Per contra James Ahiakpor, I think it is transparently obvious that the Fed failed in its classical duty to be a proper lender of last resort during the Great Depression. Just because it accommodated the public’s increased preference for cash rather than bank deposits does not gainsay this.

What happened is that in order to meet the public’s demand for cash, the banks were forced to borrow from the Fed. And because the Fed did so little to relieve the banks of their consequential indebtedness, many of them closed and the survivors’ repugnance to debt led them to contract their own lending. The result was a one-third decline in the community’s total means of payment - defined sensibly as cash plus bank deposits subject to transfer by cheque to make payments every bit as effectively as if they were using notes and coin [and properly excluding bank reserves not in circulation from a sensible definition of money].

Is James seriously suggesting that if the public had $2bn more cash but $4bn less in the banks, they would feel they had just as much money as before? That they would feel the Fed was doing its job properly? And that they would not be inclined – or forced – to reduce their spending? And that if the banks remained heavily in debt they too would continue to lend as before to maintain the community’s circular flow of income?

Even Mill (Principles, 3, XI, para 2) agreed that the maintenance of a flow of “credit” – by which he meant “money substitutes” in the form of bank deposits that were means of payment – was indispensible in “making a corresponding addition to the aggregate production of the community”.

On this criterion, the Fed was grossly delinquent. As Lauchlin Currie wrote in The Supply and Control of Money in the United States (Harvard 1934: 146-47):
    “Much of the current belief in the powerlessness of the reserve banks appears to arise from a complete misreading of the monetary history of 1929-32. It is generally held that the reserve administration strove energetically to bring about expansion throughout the depression but that contraction continued despite its efforts. Actually the reserve administration’s policy was one of almost complete passivity and quiescence.” [Cited in David Laidler, Fabricating the Keynesian Revolution, 1999: 236]

But James asks: “So wherein lies the validity of the claim that the Fed failed to act as a lender of last resort?”

The answer: Only by defining and monitoring money in the narrow sense of currency – and also by treating non-circulating bank reserves as money. And also, I would add, by treating interest-bearing time (savings) deposits as though they have the same economic effect on the circular flow as non-interest-bearing demand (transactions) deposits held for differing motives, hence differing turnovers.

With a one-third drop in the money supply, prices also fell drastically. And faster than did money wages. So real wages of those in employment rose. Ah, so it was the workers who were to blame for the Depression??

As a postscript, one of those who thought this way was Harvard's Joseph Schumpeter. Lauchlin Currie (who was Schumpeter's teaching assistant) told me that JAS's sole anti-depression policy prescription was to favour wage cuts - for Harvard's tea ladies, not for the faculty whose real incomes therefore rose. This accorded, said Currie acerbically, with his belief that "a gentleman cannot live on less than $50,000 a year."

- Roger Sandilands
--------------------------
James Ahiakor wrote:
   I tried very much to avoid getting into this discussion, but I couldn't resist because of Tom Humphrey's latest contribution.  He employs our modern (Keynesian) definition of money and "money stock" to interpret Henry Thornton's monetary analysis along the lines of Milton Friedman.  It is misleading.  He argues:

So I guess Thornton did indeed anticipate bank failure and money stock contraction resulting from the Fed’s failure to act as a lender of last resort in the Great Depression of the 1930s.

Thornton (1802, 90), along with the other classics, including David Hume, Adam Smith, and David Ricardo, defined money as specie and banknotes as money substitutes or "paper credit."   The notion of "the money stock," be it M1 or M2, is not to be found in their works.  M1 and M2 include the public's "savings," be they the regular savings deposits or checkable deposits.  The Fed did expand its liabilities (notes) by about 25%, from $4 billion to $5 billion between 1930 and 1933 (Irving Fisher 1935); Friedman and Anna Schwartz (1963, 24-29) also report that currency in circulation rose from $3.78 billion in January 1930 to $5.57 billion by March 1933.   So wherein lies the validity of the claim that the Fed failed to act as a lender of last resort during the Great Depression?   From where did the money, properly so called, arise for the public to hold its additional quantity?  Perhaps, it is noteworthy that Friedman (1960, 88-89) also acknowledges that "Under present circumstances, even the stock of money is not directly controlled by the [Federal Reserve] System.  The System controls directly its own earning assets."

As for the wage-price spiral argument, it belongs firmly with Keynes and his followers, just as Richard Lipsey has noted.  It is all in Keynes's tradition of rejecting the classical quantity theory of money as the explanation of the price level and its changes.  In the classical analysis, an increase in nominal wage rates does not by itself raise the price level.  That would rather put pressure on profits.  Thus, following David Ricardo's explanation of that mechanism, J.S. Mill chides those who would argue otherwise, noting:
“There is no mode in which capitalists can compensate themselves for a high cost of labour, through any action on values or prices.  It cannot be prevented from taking its effect on low profits” (3: 479).  Mill (3: 699; italics added) further explains:

"The doctrine, indeed, that a rise of wages causes an equivalent rise of prices, is, … self-contradictory: for if it did so, it would not be a rise of wages; the labourer would get no more of any commodity than he had before, let his money wages rise ever so much; a rise of real wages would be an impossibility.  This being equally contrary to reason and to fact, it is evident that a rise of money wages does not raise prices; that high wages are not a cause of high prices.  A rise of general wages falls on profits.  There is no possible alternative."

What von Mises should have argued regarding unions raising wage rates is this: Unions may succeed in raising the (nominal) wage rates of their members, but that may also lower the wage rates of non-unionized workers because of the increased rate of unemployment that would result from the raised union wages.    Mises's argument is one of the unfortunate results of some Austrians' disputing classical monetary analysis.

James Ahiakpor

On 2/26/2016 7:06 AM, Thomas Humphrey wrote:
Robert,

Henry Thornton in 1802 obviously could not anticipate all the events of the Great Depression that happened 128 years after he wrote. And he most certainly did not postulate a downward wage-price spiral in his analysis, which can be found on pp. 118-19 of the standard Hayek edition of his (Thornton’s) Enquiry Into the Nature and Effects of the Paper Credit of Great Britain. Instead, Thornton said that a one-time fall in prices would result from a monetary contraction. But nominal wages would remain unchanged. Nominal wages would remain unchanged because workers would interpret the price fall as being temporary (albeit perhaps for a protracted period of time), and would anticipate a later reflation of the price level. (Why lower wages in the face of a price fall anticipated to be temporary and subsequently reversed?)

Thornton was arguing that conventional domestic monetary contraction might not be the best way to deal with a balance-of-payments deficit and resulting outflow of gold. For the monetary contraction would, by causing a price fall which in the face of sticky nominal wages would produce rising real wages, lead to a fall in real output and employment in all sectors, including the export sector, of the economy. And depression in the export sector, Thornton held, was hardly the best way to correct the balance-of-payments deficit causing the gold outflow.

Thornton applied that same reasoning to argue that monetary expansion, not contraction, was the proper way to handle financial crises and panics when the demand for base money was increasing as bank depositors sought to convert deposits and notes into coin and bankers sought increases in their reserve/deposit ratios. Without monetary expansion to meet the increased monetary demand, the result would be monetary contraction, price falls, rising real wages, layoffs, and falling real activity. In this way, recession would follow from financial panics. Bank failures would also occur. So I guess Thornton did indeed anticipate bank failure and money stock contraction resulting from the Fed’s failure to act as a lender of last resort in the Great Depression of the 1930s. But, to reiterate, he did not anticipate the concept of a downward wage-price spiral. Instead he postulated a one-time rise of real wages owing to the fall of prices in the face of unchanged nominal wages. One must look elsewhere for the origins of the “spiral” idea.
——Tom Humphrey