Monetary explanations of the Great Depression: a selective survey of empirical evidence

Seventy years after the Great Depression, economists still debate the causes of this economic catastrophe. Two leading explanations are distinguished by whether or not the Federal Reserve?s monetary policies are perceived as being chiefly responsible for propagating and magnifying the initial contraction into a depression. ; This article surveys recent modeling efforts and empirical work that examine aggregate explanations for the Great Depression from both the extensive literature using vector autoregression techniques and the more recent literature using dynamic stochastic general equilibrium modeling. Neither of these approaches has yielded a consensus about the causes of the depression. ; Data alone are insufficient to distinguish the precise role of monetary policy during that period. The modeling strategies impose restrictions that help isolate the meaningful economic interactions in the data. In each literature, the ways in which the respective models identify monetary policy can differ substantially, and these differences are why monetary policy shocks may or may not explain much of the output contraction. Also, these modeling approaches vary in their ability to capture important institutional features of the banking and financial system. ; The authors believe that the search for one conclusive empirical study of the Great Depression is futile. The most promising path for future research models, they conclude, will entail a sharper focus on the financial sector, a refined specification of how monetary policy affects the real economy, and further methods to incorporate elements of labor market frictions.