Did Monetary Forces Cause the Great Depression?

The purpose of Peter Temin's `Did Monetary Forces Cause the Great Depression' is to compare and synthesis the monetarist "Money Hypothesis" of Friedman and Schwartz with the "Spending Hypothesis" of Keynesian economists. Temin's analysis is primarily quantitative/econometric but occasionally uses qualitative measurements (when quantitative analysis is not possible). Temin's conclusion is that the "Money Hypothesis" cannot explain the cause of the Great Depression because it cannot explain the downturn in 1929-1931. Temin gives two primary reasons for this: 1) If the money hypothesis is correct then a temporary spike in interest rates would have occurred in the financial markets. In fact interest rates steadily declined over this period. 2) If the money hypothesis were correct real money balances should have fallen at the beginning of the contraction. However, between 1929-1931 real money balances actually rose due to prices falling faster than the money supply. Due to Temin's findings he does not agree with Friedman's view that the Federal Reserve `caused' the Great Depression. It is important to note that poor monetary policy in the U.S. and internationally probably contributed to the severity and duration of the Great Depression. The cause of the Great Depression is due to the "Spending Hypothesis". Contrary to popular belief the depression was not caused by a fall in investment and was not completely caused by the U.S. Temin compares the Depression of 1920-21 to the Great Depression. In both cases Investment initially decreased at the same rate. The difference between each depression is the changes in consumption. Consumption remained relatively constant during the 1920 depression. However, during 1931 public perception changed regarding the depression and consumption started to drastically decrease. It was this fall in consumption, alongside the fall in investment, which caused the severity and length of the Great Depression. Temin admits that his econometric regressions related to the "spending hypothesis" can only partially explain the cause of the Great Depression. Temin's contribution to the field of economics is overwhelming. In this work he manages to compare, contrast, improve, and synthesize the "money" and "spending" explanations of the Great Depression. His explanation has become the textbook standard for the Great Depression (see Mankiw's `Macroeconomics' 6ed). Unfortunately, economists may never be able to fully explain what caused the Great Depression. Temin warns, "The economist who uses this conclusion or any other conclusion about the Depression as a basis for economic policy recommendations essentially is performing an act of faith".

Peter Temin's answer to the title of his book is NO. He explains clearly the two main hypotheses concerning the Great Depression. First, the money hypothesis (Friedman & Schwartz), which states that the collapse of the banking system was the primary cause. The fall in consumption and investment were a result of the Depression. Secondly, the spending hypothesis, which states that a fall in consumer spending was the prime cause. The banking crisis was a result of the Depression. The author shows clearly that the banking panic was also caused by high-level fraud. The spending collapse was caused by a fall in income (wages), to a lesser extent by a decline in wealth (the stock market crash) and a fall in consumer sentiment (bad expectations). It influenced negatively the residential construction market and via the textile industry, agriculture (a steep fall in cotton prices). The ultimate result was huge unemployment. The Depression was also aggravated by international events. A steep depression in Europe caused a fall in exports. The Federal reserve did nothing to stem the decline by e.g. an expansionary fiscal policy. On the contrary, it chose to raise interest rates in order to preserve the international value of the dollar during the European currency crisis. Peter Temin's book is an important and extremely balanced econometric study. It could be rather difficult for the layman, although the author thinks otherwise.

This book was intended to argue against Friedman's monetary description of the Great Depression. However, it is hard to say that Temin responded to Friedman's main contention properly. For, while Friedman maintained that the Depression could have been alleviated had there been some appropriate actions of the Fed (namely, policies related to monetary expansion), Temin's response was composed of two parts which kill each other's clarity; namely, (A) there was no monetary constraint before September 1931: however, (B) we cannot say whether or not macroeconomic policies which were not used then could have been effective if they were actually used. At the same time, Temin's logic which made him say (A) above is based upon a coarse (and probably wrong) interpretation of Friedman's another article, ''Money and Business Cycles''. Nonetheless, I have to be fair to add that this book is one of good materials to examine Friedman's position from various points of views.