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Subject Area: Political Theory

Monetarism and the Depression - Leonard P. Liggio, Literature of Liberty, July/September 1979, vol. 2, No. 3 [1979]

Edition used:

Literature of Liberty: A Review of Contemporary Liberal Thought was published first by the Cato Institute (1978-1979) and later by the Institute for Humane Studies (1980-1982) under the editorial direction of Leonard P. Liggio.

Part of: Literature of Liberty: A Review of Contemporary Liberal Thought, 20 vols. 19781-982

About Liberty Fund:

Liberty Fund, Inc. is a private, educational foundation established to encourage the study of the ideal of a society of free and responsible individuals.


Monetarism and the Depression

Thomas Mayer

  • University of California, Davis

“Money and the Great Depression: A Critique of Professor Temin's Thesis.” Explorations in Economic History 15 (1978): 127–145.

Peter Temin's essay on the “great contraction” of the 1930s, Did Monetary Forces Cause the Great Depression? (1976), has clarified the Keynesian interpretation of the Depression. Challenging the long prevalent monetarist explanation of Milton Friedman and Anna Jacobson Schwartz in their Monetary History of the United States, Temin claims that a major, autonomous decline in consumption occurred in the early 1930s and that this decline, by its repercussions on financial markets, caused the sharp and persistent recession. Thus, Temin argues that the declining money stock of the 1930s was a symptom of basic changes in the real sector. Consequently, even if bank failures had not reduced the money stock, declines in money would still have been near the actually observed levels. Temin interprets fluctuating interest rates as a sign that the demand for money fell faster than the supply of money contracted (for any given rate of interest).

If valid, these arguments would clearly weaken the monetarist claim that the “great contraction” resulted from inept and unnecessary money management. Several problems, however, weaken Temin's attack. For example, Temin emphasizes the year 1930 in his analysis of the monetarists' argument on the decline of the money stock. This emphasis is surprising inasmuch as Friedman and Schwartz deal with the period 1929 to 1933 and note that the major declines occurred after 1930. Then again, Temin's argument for an autonomous decline in consumption rests on only three observations, consumption in 1921, 1930, and 1938. This narrow focus precludes reliable conclusions: It is difficult to even identify the abnormal year in a selection as sparce as Temin's. Also, it is unclear that a major autonomous fall in exports reinforced the decline in consumption, as Temin argues. Furthermore, he fails to investigate whether declines in the incentive to spend and invest might be a cause of recession.

Temin may also be faulted for suggesting that the money stock would have fallen regardless of bank failures. The evidence indicates an excess supply of money preceding the wave of bank failures. Also, Temin lacks a defensible explanation for the behavior of real money balances. It is possible to explain the decline in short-term interest rates from either a Keynesian or a monetarist viewpoint. Thus, the evidence on real money balances fails to support Temin's explanation of declines in incomes.