The Banking Crisis
and the Labor Market
The initial determinant of the labor-market disequilibrium that produced the unprecedented unemployment of the Great Depression was the high‐ wage, underconsumptionist policy followed by the Hoover administration, which manifested itself in jawboning and tariff increases that kept wages remarkably high into 1931. Yet money wages did finally begin to fall considerably, and by 1931 Hoover and his policy were increasingly viewed with disdain. To the extent that high wages were maintained by "moral suasion," that tactic was increasingly ineffective as the Depression worsened. Despite the inability to maintain wages after 1931, the fall in money wages was inadequate to return the system to equilibrium, and unemployment continued to increase. Why?
Milton Friedman and Anna Schwartz have effectively argued that the Depression largely reflected the effects of the sharp decline in the stock of money after the fall of 1929 and, in particular, after late 1930. 1 The statistical evidence is strongly consistent with the view that the economic decline was closely correlated with a decrease in the stock of the medium of exchange. 2 For example, a very simple regression relating the magnitude of money (M2) to the quarterly unemployment rate from the fourth quarter of 1929 to the first quarter of 1933 is extremely robust, with a R2 of .951; the relationship is also statistically significant at the 1 percent level.
We believe that the Friedman and Schwartz story is important and indeed helps in understanding the Great Depression. Yet we would stress that the