The book is a sequel to Parker’s Reflections on the Great Depression, in which he interviewed a number of the prominent economists who lived through the U.S. Great Depression of 1929-39. In the new book, Parker talked with some of us who tried to go back and make sense of the episode a half-century later. The book includes interviews with luminaries such as Ben Bernanke, Robert E. Lucas, Jr., and Allan Meltzer.
Here’s a brief snippet of my discussion with Randy:
PARKER: Are Kitson’s assumptions pertaining to the gold standard also correct? He goes through four different things about what is needed for the gold standard to function. First of all, the gold standard assumes the law of one price. Second, it assumes that the demand for money is stable. Third, it assumes that the monetary authorities do not intervene to prevent increased gold reserves adding to the money supply. And fourth, it assumes that the burden of adjustment will be borne by prices and not by quantities. This is the pre-Keynesian assumption that the economy tends toward full employment– an assumption that is so obviously inappropriate to the interwar period. Are these really limiting assumptions of how the gold standard functions?
HAMILTON: Well, let me say I think he’s leaving out what I regard as one of the key issues of this time, and that is a gold standard means that the price of gold, in terms of dollars, is fixed. Therefore, if the price of gold in terms of potatoes goes up, the price of potatoes in terms of dollars must go down. An increase in the relative price of gold must mean deflation in the overall price level. That’s just an accounting identity and it says as long as you’re on the gold standard, if you have explained why the relative price of gold went up, you have explained why the overall price level fell. Now, a lot of people talk about deflation in the Depression just in its own right, just looking at the overall price level and implicitly they are assuming that what goes on with gold is some kind of residual, that there is no demand and supply for this commodity and the relative price could be any old thing. I don’t think that’s the right way to view it economically, I think there is a demand and supply of gold. Now, it’s fundamentally coming in part from the monetary system, the international payments mechanism, and a lot of that demand is in fact from central banks wanting to hold gold for purposes of reserves. So, I would, I guess, amplify Kitson’s remarks to say I think why that mattered was that there was an increase in the demand for gold coming from the financial instability, that there was an increase in the relative price of gold. I take that as a fundamental.
PARKER: This is from your 1988 Contemporary Policy Issues paper when you talk about hoarding on the part of the public.
HAMILTON: Yes. So I would add to these assumptions that there’s an implicit view that the relative price of gold isn’t going to move very much, that it is basically limited by the supply of mining and so the relative price doesn’t change. If the relative price of gold is kind of volatile and wild, it’s a terrible system to use because then you’re imposing all of this same volatility and wildness on the aggregate price level and we pretty clearly don’t want that. So I would say that’s an important thing he’s left out. All the other aspects he discusses, the maldistribution of gold and problems with cooperation, all of that I would translate into the factors that were causing the relative price of gold to go up and therefore any country that was sticking to the gold standard to experience a severe deflation.
Or perhaps you’re also interested in what Fed Chair Ben Bernanke had to say on this topic:
PARKER: If I may, I’ll break the depression down into several different questions. What started it? Why was it so deep? Why did it last so long? Why did it spread so completely? Why did recovery come when it did? Is there any one of those segregating questions that you think remains a mystery today?
BERNANKE: I don’t think of any of them as a complete mystery. I think we have ideas about all of them. I think we still may be missing some complete explanations in terms of the quantitative magnitudes. For example, there’s a good monetary story that explains why the initial downturn occurred and secondly why the decline in the early 1930s was severe. We are only beginning to get a sense of what we would need to understand and see why these effects were as large as they were quantitatively in an economy that was presumably more flexible than the one we have today. With respect to the recovery, the gold standard had a lot to say about that. We know from Eichengreen and Sachs (1985) that leaving the gold standard was very strongly correlated with the recovery process. But once again, there is quite a bit of variation across countries in the speed of recovery. We need to better understand why, once the monetary contractionary forces were removed, the recovery was not more powerful than it was. In the case of the United States some scholars like Cole and Ohanian (2004) and others have argued that the National Industrial Recovery Act, which reduced the flexibility of wages and prices, was a significant contributor.
The Fed Chair seems to be a bit more articulate speaking extemporaneously than I am– big surprise there. By the way, if you’re curious to hear more about the research Bernanke mentioned in that passage, Barry Eichengreen and Lee Ohanian are also among those interviewed in this new book. Thanks much to Randy for putting this all together.
Update: Arnold Kling has some further remarks about the book.