one of ignorance as of the mindset of the New Dealers.

Economic ignorance alone does not adequately explain historically how the series of misguided policies that caused and sustained the Depression came to be. What may seem today to be misguided policies were not necessarily obvious at the time. During the 1930s, few private or public leaders in America other than a small number of economists, Wall Street bankers, and Fed officials pointed to monetary policy as a primary cause of the contraction. Ultimately, The Great Depression fails to clarify for the reader precisely what the authors believe should have been obvious to contemporary policymakers, enabling them to avoid the calamity.

On the whole, the main macroeconomic conclusions of the book are sound: that policy mistakes of the 1920s and 1930s were the most important factors in causing the Great Depression; that the severity of the 1929–1933 contraction in America was due to bank failures that resulted from Fed inaction; and that the duration of the Depression owed to the lack of pro-active Fed policy after 1933 and the economic incoherence of the subsequent New Deal program.

This book, while limited in some respects in its explanatory power, helps to refute the still-popular notion that the Depression was caused by an inherent flaw in the market economy, inexplicably causing economic collapse. []

Michael R. Adamson is a Ph.D. candidate in history at the University of California-Santa Barbara.