The first paragraph in the preface to Ben Bernanke's 2004 book, Essays on the Great Depression, reads as follows:
"My particular research specialty is macroeconomics, not economic history. Nevertheless, throughout my academic career, I have returned many times to the study of the vertiginous economic decline of the 1930s, now known as the Great Depression. I guess I am a Great Depression buff, the way some people are Civil War buffs. I don't know why there aren't more Depression buffs. The Depression was an incredibly dramatic episode--an era of stock market crashes, bread lines, bank runs, and wild currency speculation, with the storm clouds of war gathering ominously in the background all the while. Fascinating, and often tragic, characters abound during this period, from hapless policymakers trying to make sense of events for which their experience had not prepared them to ordinary people coping heroically with the effects of the economic catastrophe. For my money, few periods are so replete with human interest."
"My particular research specialty is macroeconomics, not economic history. Nevertheless, throughout my academic career, I have returned many times to the study of the vertiginous economic decline of the 1930s, now known as the Great Depression. I guess I am a Great Depression buff, the way some people are Civil War buffs. I don't know why there aren't more Depression buffs. The Depression was an incredibly dramatic episode--an era of stock market crashes, bread lines, bank runs, and wild currency speculation, with the storm clouds of war gathering ominously in the background all the while. Fascinating, and often tragic, characters abound during this period, from hapless policymakers trying to make sense of events for which their experience had not prepared them to ordinary people coping heroically with the effects of the economic catastrophe. For my money, few periods are so replete with human interest."
This book is a collection of nine papers authored by Bernanke and previously published between 1983 and 1996 in top economic journals (American Economic Review; Journal of Political Economy; Quarterly Journal of Economics; Journal of Money, Credit, and Banking) as well as some book chapters. The compilation was published in 2004 while Bernanke was a member of the Federal Reserve Board of Governors, before he became the Chairman of the Federal Reserve. His contributions to current understanding of the causes of the Great Depression, as well as the reasons why countries recovered, are among the most valuable and path breaking. Ben Bernanke is the right person to have leading the U.S. economy during this time of financial crisis. He literally wrote the book.
A comparison of Bernanke's analysis of the Great Depression to what we are facing now gives some interesting insights. His work highlights the following three main factors that caused countries to experience such deep and prolonged declines in economic output during the 1930s, rather than the milder and shorter duration recessions with which we are more familiar. I discuss them each in turn and compare them to the environment today.
1) Contraction of the money supply
2) Sticky nominal wages
3) Failing financial institutions
1. Contraction of the money supply. The most widely accepted cause of the Great Depression--a cause that Bernanke confirms--is that monetary authorities across the globe allowed their money supplies (as measured by the currency/gold ratio) to decline in the face of a slowing economy. This would be like the Federal Reserve today raising interest rates in the face of our current economic crisis. The monetary contraction across countries was somewhat a result of the international gold standard exchange rate regime in place at the time, which put constraints on how central banks could implement monetary policy. One contribution of Bernanke's in this area is his finding that countries that left the international gold standard began to recover faster than those that remained in the system because they had greater freedom to initiate expansionary monetary policies. The likelihood today of any central bank allowing its money supply to contract in a time of crisis is almost zero. This is a lesson that has been learned and will not be repeated.
2. Sticky nominal wages. A problem during the Great Depression, as well as during the Japanese recession of the 1990s, was that the overall price level declined--a rarely seen phenomenon called deflation. However, Bernanke found that, in some countries, nominal wages fell more slowly than the overall price levels. In these countries, unemployment was higher and gross domestic product was lower. Bernanke found that the sticky nominal wages were often due to interventionist national employment policies. Although current research has shown that wages in the United States still have some degree of resistance to downward movements, this effect is probably much less pronounce than it was during the Great Depression because of the better job search and job matching mechanisms and increased labor mobility. Sticky nominal wages were one of the smaller factors exacerbating the Great Depression and would likely be even less of a problem today in the United States.
3. Failing financial institutions. This factor is the most novel contribution of Bernanke's to our understanding of what caused the Great Depression, and it is clearly the focus of most of the current government interventions that we have seen from both Congress and the Fed. Bernanke is not the only researcher to note that widespread bankruptcies of individuals and firms affected banks and the financial system in a way that led to a rapid decrease in the money supply. As noted previously, this is a commonly accepted cause of the Great Depression.
However, Bernanke found evidence that widespread failures of banks resulted in the loss of invaluable financial information that caused the price of credit to rise in an environment on incomplete markets. That is, banks reduce the cost of credit because they know their customers down the line, and they know the global financial market up the line. Widespread bank failures therefore resulted in a frozen credit market due to loss of information in the face of imperfect information. This is extremely similar to the environment we are in now. For this reason, the Fed and the Treasury have been taking steps to "bail out" many of the nations largest banks and to shore up confidence in the financial system as a whole. This is the argument against the Libertarian solution of letting big banks fail and then waiting for market forces to pick up the pieces. The Libertarian solution does not account for the time it takes for the market to reacquire the lost information after widespread bank failures.
Conclusion. Ben Bernanke is the right man to have at the Fed's helm during our current financial crisis. He knows as well as anyone the risks that might cause a severe economic downturn and what factors could most help a struggling economy to reemerge. We should not worry about another Great Depression being started by a contraction in the money supply or sticky nominal wages. However, we should be extremely afraid of widespread bank failures and bankruptcies. For this reason, I think the government's current focus on propping up the financial sector and providing aid to individuals is the right approach to minimize the length and severity of the recession.
A comparison of Bernanke's analysis of the Great Depression to what we are facing now gives some interesting insights. His work highlights the following three main factors that caused countries to experience such deep and prolonged declines in economic output during the 1930s, rather than the milder and shorter duration recessions with which we are more familiar. I discuss them each in turn and compare them to the environment today.
1) Contraction of the money supply
2) Sticky nominal wages
3) Failing financial institutions
1. Contraction of the money supply. The most widely accepted cause of the Great Depression--a cause that Bernanke confirms--is that monetary authorities across the globe allowed their money supplies (as measured by the currency/gold ratio) to decline in the face of a slowing economy. This would be like the Federal Reserve today raising interest rates in the face of our current economic crisis. The monetary contraction across countries was somewhat a result of the international gold standard exchange rate regime in place at the time, which put constraints on how central banks could implement monetary policy. One contribution of Bernanke's in this area is his finding that countries that left the international gold standard began to recover faster than those that remained in the system because they had greater freedom to initiate expansionary monetary policies. The likelihood today of any central bank allowing its money supply to contract in a time of crisis is almost zero. This is a lesson that has been learned and will not be repeated.
2. Sticky nominal wages. A problem during the Great Depression, as well as during the Japanese recession of the 1990s, was that the overall price level declined--a rarely seen phenomenon called deflation. However, Bernanke found that, in some countries, nominal wages fell more slowly than the overall price levels. In these countries, unemployment was higher and gross domestic product was lower. Bernanke found that the sticky nominal wages were often due to interventionist national employment policies. Although current research has shown that wages in the United States still have some degree of resistance to downward movements, this effect is probably much less pronounce than it was during the Great Depression because of the better job search and job matching mechanisms and increased labor mobility. Sticky nominal wages were one of the smaller factors exacerbating the Great Depression and would likely be even less of a problem today in the United States.
3. Failing financial institutions. This factor is the most novel contribution of Bernanke's to our understanding of what caused the Great Depression, and it is clearly the focus of most of the current government interventions that we have seen from both Congress and the Fed. Bernanke is not the only researcher to note that widespread bankruptcies of individuals and firms affected banks and the financial system in a way that led to a rapid decrease in the money supply. As noted previously, this is a commonly accepted cause of the Great Depression.
However, Bernanke found evidence that widespread failures of banks resulted in the loss of invaluable financial information that caused the price of credit to rise in an environment on incomplete markets. That is, banks reduce the cost of credit because they know their customers down the line, and they know the global financial market up the line. Widespread bank failures therefore resulted in a frozen credit market due to loss of information in the face of imperfect information. This is extremely similar to the environment we are in now. For this reason, the Fed and the Treasury have been taking steps to "bail out" many of the nations largest banks and to shore up confidence in the financial system as a whole. This is the argument against the Libertarian solution of letting big banks fail and then waiting for market forces to pick up the pieces. The Libertarian solution does not account for the time it takes for the market to reacquire the lost information after widespread bank failures.
Conclusion. Ben Bernanke is the right man to have at the Fed's helm during our current financial crisis. He knows as well as anyone the risks that might cause a severe economic downturn and what factors could most help a struggling economy to reemerge. We should not worry about another Great Depression being started by a contraction in the money supply or sticky nominal wages. However, we should be extremely afraid of widespread bank failures and bankruptcies. For this reason, I think the government's current focus on propping up the financial sector and providing aid to individuals is the right approach to minimize the length and severity of the recession.
