Late 19th Century and Early 20th Century United States Business Cycles and Monetary Policy

Patrick T. Newman

Advisor: Lawrence H White, PhD, Department of Economics

Committee Members: Peter J. Boettke, Christopher J. Coyne

Buchanan Hall, #D180
May 11, 2016, 02:00 PM to 11:00 AM


My dissertation deals with late 19th and early 20th century United States monetary and macroeconomic history. The three chapters are on the Depression of 1873-1879, the Depression of 1920-1921, and the Federal Reserve’s monetary policy in the 1920s. All three place a unique economic perspective on the various historical episodes and seek to engage the contemporary literature in innovative ways. In particular, the first two utilize Austrian Business Cycle Theory (ABCT) and argues that these depressions were the result of unsustainable booms. They also argue that the depressions ended due to a market based natural recovery and were aided, and not inhibited by, the prevailing laissez faire policies of the time. The third investigates a hotly debated topic among monetary historians about whether Federal Reserve monetary policy in the 1920s was expansionary or contractionary, an issue that has relevance for understanding the Great Depression. I argue that the Federal Reserve did in fact engage in expansionary monetary policy, although I leave for future research the particular business cycle implications of this. 

The first chapter deals with the period 1867-1879 in American economic history from an “Austrian” perspective. The post-Civil War boom, the Panic of 1873, and the subsequent Depression of 1873-1879 are investigated in light of ABCT and its structure of production framework. It shows how recent Civil War legislation allowed for monetary inflation and a boom to develop in the 1870s that inevitably turned into a bust. However, since the federal government pursued a policy of relative laissez faire, the economy successfully recovered. Consequently, there was no prolonged depression in the 1870s, despite it being known as the longest period of economic contraction in modern United States history which surpassed of even the Great Contraction (1929-1933). Contemporaries overstated the severity and length of the depression because they relied on nominal rather than real series, and confused nominal price declines for declines in real output. In addition, they also engaged in poor data collection, which provided very incorrect information and made them overstate the severity of the decline in economic activity (such as in unemployment figures). 

The second chapter examines the American post-World War 1 boom and bust. It argues that the Federal Reserve’s monetary easing from 1919 to 1920 created an ABC and the collapse of the boom initiated the Depression of 1920-1921. The Depression, while relatively unknown, is noted for being unusually severe but also relatively brief. The specific causes and consequences of the Depression, as well as its relationship to the effectiveness of traditional countercyclical policies, have come under increased scrutiny since the 2008 financial crisis. In particular, while many have argued that the depression ended quickly due to the prevailing fiscal and monetary contraction, many have countered that the depression was an unusual idiosyncratic episode that does not have much applicability to other downturns and recovery was in fact due to the Federal Reserve’s monetary easing from 1921-1922.  The subsequent laissez faire policy promoted a swift recovery which began following a severe liquidation of firms, reallocation of resources, and wage cuts stimulated by fiscal and monetary contraction. Contrary to some other accounts, significant recovery began before the Federal Reserve’s 1921-1922 monetary easing affected the economy. 

            The third chapter analyzes the two main divergent interpretations of Federal Reserve monetary policy in the 1920s, the expansionary view described by the Rothbard and the earlier “Austrian” writers, and the contractionary view most notably held by Friedman and Schwartz and later monetary historians. It argues in line with the former that the Federal Reserve engaged in expansionary monetary policy during the 1920s, as opposed to the gold sterilization view of the latter. The main rationale for this argument is that the increase in the money supply was driven by the increase in the money multiplier and total bank reserves, both of which were caused primarily by Fed policy (i.e., a decrease in reserve requirements and an increase in controlled reserves, respectively). Showing that this expansion did in fact occur provides the first step in supporting an ABCT interpretation of the 1920s, namely that the Federal Reserve created a credit fueled boom that led to the Great Depression, although this is not pursued in the chapter.