Anna Jacobson Schwartz, who died last week at 96, was the last principal of a once lively debate which, thirty years ago, she and Milton Friedman won, and, having won, refused to take “yes” for an answer. That argument between “monetarists” and “Keynesians” will now finally fade into the history of thought. As it happens, Economic Principals is on the road, covering the annual meeting of the History of Economics Society, at Brock University, in Ontario. But it seemed important to note Schwartz’s passing, if only with a few broad strokes.
Stripped to its essentials, the story is this. After a decade of boisterous growth (“the Roaring Twenties”), the US stock market crashed in October 1929. Instead of recovering relatively quickly (as it had after a sharp fall in prices in 1921), the American economy, and then the rest of the industrial world, sank slowly into a decade of severely diminished economic activity that became known as the Great Depression.
By 1936, John Maynard Keynes had transmuted a series of folk terms (“magneto trouble,” “pump priming,”) into a more technical analysis whose centerpiece was strange new term (“liquidity trap”). A new generation of young economists, committed to models and measurement as new methods of understanding the business cycle, took up the challenge and began to build an approach they soon dubbed macroeconomics.
In 1950, Miton Friedman began a critique of what had by then become “the Keynesian revolution” (to whose detailed working-out Friedman was himself contributing substantially). And in 1963, in collaboration with research assistant Schwartz, he published the landmark A Monetary History of the United States 1867-1960.
Its most important chapter, “The Great Contraction, 1929-1933,” argued that the Federal Reserve Board failed nearly completely to perform as lender of last resort after the Crash. (The chapter was republished separately in 2008 with a new preface by Schwartz and a new introduction by financial journalist Peter Bernstein.)
Hampered, Friedman and Schwartz argued, by the death of its confident leader (New York Federal Reserve Bank chief Benjamin Strong); constrained by the straitjacket of the gold standard; and crippled by fundamental misunderstanding of its powers (it had been created only in 1913); the Fed turned what might have been a normal recession into the global disaster that led to World War II, according to Friedman and Schwartz.
This much, at least, was history instead of theory. It could be carefully examined, expanded, tested, confirmed or rejected. But it was immediately obscured by lot of passionate talk among Keynesians and monetarists about the appropriate conduct of monetary policy and its importance or lack thereof in management of the economy.
That debate – does money matter? – was settled pretty completely in 1979 by Federal Reserve chairman Paul Volcker when he tightened monetary policy abruptly and endured a deep three-year recession, in which many businesses failed and unemployment rose to 10.8 percent, in order to slow inflation to a crawl. The maneuver touched off a long boom in financial-asset prices.
Meanwhile, the question of the Fed’s role in deepening and prolonging the Depression was pretty much settled in the 1980s by historians Ben Bernanke, Barry Eichengreen and A couple OF dozen other history-minded theorists. Bernanke’s key paper, “Non-monetary Effects of the Financial Crisis in the Propagation of the Great Depression,” appeared in the American Economic Review in 1983. In 2000, he collected it (and several other of his papers feathering together the growing consensus of other researchers) as Essays on the Great Depression.
The technical debate in central banking circles ended in 2002, at a ninetieth-birthday celebration for Milton Friedman at the University of Chicago. Bernanke, by then one of seven governors of the Fed, congratulated Friedman and Schwartz on having uncovered, as he put it, “the leading and most persuasive explanation of the worst economic disaster in American history.”
And then, “abusing slightly” his status as an official representative of the Federal Reserve, Bernanke addressed Friedman and Schwartz directly, where they sat in the audience, slightly dumbstruck: “I would like to say to Milton and Anna: regarding the Great Depression, You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”
And the nontechnical debate ended, probably once and for all, in October 2008, when Bernanke, by now chairman of the Fed, flooded the market with liquidity, performing exactly the sort of open market operations by which Friedman and Schwartz argued that their “Great Contraction” of credit could have been avoided in the early 1930s. Twelve of the thirteen leading institutions in the United States were at risk of failure, Bernanke later told the Financial Crisis Inquiry Commission. Had they been allowed to collapse, the result presumably would have been even worse than in the years after 1929.
A few living speakers of the now-dead language of Keynesian/monetarism remain. The decisive turn took place in the 1980s, the period when Paul Krugman, for example, was busy elsewhere, earning his future Nobel Prize with work on the economics of international trade. In hsi exchange with Schwartz last winter in The New York Review of Books can be seen the phenomenon known as the incommensurability of one view with another – with neither party speaking much to the point of current events.
It is not yet widely understood, but a great deal of intellectual capital evaporated with the financial crisis, and must be painstakingly rebuilt. The fifty-year-long argument about what got us into the Great Depression is over. A substantially new argument about recovering from financial crises has only just begun.