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The Great Depression and the Friedman-Schwartz Hypothesis

106 Pages Posted: 29 Jul 2004  

Lawrence J. Christiano

Northwestern University; Federal Reserve Bank of Cleveland; Federal Reserve Bank of Chicago; Federal Reserve Bank of Minneapolis; National Bureau of Economic Research (NBER)

Roberto Motto

European Central Bank (ECB)

Massimo Rostagno

European Central Bank (ECB)

Multiple version iconThere are 3 versions of this paper

Date Written: March 2004

Abstract

We evaluate the Friedman-Schwartz hypothesis that a more accommodative monetary policy could have greatly reduced the severity of the Great Depression. To do this, we first estimate a dynamic, general equilibrium model using data from the 1920s and 1930s. Although the model includes eight shocks, the story it tells about the Great Depression turns out to be a simple and familiar one. The contraction phase was primarily a consequence of a shock that induced a shift away from privately intermediated liabilities, such as demand deposits and liabilities that resemble equity, and towards currency. The slowness of the recovery from the Depression was due to a shock that increased the market power of workers. We identify a monetary base rule which responds only to the money demand shocks in the model. We solve the model with this counterfactual monetary policy rule. We then simulate the dynamic response of this model to all the estimated shocks. Based on the model analysis, we conclude that if the counterfactual policy rule had been in place in the 1930s, the Great Depression would have been relatively mild.

Keywords: general equilibrium, lower bound, deflation, shocks

JEL Classification: E31, E40, E51, E52, E58, N12

Suggested Citation

Christiano, Lawrence J. and Motto, Roberto and Rostagno, Massimo, The Great Depression and the Friedman-Schwartz Hypothesis (March 2004). ECB Working Paper No. 326. Available at SSRN: https://ssrn.com/abstract=526989

Lawrence J. Christiano (Contact Author)

Northwestern University ( email )

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Federal Reserve Bank of Cleveland

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Federal Reserve Bank of Chicago

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Federal Reserve Bank of Minneapolis

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National Bureau of Economic Research (NBER)

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Roberto Motto

European Central Bank (ECB) ( email )

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Massimo Rostagno

European Central Bank (ECB) ( email )

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Germany
+49 69 1344 7663 (Phone)
+49 69 1344 7604 (Fax)

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