Reddit reviews Essays on the Great Depression

Both Friedman and Bernanke have good books on this subject.

http://www.amazon.com/Contraction-1929-1933-Princeton-Classic-Editions/dp/0691137943/ref=cm_cr_pr_product_top

http://www.amazon.com/Essays-Great-Depression-Ben-Bernanke/dp/0691118205/ref=sr_1_1?s=books&ie=UTF8&qid=1421083324&sr=1-1&keywords=bernanke+depression

Bernanke and Friedman are in basic agreement on the Federal Reserve being the cause of the depression. Bernanke is famous for having said: "Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again." I should add that although Friedman is sometimes seen as a free-market hack, his work on monetary theory and the great depression is respected by economists of all political stripes.

Modern central bankers now know to increase the money supply during a recession. This is necessary to prevent deflation because the effective amount of money circulating in the economy is increased by lending. Lending decreases during a recession, so if the central bank does not increase "base money", then the effective amount of money will decrease in the recession. A fall in the money supply can cause problems, particularly for banks if the duration of their assets and liabilities differ (as is almost always the case) (fyi, the duration of and asset or liabilities is basically when it pays out. Mortgages have a long duration because mortgage holders will be baying back their debts over decades. Demand deposits have a short duration -- consumers can withdraw their deposits on a day's notice to take them to another bank or take them home. If the interest rate goes up, then consumers can withdraw their deposits to get a bigger return on them, but banks cannot call their mortgages. Thus, banks are typically hurt when interest rates go up. Furthermore, if enough people start withdrawing their deposits, the bank can run out of cash -- even if their mortgages are good and they'd be able to pay back their depositors if given enough time. This can result in a bank run. If a lot of people withdraw their deposits, then the bank will go bankrupt and the other depositors could be ruined. Thus, lots of depositors may withdraw their deposits in anticipation that others will, causing a bank failure that would not have happened otherwise. Banks failing and being close to failure will reduce the supply of credit to various enterprises, which directly reduces output (this is the link between the "real economy" and the financial economy. In a market economy, the financial sector plays a crucial role in determining to which enterprises capital is allocated. Banks can do a good job identifying where capital is most productive, but during a liquidity crises they will fail to extend this credit -- they know the project is good but they can't give the money without going bankrupt).

At the start of the great depression, the US Federal reserve decreased the money supply rather than increasing it, transforming what would probably have been a sharp but brief recession (as the United States had experience regularly throughout its history) into the great depression. Indeed, the effective money supply decreased by over a third early in the great depression.

There were a couple of reasons for this, but part of it came from a power struggle between the New York Fed and the Washington DC fed. In the 1800's and early 1900's, big financiers like J.P.Morgan played the role of the federal reserve by generously extending financing during contractions to avert catastrophe. After the panic of 1907 (where J.P. Morgan assembled a coalition of other bankers to extend credit to banks during the liquidity crisis), many bankers urged the creation of a government body to play the role that J.P. Morgan had played in the past, thinking something like "we only avoided catastrophe because J.P.Morgan saved the day - what if someone like J.P. Morgan is not around for the next crisis? We need an official body to play this role". This resulted in the Federal reserve board.

The Federal reserve board is a fairly decentralized system. The D.C. fed is responsible for controlling money supply. But the New York Fed has always been better connected with the banks and more proactive in extending credit during liquidity crises. When the federal reserve boards were founded, Benjamin Strong was appointed the first governor of the Federal Reserve Bank of New York, and continued the practice of providing strong support of the banks during liquidity crises (exe. extending emergency credit).

However, the D.C. fed wanted to centralize power, and reflexively opposed the actions of the New York Fed as a means to acquire this power. Benjamin Strong was an effective leader and was able to resist the encroachment of the D.C. fed. Unfortunately, he died in 1928 on the eve of the stock market crash. Thus, when the crash happened, the D.C. fed was able to assert its authority unopposed and prevent the New York Fed from extending credit to distressed banks at the outset of the crises.

In addition, many banks around the world at this time were trying to strengthen their currencies (the dollar is strong if it can buy relatively more euros, for example). One way to accomplish this is to raise interest rates, because money from foreign countries will rush in to buy the higher-interest rate assets, thus bidding up the price of the dollar. If many central banks in different countries do this at once, the result is no change in the strength of the currencies but large increases in the interest rate in all countries. Many countries were caught up in this game of competing for a strong currency, with the US and France at the forefront (France also had a terrible great depression). Unfortunately, the Fed increases interest rates by buying up bonds, so the Fed was actually reducing the money supply at the outset of the great depression, which is the exact opposite of what should be done.

As for other countries, the UK did not tighten monetary policy after the initial recession like the United States did. They had a relatively brief and less severe recession.

Canada also did not tighten monetary policy. In addition, Canada had fewer, larger banks, whereas the United States had an abundance of small banks. Small banks are less diversified and are more likely to go under during a credit crunch. This is why not many (actually, i don't think any) of the banks in Canada went under. But something like a third of all banks in the United States went bankrupt in the early phases of the great depression. The reason the United States had many small banks was because there were regulations preventing banks from growing very large. I can't remember the details of these regulations, but I believe they prevented banks from operating in multiple states.

TLDR
the great depression probably would have been a minor recession except for the fact that a recently founded federal agency led by naive and power-hungry leadership both failed to extend credit to banks during a liquidity crisis (as banking giants like J.P. Morgan had done in the past) and actively reduced the money supply in pursuit of a strong dollar. In addition, regulations limiting the size of banks made the US financial system more vulnerable to financial shocks.

It sounds like I am blaming government and saying that the Fed should not exist. That is not the case. The Fed can be beneficial if it is run correctly, and the current leadership is much more knowledgeable about how the macro economy works than the leadership was in the past. Criticizing bad regulation is not the same as criticizing regulation. In any case, the Great Depression probably would not have happened if either the Fed didn't exist or the Fed had been properly managed.

You think if they had such a strong opinion on it, they'd have noticed by now that generally the first countries to ditch the gold standard were also the same countries to recover from the Great Depression first, given fiat currency isn't nearly as susceptible to currency shocks, being able to recover its value far better than the gold standard.

But I guess it'd be too much to ask them to read Bernanke.

Can't go wrong with Bernanke's "Essays on the Great Depression".

>you must be advocating for more government input into the economy right?

No, and I would disagree with the characterization about the war itself saving the economy. Perhaps the best expert on the New Deal is Ben Bernanke. In Ben's view, the New Deal was an important reset to the economy, but the recovery itself was due to monetary reform, not the war or the vast spending efforts from the New Deal.

This article isn't bad either, but glosses over important details.

From the article:

>The Fed did not put enough money in circulation to get the economy going again. Instead, the Fed allowed the total supply of U.S. dollars to fall 30 percent. Later research has supported parts of Bernanke's assessment.