July 24, 2025
Various theories exist to explain
the root cause of the Great Depression, which began in October 1929 and lasted
for nearly a decade. The theories exhibit commonalties in factors, but also
vary significantly, and consensus on a specific set of causal factors by
historical and contemporary economists has been largely nonexistent.[1] However, various analysis and interpretations have
coalesced around a set of competing theories, all of which point to the U.S
Federal Government’s failure to adequately respond during this period of
economic crisis through rapid changes to liquidity, tax rates, and interest
rates.[2]
Broadly Accepted Economic Theories behind the Great
Depression
Various economic
theories are widely accepted as casual factors leading to the Great Depression and
its sustained negative impact on economic conditions.[3] The leading theories are the: (1), Common Theory; (2),
Austrian School Theory, (3) Monetarist Theory; and (4), Keynesian
Theory. The Common Theory focuses on the government’s responsibility to
manage and enact fiscal policy that stabilizes the supply and demand of money
over the long term, and their failure to do so effectively.[4] Austrian School Theory suggests that lax credit
policies by the Federal Reserve contributed to a unsustainable credit boom in
the 1920’s, which created a bubble that had to self-correct.[5] Monetarist Theory ascribes responsibility to the
Federal Reserve to manage the economy effectively, and points to the Federal
Reserve as the failure leading to the Great Depression.[6] Finally, Keynesian Theory that posits government
responsibility to keep employment high, while cutting taxes or increasing
government spending to stimulate the economy.[7] This blog examines the Monetarist Theory as one of
the major theoretical causes of the Great Depression. Primary source and secondary
source websites and scholarly articles were used to identify and analyze
theoretical causes of the Great Depression and the factors that ended this
steep economic downturn. From these sources, quantitative data sets of key
economic indicators were analyzed, and a qualitative analysis the of
contributing factors was conducted.
The Monetarist
Theory
The Monetarist Theory places the blames for the great depression squarely on both banks and the U.S. Federal Reserve for their failure to enact immediate measures to shield the economy during the Great Depression. During the Great Depression, the real Gross Domestic Product (GDP) per capita decreased precipitously between 1929 and 1933 falling ~30%, unemployment rose sharply from ~3% to >25%, and the Consumer Price Index (CPI) dropped by ~25% with deflation exceeding 10% in 1932. Figure 1 depicts unemployment and CPI during this period.
This theory widely contends that the Federal Reserve response was far too slow in responding to market conditions, and that the Federal Reserve failed to take rapid measures to lower interest rates, increase the monetary supply, or inject liquidity into the banking system to mitigate the risk of failures.[8] The net result of this inaction was a delay that enabled the stock market to experience a precipitous overnight decline of 25% from October 28-29, 1929, which caused investors to panic and sell off assets, and further enabled what otherwise may have been a strong recession to cascade into the Great Depression.[9] Figure 2 depicts the sharp drop in the Dow Jones Industrial Average during this time.
Money Supply
The monetarist theory is largely credited to economist
Milton Friedman. In 1963, Friedman coauthored A Monetary History of the
United States, 1867-1960 (1963) with economist Anna Schwartz.[10] In this critically acclaimed work, Friedman and
Schwartz asserted that the Federal Reserve’s erroneous monetary policy served
as the catalyst of the Great Depression.[11] Advancing the theory that the Federal Reserve
implemented incorrect fixes that caused the markets to act unpredictably,
Friedman and Schwartz believed the Federal Reserve should have implemented
monetary policy to address the market forces applying downward pressure on the
money supply in order to effectively address the economic problems.[12]
Monetarists further insist that the Federal Reserve’s
failure to effectively regulate the supply of money during the catastrophe exacerbated
both the duration and the severity of the Great Depression. [13] To illustrate this concept, monetarist’s imply that
had the Federal Reserve lowered interest rates, this would have effectively
increased the supply of money, which would have possibly mitigated the negative
impact of the stock market decline and subsequent bank failures.[14] In contrast, the banks fearing another run on
deposits and subpar loans, only offered loans for safe investments, and the
Federal Reserve, in 1936, instead raised interest rates in fear of inflation,
which further served to tighten the money supply.[15]
Failure of the Federal Reserve to Take Effective
Actions
The leadup to the Great Depression started in August
1929 with a recession that was bad, but not catastrophic.[16] However, by the fall of 1930 banks began failing at
an alarming rate with 256 banks failing in November 1930, and 352 in December
alone.[17] The failure of banks and the Federal Reserves to
implement measures to stem the problem was twofold: (1), Benjamin Strong,
president of the New York Fed, died on October 1928, leaving a knowledge gap
that could not be overcome; and (2), banks did not have the authority to limit
withdrawals and prevent the cascading failures that were occurring due to
panicked account holders.[18]
The End of the Great
Depression
Gaining
consensus among economists on the factors that resulted in the end of the Great
Depression has been equally difficult due to the lack of sufficient scholarly
study.[19] Two intertwined but dissimilar factors are frequently
attributed to ending the depression. The first is the influx of gold from
Europe resulting from political implications in conjunction with President
Roosevelt’s gold reevaluation policies, which resulted in a dramatic growth in
money availability that eased the effects of the Great Depression by lowering
interest rates and spurring investments.[20] The second factor often attributed was the
industrialization of the economy due to the war footing of World War II.[21] What is not clear is if there is a specific
attribution to either of these events, or if they served as an element of a
larger set of factors that contributed to ending the Great Depression. Limited research reflects that monetary policy, not fiscal
policy, and the reevaluation of gold by Roosevelt, largely, but not
definitively ended the depression.[22]
Conclusion
Monetarists view
the Federal Reserve’s failures as factors that contributed to the Stock Market
Crash of 1929 that effectively wiped-out wealth overnight and caused a
significant decline in confidence, which further led to a significant reduction
in investment and spending.[23] And with the failure of thousands of banks in a very
short period, credit availability and money supply were further negatively
impacted, which the Federal Reserve could have mitigated by infusing money into
the banks to increase liquidity and reduce the risk of failures.[24] From this perspective, the failure of the Federal
Reserve is a legitimate argument, but the factors leading to the failure merit
further discussion as it was not simply a case of malfeasant behavior. Research
on the factors leading to the end of the Great Depression is limited in
contrast to the amount of research conducted on the leading causes of the Great
Depression. What exists is contradictory assessments indicating World War II ended
the Great Depression, or that that fiscal policy did not end the Great
Depression, rather it was monetary policy and Roosevelt’s reevaluation of gold that
ended the depression.
[1], Michael A Bernstein, “The Great
Depression as Historical Problem,” OAH Magazine of History 16, no. 1 (2001):
3-10. https://www.jstor.org/stable/25163480.
[2] Tim Vipond, “The Great Depression: Overview and economic explanations,” Resources at the Corporate Finance Institute, accessed July 21, 2025, https://corporatefinanceinstitute.com/resources/economics/the-great-depression/#.
[3] Vipond, “The Great Depression.”
[4] Vipond, “The Great Depression.”
[5] Fred E. Foldvary, “The Austrian
Theory of the Business Cycle,” The American Journal of Economics and Sociology
74, No. 2 (2015): 293, https://www.jstor.org/stable/43818666.
[6] Vipond, “The Great Depression.”
[8] Vipond, “The Great Depression.”
[9] Vipond, “The Great Depression.”
[10] Sarwat Jahan and Chris
Papageorgiou, “What Is Monetarism?” Finance & Development 51, no. 1
(2014): 38-39, https://www.imf.org/external/pubs/ft/fandd/2014/03/basics.htm.
[11] Jahan and Papageorgiou, “What Is
Monetarism,” 38-39.
[12] Jahan and Papageorgiou, “What Is
Monetarism,” 38-39.
[13] Jean Caldwell and Timothy G.
O’Driscoll, “What Caused the Great Depression?” Social Education 71, no.
2 (2007): 70–74,
https://www.socialstudies.org/system/files/publications/articles/se_710270.pdf.
[15] Caldwell and O’Driscoll, “What
Caused the Great Depression?” 70-74.
[16] Thomas S. Coleman, “Milton
Friedman, Anna Schwartz, and A Monetary History of the US,” History of Chicago
Economics at The University of Chicago, May 14 2020,
https://harris.uchicago.edu/research-impact/centers-institutes/center-economic-policy/history-chicago-economics.
[17] Coleman, “Milton Friedman, Anna
Schwartz.”
[18] Coleman, “Milton Friedman, Anna
Schwartz.”
[19] Christina D. Romer, “What Ended
the Great Depression?” The Journal of Economic History 52, no. 4 (1992):
757, http://www.jstor.org/stable/2123226.
[20] Romer, “What Ended,” 781.
[21] Gary Richardson, “The Great
Depression,” Federal Reserve History, November 22, 2013,
https://www.federalreservehistory.org/essays/great-depression.
[22] Romer, “What Ended,” 781.
[23] Coleman, “Milton Friedman, Anna Schwartz.”
[24] Coleman, “Milton Friedman, Anna Schwartz.”
References
Bernstein, Michael A. “The Great Depression as
Historical Problem.” OAH Magazine of History 16, no. 1 (2001): 3-10. https://www.jstor.org/stable/25163480.
Caldwell, Jean and Timothy G. O’Driscoll. “What Caused the Great Depression?” Social Education 71, no. 2 (2007): 70–74. https://www.socialstudies.org/system/files/publications/articles/se_710270.
pdf.
Foldvary,
Fred E. “The Austrian Theory of the Business Cycle.” The American Journal of
Economics and Sociology 74, No. 2 (2015): 293.
https://www.jstor.org/stable/43818666.
Jahan, Sarwat and Chris Papageorgiou. “What Is Monetarism?” Finance & Development 51, no. 1 (2014): 38-39. https://www.imf.org/external/pubs/ft/fandd/2014/03/basics.htm.
Romer, Christina D. “What Ended the Great Depression?” The Journal of Economic History 52, no. 4 (1992): 757–84. http://www.jstor.org/stable/2123226.
Vipond, Tim. “The Great Depression: Overview and economic explanations.” Resources at the Corporate Finance Institute, accessed July 21, 2025. https://corporatefinanceinstitute.com/resources/economics/the-great-depression/#.
