Opinion from a Libertarian ViewPoint

How to Avoid Depressions? Foster Saving and Investment | Mises Wire

Posted by M. C. on December 31, 2021

Contrary to the popular thinking, economic depressions are not caused by a strong decline in the money stock, but are rather the result of the depleted pool of savings. This depletion emerges because of the previous loose monetary policies. A tighter monetary stance arrests the depletion of the pool of savings, thereby laying the foundation for an economic recovery.

Frank Shostak

In his writings, the leader of the monetarist school of thinking, Milton Friedman, blamed central bank policies for causing the Great Depression of 1930s. According to Friedman, the Federal Reserve failed to pump enough reserves into the banking system to prevent a collapse of the money stock. Because of this, Friedman held, the M1 money stock, which stood at $26.34 billion on March 1930, fell to $19 billion by April 1933—a decline of 27.9 percent.1


According to Friedman, as a result of the collapse in the money stock, economic growth also dropped off. By July 1932, industrial production had fallen by over 31 percent year on year (see chart). Also, year on year the Consumer Price Index (CPI) had plunged. By October 1932, the CPI had declined by 10.7 percent (see chart).


A closer examination of the historical data shows that the Fed was actually pursuing very easy monetary policy in its attempt to revive the economy.2

The Fed’s holdings of US government securities depict the extent of monetary injections. In October 1929, holdings of US government securities stood at $165 million. By December 1932, these holdings had surged to $2.432 billion—an increase of 1,374 percent (see chart).


Also, the three-month Treasury bill rate fell from almost 1.50 percent on April 1931 to 0.4 percent by July 1931 (see chart).

Another indication of the Fed’s loose monetary stance was the widening differential between the yield rates on the ten-year Treasury bond and the three-month Treasury bill. The differential increased from 0.04 percent in January 1930 to 2.80 percent by September 1931 (see chart; an upward-sloping yield curve indicates a loose monetary stance).


The sharp fall in the money stock during 1930–33 does not indicate that the Federal Reserve did not try to pump money. Instead, the decline in the money stock came because of the shrinking pool of savings brought about by the previous loose monetary policies of the Fed.

The yield curve between 1920 and 1924 reveals this easy stance by the Fed: the yield spread increased from –0.67 percent in October 1920 to 2 percent by August 1924.

The reversal of this stance by the Fed, which saw the yield spread decline from 2 percent in August 1924 to –1.45 percent by May 1929, finally burst the monetary bubble (see chart).


In addition to this, at some periods the monetary injections were nothing short of massive, contradicting Friedman’s claim. For instance, the yearly growth rate of M1 increased from –12.6 percent in September 1921 to 11 percent by January 1923, and then from –0.4 percent in February 1924 the yearly growth rate accelerated to 9.8 percent by February 1925. Such large monetary pumping amounted to a massive exchange of nothing for something.

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