Bayesian Investor Blog

Richard Timberlake’s article in the June 2006 issue of Liberty makes some arguments about the causes of the Great Depression that are tempting to believe but at best only partly convincing.
Much of the article is about the Fed becoming dominated by followers of the real bill doctrine. While he presents evidence that leaders of the Fed liked the doctrine, and I can imagine that following that doctrine could explain much of the 1930-1932 contraction. But if the Fed was fully following that doctrine and that were the primary cause of the contraction, the narrow measures of the money supply (which are the ones most directly under the Fed’s control) would have contracted, when they actually expanded during 1930-1932. So I doubt that the Fed was as influenced by the doctrine as Timberlake suggests. But as a factor contributing to the Fed’s caution about expanding the money supply further, it’s fairly plausible, and causes me to be a bit more skeptical of the Fed’s competence than I was before.
The more interesting part of the article is the attempt to deny that the gold standard did anything to cause the contraction. Timberlake notes that the Fed’s gold reserves remained well above the legally required minimum, and claims that shows the Fed wasn’t constrained from expanding the money supply by risks to the gold standard. But that’s true only if the legally required reserves were either sufficient to cover all potential claims or to convince holders of paper dollars that all likely claims would be satisfied. I’m not aware of any clear reason to think this was the case, and it’s easy to imagine that the Fed knew more than Timberlake does about how eager holders of paper dollars would have been to demand gold if the Fed’s gold reserves had dropped further. So I’m still inclined to think that the Fed’s restraint in late 1931 and 1932 resulted from a somewhat plausible belief that it couldn’t do more without taking excessive risk that the gold standard would fail and that we would be stuck with the kind of inflation-prone system that we ended up with anyway.