The Gold Standard, Deflation, and
Financial Crisis in the Great Depression:
An International Comparison
WITH HAROLD JAMES
Recent research on the causes of the Great Depression has laid much of the blame for that catastrophe on the doorstep of the international gold standard. In his new book, Temin (1989) argues that structural flaws of the interwar gold standard, in conjunction with policy responses dictated by the gold standard’s “rules of the game,” made an international monetary contraction and deflation almost inevitable. Eichengreen and Sachs (1985) have presented evidence that countries which abandoned the gold standard and the associated contractionary monetary policies recovered from the Depression more quickly than countries that remained on gold. Research by Hamilton (1987, 1988) supports the propositions that contractionary monetary policies in France and the United States initiated the Great Slide, and that the defense of gold standard parities added to the deflationary pressure.1
The gold standard-based explanation of the Depression (which we will elaborate in section 2) is in most respects compelling. The length and depth of the deflation during the late 1920s and early 1930s strongly suggest a monetary origin, and the close correspondence (across both space and time) between deflation and nations’ adherence to the gold standard shows the power of that system to transmit contractionary monetary shocks. There is also a high correlation in the data between deflation (falling prices) and
Reprinted with permission from R. Glenn Hubbard, ed., Financial Markets and Financial
Crises, (Chicago: University of Chicago Press, 1991). Copyright © 1991 by the National Bu-
reau of Economic Research. All rights reserved.
The authors thank David Fernandez, Mark Griffiths, and Holger Wolf for invaluable research
assistance. Support was provided by the National Bureau of Economic Research and the Na-
tional Science Foundation.
1 The original diagnosis of the Depression as a monetary phenomenon was of course made in
Friedman and Schwartz (1963). We find the more recent work, though focusing to a greater
degree on international aspects of the problem, to be essentially complementary to the Fried-