Clashing Over Commerce: A History of US Trade Policy (Markets and Governments in Economic History)

by Douglas A. Irwin

Because the Depression followed so closely on the heels of the tariff increase, many people at the time believed that the Hawley-Smoot tariff was responsible for the economic disaster. However, as in the case of previous downturns, the consensus among economic historians is that monetary and financial factors were the dominant cause of the Great Depression. Friedman and Schwartz (1963) contend that a banking panic in October 1930 led to a large, unanticipated fall in the money supply that turned what had been a fairly normal recession into the Great Depression. The panic led the public to withdraw currency from the banking system because there was no deposit insurance; if a bank failed, depositors would lose all of their money. The loss of deposits forced banks to curtail lending, which reduced investment spending, and contributed to the decline in the money supply, which led to deflation and reinforced all these problems. With deflation, real interest rates soared, and investment collapsed. Falling prices also increased the real burden of debt, making it harder for borrowers to repay banks, which in turn increased the fragility of the financial system. Many economists blame the Federal Reserve for not taking more aggressive action to stop the bank failures and the decline in the money supply, actions that could have prevented the Depression.68