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Posted on 8 April 2011 | 7,702 views

Dollars Purchasing Power After the 1929 Crash

The purchasing power of the US Dollar after the Great Depression, forwarded most notably by economists Milton Friedman and Anna Schwartz, involves the quantity theory of money. According to this theory, most of the depression’s severity was caused by poor decision-making at the Federal Reserve.

For the first four years of the Depression, the Federal Reserve Board (Federal Reserve System created in 1913 under Woodrow Wilson) contracted the money supply at a time when Friedman says they should have been expanding it. Friedman and Schwartz write: “From the cyclical peak in August 1929 to a cyclical trough in March 1933, the stock of money fell by over a third.”

The result was what Friedman calls the “Great Contraction” — a period of falling income, prices, and employment caused by the choking effects of a restricted money supply. A corollary of this theory rejects the gold standard theory of the depression. It is a notable development because it implies that the depression’s severity was caused by the Federal Reserve’s mismanagement of the economy, not the absence of management. This theory is popular among the monetarist school of economics. Many give credence to Friedman’s theory because the theory has robustly explained subsequent U.S. recessions and inflation.

The contraction in money supply is a factor in most theories of the “Great Depression“, and it is another way of saying that there was a tremendous fall in aggregate demand. From the perspective of monetarist explanations for the Depression, the depth of the financial collapse could have been averted by monetary policy, rather than requiring what eventually did happen, namely the use of regulations and fiscal policy to stabilize the economic activity in the U.S. and other nations. According to the monetarist formulation, the root cause of the global downturn was the failure to reestablish the gold standard at a level higher than the pre-war level, in order to account for inflation. This view was held by many observers at the time, even those who supported a return to the gold standard.

The debate over this theory centers on whether easing of monetary policy would have actually corrected structural imbalances in the economy, or whether it would have simply led to a secondary bubble which would have collapsed later, after increasing the U.S. deficit and depleting U.S. gold stocks. To monetarists, there were no structural imbalances to cure, the problem was strictly an ordinary downturn extended into a deeper one through poor monetary policy.

The rate of decline in the purchasing power of the dollar today would buy one less than a nickel’s worth of goods and services in Woodrow Wilson’s time and according to a recent article posted on the website of the American Institute of Economic Research, the purchasing power of a U.S. dollar declined from $1.00 in 1913 to 4.6 cents in 2009.

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