10 Dec 2005

“We Won’t Do it Again”

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Not so very long ago, almost universally accepted common wisdom blamed the Great Depression on “the excesses of capitalism,” and believed that it was Franklin Delano Roosevelt and the New Deal which saved the capitalist system from itself by the addition of social welfare and more intense federal management of the economy. As the Wall Street Journal reports, the world has since turned upside down:

For decades, many economists and policy makers thought the Depression was the inevitable consequence of excess investment, flawed corporate governance and speculation in the 1920s, culminating in the 1929 stock-market crash. That view was reinforced by John Kenneth Galbraith’s 1955 book “The Great Crash, 1929.”

Milton Friedman and Anna Jacobson Schwartz upended that view in 1963. In “A Monetary History of the United States, 1867-1960,” they argued that the Depression was far from inevitable, but brought about by an “inept” Federal Reserve. First, they said, the Fed foolishly raised interest rates in 1928 to end speculation on Wall Street, causing a recession the next year that precipitated the crash. Then, it let thousands of banks fail and the money supply shrink. In part, it thought weak banks should be allowed to fail. It also feared that lower interest rates might lead foreigners to dump dollars, straining the currency’s link to gold.

Mr. Bernanke read the book as a graduate student at Massachusetts Institute of Technology in the 1970s. “I was hooked, and I have been a student of monetary economics and economic history ever since,” he recalled at a 2002 conference honoring Mr. Friedman’s 90th birthday. Mr. Bernanke, by then one of the Fed’s seven governors, told Mr. Friedman: “Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

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