Home > depression > How can we resolve the apparent conflict in Friedman’s views?

How can we resolve the apparent conflict in Friedman’s views?

from Asad Zaman

Friedman & Scwhartz famously blame the contraction in the money supply for the Great Depression of 1929. However, their own data shows that money supply, prices and wages all fell by about 30% over the four year period following the Great Depression. So according to the quantity theory, there should have been no real effect from this contraction.

My question is the following: How can we resolve the apparent conflict in Friedman’s views, who both holds the Fed responsible for not preventing the Great Depression, and who also argues that the quantity theory is valid?
  1. November 24, 2014 at 6:13 pm

    Rel GDP fell also. So, velocity of money fell because demand of money rose more than Suply.

  2. November 24, 2014 at 6:16 pm

    Velocity = black box

  3. Jeff Z
    November 25, 2014 at 5:55 am

    Or the answer is simpler: You can’t. Maybe it is a contradiction that really exists and is not resolvable.

    Or maybe it is resolvable only by rejecting the quantity theroy because it has been tested against evidence and found to be false. But Friedman and Schwartz can’t give it up for other reasons.

  4. November 25, 2014 at 12:54 pm

    Thanks for both responses — I think Miguel is right in that Friedman does use changes in velocity to explain the conflict, and also that any kind of relationship between money and gnp can be explained if velocity is a black box which can be used to adjust the explanation. Jeff is also right that the whole point of Friedman’s explanation is to put the blame on the government, and take it away from free markets — to achieve this purpose all sorts of logical contortions are permissible.

    This was not an idle question — rather it seems to me that it is trivially easy to reject to quantity theory on the basis of ample data, and I am writing up something to this effect, which I will post soon.

  5. November 25, 2014 at 5:18 pm

    I’m expecting it. I’m obsessed with the question.

  6. November 25, 2014 at 5:24 pm

    Velocity = NGDP/M + Transactions not included in NGDP (= transactions without AV)

  7. November 25, 2014 at 8:18 pm

    Velocity = NGDP/M + Transactions not included (= Transactions without VA)/M

  8. Macrocompassion
    November 26, 2014 at 7:41 am

    The great depression was not caused by a shortage of money nor had it anything to directly do with it. The changes in the wages and in the money supply etc were the results not the causes of this economic crisis. Nor can we blame this money lack on our more recent economic crisis. At both times money could be borrowed and loans from banks were possible, even when interest rates were low, because during these hard times the banks still need to earn money by collecting the interest on the loan. People did not borrow because it was not worth their while to do so.

    The cause of the crises is associated with the whole system acting together, where a critical part of it affects the rest. When the natural resources become so expensive that access to them is denied, less economic activity takes place and the system slows down. This was and is the cause of our current lack of progress.

    A wise government whose treasury understands what is really happening should lead, by making the restriction and lack of opportunity for access to the land a past thing. This lack is due to speculation in the natural resources (particularly the land) when they are not used due to their unreasonable price or hire cost. These resources should be made less costly for access and use. This can be achieved by stopping speculation in their values by confining their potential and actual rent as a tax on land values. This would cause the value of land (and its tax) to fall so there would be greater opportunities because then the rest of the taxation would no longer be necessary. It would also make it much harder to avoid paying the tax, since land ownership cannot be hidden.

  9. David Chester
    November 26, 2014 at 12:40 pm

    This is a good question! The answer is that all of them are related and the cause of the great depression was due to something else.

    Consider a macroeconomics system which is roughly in equilibrium. Suppose the price of oil (say) increases. This will make the cost of producing many kinds of goods more expensive and so the consumer goods will be more expensive for the consumer too. Whilst some of this cost is covered by the consumer taking out more savings, in general there will be a reduction in demand for such goods and so less of them will be needed. This reduction in production results in less employment, and fewer jobs and this creates more poverty and a economic depression, if not worse.

    Thus our social system is temporally unstable. However the oil producers who are having less business due to the lower demand for their oil will be competing. Since one of them does not hold a monopoly, the competition for selling oil will result in the oil prices becoming lower after some time, and then the whole system tries to go back to its previous condition. Thus the effect of competition for the produce (oil) has a stablizing effect.

    Although this important effect works for many kinds of produce and is the reason for both some price changes and the tendency for many of them to stay the same, there is one kind of saleable item for which this principle does not apply because it is a kind of “goods” which can be hoarded without it going bad, and not being used until its price rises. This is the value of landed sites.

    Speculators in these sites will buy them and hold them out of use whilst the surrounding region become more developed and expensive. This lack of suitable space and the competition for renting it has the result of making all the production more costly, demand drops and unemployment becomes worse. There is no competition for selling this land because the banks and other money suppliers to the speculators can manage (very well) on the interest, without getting back the principle for many years. This situation goes on until the rising site costs finally become so high that mortrgages begin to be no longer affordable and with the stopping of the buiklding industry the bubble bursts.

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