The 1920-21 recession

 

Calvin Coolidge and Andrew Mellon

A new paper by Ahmad Borazan on the 1920-21 recession, often seen in libertarian and Austrian circles as an example of a laissez-faire recovery. From the abstract:

The US recovery from the 1920–21 recession has been presented as a triumph of laissez-faire policies and a serious challenge to Keynesian economics. This study interrogates this claim by using previously unutilised data and examines the historical development of the early 1920s recession and recovery. The study refutes the laissez-faire view and shows that the recovery indeed fits Keynes’s perspective. The deflationary recession was largely engineered by the Federal Reserve a la 1980s Volker disinflation. The recovery closely followed the reversal of tight monetary policy and was propelled by exceptionally long pent-up private consumption and residential spending. The recovery initiated the Roaring Twenties boom of weakened organised labour, rising income inequality and mounting private debt. This private debt-led boom proved unsustainable and was fraught with risks that contributed to the severity of the Great Depression. Although the recovery was not driven by fiscal policy, it cannot be seen as driven by price flexibility either.

Full paper here.

Employment losses in historical perspective

My colleague Chris Magee sent this graphs around about employment losses during different recessions. The first one below show all the recession from the 1970s onwards.

The next one, which I modified to show just the Great Recession and the Great Depression, is below, and gives a sense of the dimension of the Depression.

The sheer size of the Depression is impressive. Even though the last recession is an outlier, it pales in comparison with the Great Depression. You can see in the graph very clearly the Roosevelt recession of 1937-38, and also the fact that the recovery was very slow, even though as one can see from the graph above the current recovery was also slow, by historical standards.

I'm not sure what lessons Chris derived from his graphs, but I would argue that is safe to say that both the macro interventions, the fiscal package and the alternative monetary policy(even if one might have criticisms about particular elements of both), and the more widespread existence of automatic stabilizers, worked very well and precluded another Great Depression. I would see that as some evidence in favor of the New Deal policies and institutions, which essentially were behind the macro policies, and of the importance of Keynesian ideas, which gave theoretical foundation to those policies.

Josh Bivens had a piece on EPI a few years back on the slow recovery which is still worth reading. Btw, his lessons seems to be that there was not enough fiscal stimulus, something that also explains to some degree the persistence of the Depression. I wrote, even longer ago, that one should also take into consideration the conditions of the labor market, and not just the employment recovery, to have a better picture of the economic conditions.

PS: I have done a similar graph with GDP losses comparing the US and Greece. That one indicates the costs of austerity (in Greece).

Keynes' intellectual influence: the theorist vs the pamphleteer

Keynes' 1933 and 1929 pamphlets, respectively

One of the many unfair criticisms of Keynes' General Theory (GT) is that is badly written or somewhat incomprehensible. Note that Keynes started to write it in 1932, four years into the Depression, and two years after publishing the Treatise, which he probably thought was going to be his Magnus Opus. In other words, by the time he started to write the GT the worst part of the Depression was coming to an end (the UK had abandoned gold in 1931, and the US would start the New Deal the following year). Keynes' policy advice, mostly about the need to abandon gold and promote public works was not based on the GT, which came considerably later. The idea of an employment multiplier, even before Richard Kahn developed the concept, can be found in one of the pamphlets depicted above (Can Lloyd George Do It?).

As he said, the book was basically for his fellow economists. More importantly the book marked a theoretical break with neoclassical economics (which he sadly called classical, creating more confusion than needed), one that was NOT necessary to promote public works or expansionary fiscal policy that would come to be associated with Keynesianism (he was advocating that before he reached the main conclusions of the GT). The point of the book was that, even with price and wage flexibility, the economic system did not have a tendency to full employment (that means you must wait for chapter 19, when wage flexibility is introduced, to get his main argument).

The fact that the Keynesian Revolution led to a reinterpretation of Keynes on the basis of rigid wages (or interest rates) or some other kind of imperfection in more modern versions of mainstream Keynesianism, suggests that to some extent Keynes the pamphleteer was more effective than the theorist, which is not altogether surprising, since Keynes was indeed very good at writing for greater audiences, and became internationally known as a result of his pamphlet on the Treaty of Versailles.

This is my list of his most influential essays or pamphlets:

• The Economic Consequences of the Peace
• The Economic Consequences of Mr. Churchill
• The End of Laissez-Faire
• Can Lloyd George Do it? (with H. Henderson)
• Economic Possibilities for our Grandchildren
• The Means to Prosperity
• My Early Beliefs

Arguably someone may put How to Pay for the War in the list of important pamphlets. He basically wanted to finance war with taxes, and was concerned with demand pull inflation.

Has this happened before?

So I have discussed this before. The idea that the Great Depression bears a resemblance to the Great Recession, in that in both cases income inequality increased in the previous period, and went hand in hand with debt accumulation. I cited the Barba and Pivetti paper for the more recent event, and the work by my student Ahmad Borazan on the previous case (see also this post). Now I've been reading Matthew Drennan's book on Income Inequality, and he shows the following figure.

In the same vein, he suggests that income inequality was at the heart of the increasing private indebtedness, and at the heart of the Great Depression. Nothing particularly new. An interesting book, worth reading.

On Eccles and QE in the 1930s

So last weekend I was at the Eastern Economic Association meetings, and I presented with Steve Bannister (on and off contributor to NK) a paper on Quantitative Easing in the 1930s. It's been a while since we looked at this work, which started long ago (4 years at least). One point worth noticing is that while most accounts of Eccles performance at the Fed suggest that he didn't do much (see Meltzer in his A History of the Federal Reserve), we suggest that he was crucial in pushing qualitative easing (the term first used by Buiter here), that is a shift in the composition of the Fed's balance sheet.

The figure shows that when Eccles assumed at the Fed, in 1934, QE, the increase of the balance sheet had already started, but the shift from short term government bills (blue ones) to long term bonds (green) had not. The dark line shows Eccles' policy, which had the objective of keeping long term interest rates at 2.5 percent, in order to allow for fiscal stimulus and sustainable expansion of public debt.

Consumer credit and mortgage finance in the 1920s

I've been reading Robert Gordon's The Rise and Fall of American Growth: The U.S. Standard of Living since the Civil War (The Princeton Economic History of the Western World), that I bought at the ASSA Meeting in San Francisco. There is a wealth of data. One topic discussed here before was the expansion of credit in the 1920s, and the role of the housing market in the boom of the roaring 20s. Gordon says with respect to the housing market:

“One reason homeownership rates soared in the 1920s as part of the massive building boom of that decade was a widespread loosening of credit conditions that allowed families to take out second and third mortgages. The value of outstanding mortgages soared from about $12 billion in 1919 to $43 billion in 1930 (i.e., from 16% to 41% of nominal GDP). Figure 9–2 plots the ratio of mortgage debt to GDP against the non-structures consumer debt ratio already examined in figure 9–1. The differing left-hand and right-hand axes indicate that mortgage debt for structures during the 1920s was consistently seven times higher than for non-structures consumer debt. The longer view in figure 9–2 shows that the value of outstanding mortgages was roughly 20 percent of GDP from 1900 to 1922.”

“Ratios to GDP of Non-Structures Consumer Credit and Residential Structures Credit, 1896–1952.

Sources: Olney (1991, Table 4.1), Gordon (2012a, Table A-1), and HSUS series Dc903.”

The Great Depression put an end to the roaring 20s. The unsustainable expansion of consumer credit and mortgages seems to have played, as much as in the last crisis, a significant role. 

The Great Depression and the Great Recession compared

So I teach a course on the two (old syllabus here). One of the initial classes looks at Eichengreen and O'Rourke's comparison of the two events, and how, even though at the beginning the shock seemed similar, the recovery has been faster the second time. O'Rourke had noticed in his blog last year that the current recovery started way before, but has been so slow that now the 1930s look better when industrial output (rather than GDP) is used as a measure. Below the same data for the US economy (he uses world industrial output).

Note that I added more of the 1930s recovery, and one can see the effects of the Roosevelt recession in 1937-38 (the indexes are monthly and start in October 1929 and December 2007 as 100 respectively). Industrial output growth has slowed down in the last year, by the way. I don't think we are on the verge of a recession in the US. My guess is that sluggish growth will continue. But it is an additional reason to be cautious about hiking interest rates, and presuming that the economy is all fine.

On the Way to the Great Depression: The Demand Regime of the US Economy (1900-1929)

New Working Paper by Ahmad Borazan. From the abstract:

It has become commonplace to raise the analogy between the recent experience of the dynamics of income distribution and growth, and that of the era before the Great Depression. However, no study of the demand regime has been done for the early twentieth century period; this study attempts to fill that gap in the literature. Based on a Kaldorian model, I estimate whether the demand regime of the pre-Great Depression era for private domestic output was wage-led or debt-led. The results of the study show the demand regime was wage-led with a considerable role of private debt in driving aggregate demand. Furthermore, I discuss the Roaring Twenties period and argue that increased income inequality led to the rise of destabilizing channels that propped up demand which contributed to increasing economic fragility on the way to the Great Depression.

Read paper here.

The Gold Standard and the Depression

I have been teaching on this topic this week. One of the accepted views on the Depression is that countries that depreciated earlier recovered faster from the crisis. The classic paper by Eichengreen and Sachs sort of established the result.* The notion is the traditional one. Depreciation leads to lower prices in foreign currency, increased competitiveness and higher exports. Graph below shows the correlation between depreciation (since the exchange rate is measured as the foreign price of domestic currency, lower rate means depreciation).

The indexes show the difference between the exchange rate and export volumes in 1929 (100) and 1935. So in 1935 France had not left the Gold Standard and the exchange rate remained at 100, while the exports were close to 50% of their 1929 level. There seems to be a clear negative relation between the exchange rate depreciation and export performance. However, note that in the United Kingdom a depreciation of about 40% implied exports at around 75% or so of the 1929 level. Only Norway and Finland seem to have higher exports in 1935 than in 1929. This was not an external demand led recovery.

This suggests that if depreciation had a role it was more likely related to the space that breaking with the Gold Standard rules provided for domestic authorities to pursue expansionary policies at home. Note that in this context, the depreciation, as much as higher tariffs and other trade related policies, are less relevant for their role in stimulating external demand, than by their role in protecting domestic production.

In the US the group of economists that were in favor of the depreciation of the dollar (see the letter by Harvard economists J. Raymond Walsh, Lauchlin Currie, John B. Crane, John M. Cassels, Robert Keen Lamb and Alan R. Sweezy in support of FDR's depreciation policy in 1934; and yes that includes Currie, later advisor to Eccles, and Paul's brother Alan, a Keynesian, not a Marxist), were also in favor of domestic fiscal expansion, which was at the end of the day Keynes point too. You can see Keynes arguing why the abandonment of the Gold Standard would be a good thing here, at the beginning of John Kenneth Galbraith's documentary.

This is still an important point, since there are significant lessons, at least it seems to me, for the European periphery story, in particular Greece. Depreciation alone cannot do the job. But a combination of import substituting policies, to reduce external constraint problems, with expansionary demand policies might work.

* There are also issues related to the role of the Gold Standard in causing the Depression, since the crisis was international, and many authors think that this suggests that it must have international causes. Hence, the Monetarist contraction story, or the Keynesian consumption collapse story (including the more radical version in which income distribution plays a role) would be incomplete. In this view, the relatively high rate of interest, related to the not credible inter-war Gold Standard, would be the cause of the depression. This view, as I noted before, seems closer to Keynes' Treatise on Money than his GT.

The Forgotten Bubble

Over the years I've heard of a new story about the 1920s. Mostly in class comments or in the papers of my undergraduate students. First in Utah, now here at Bucknell. The notion is that the 1920-21 recession was solved by laissez-faire policies. This fits the revisionist view about the Great Depression defended by Amity Shlaes and others. In other words, the depression was prolonged by the New Deal policies (I discussed those here).

A new book by James Grant, The Forgotten Depression, suggests exactly that the recovery in 1922 was the result of the lack of government intervention. The notion is that there was no fiscal stimulus, and yet the economy recovered. By the way, the book also suggests that the cause of the recession was the Fed's policy. I guess it was the first Fed caused crisis in this view, in line with Friedman's explanation of the Depression as the Great Contraction.

There is a relatively well-know and established story about the 1920s recovery and boom, which does not suggest that laissez-faire is a good idea. It suggests that it was a consumption boom associated to a bubble, and, hence, unsustainable leading to a collapse. The 1920s is when debt-driven consumption of mass produced goods became the norm, and when a whole set of new goods were available for the middle class (e..g cars, refrigerators, radios, etc.). A good description of that story can be found in Livingstone here (subscription required). In other words, in spite of wage stagnation, worsening income distribution, and lack of government stimulus the roaring twenties were possible as a result of private debt accumulation. And you know how well that ended.

There was also a housing bubble. Ahmad Borazan, who is working on these topics at the University of Utah, pointed out to me the paper by Eugene White on national housing bubble that bursted in 1926. In that respect it is worth noticing that bubbles and speculation on land were central for almost all booms and busts in the 19th century, as seen in the figure below.

Note that there were financial crashes in 1819, 1837 and 1857, often associated to higher rates of interest in the UK, the main financial center back then, and to the collapse of commodity and asset prices. Housing bubbles seem to be the modern version of land speculation, when the frontier has vanished, and they seem to have played a role in the Great Depression and the last crisis.

PS: Figure above comes from Reynolds Nelson's A Nation of Deadbeats.

Did the New Deal help in the recovery?

I have posted on this before (e.g. here and here, but there is more). Here a short excerpt from Joshua Hausman dissertation, supervised by Barry Eichengreen and Brad DeLong. He suggests in this particular paper that the 1936 Veteran Bonus was essential for the expansion of consumption and growth in 1936. Table below show aggregate data. Note that most of the accelerated expansion is explained by consumption (one might add, investment is derived demand and follows the accelerator, but that's another discussion).

He says: "All this is not easily explained by factors other than the bonus. Monetary factors were if anything contractionary in 1936. Broad money supply growth slowed from 14 percent in 1935 to 11 percent in 1936. And in August 1936, the Federal Reserve raised reserve requirements."

Hausman correctly notices that monetary policy had little effect on the boom in 1936, which fits what Eccles thought about that, and also about the role of monetary policy in the 1937-8 recession. The recession was for Eccles caused by a fiscal contraction largely due to two factors, the new Social Security Law that went into effect, increasing taxes, without initially disbursing payments, and the end of soldier’s bonus payments, which would add support to Hausman's story. Yep, multipliers (effective demand) work.

Keynes is all you need

From BusinessWeek:

Is there a doctor in the house? The global economy is failing to thrive, and its caretakers are fumbling. Greece took its medicine as instructed and was rewarded with an unemployment rate of 26 percent. Portugal obeyed the budget rules; its citizens are looking for jobs in Angola and Mozambique because there are so few at home. Germans are feeling anemic despite their massive trade surplus. In the U.S., the income of a median household adjusted for inflation is 3 percent lower than at the worst point of the 2007-09 recession, according to Sentier Research. Whatever medicine is being doled out isn’t working. Citigroup (C) Chief Economist Willem Buiter recently described the Bank of England’s policy as “an intellectual potpourri of factoids, partial theories, empirical regularities without firm theoretical foundations, hunches, intuitions, and half-developed insights.” And that, he said, is better than things countries are trying elsewhere.

Read rest here.

Foster and Yates on Piketty & The Crisis of Neoclassical Economics

Michael D. Yates kindly asked me to post a link to his new MR article, co-authored with John Bellamy Foster, on Piketty & the current state of mainstream economics; comments & feedback are welcomed.

Not since the Great Depression of the 1930s has it been so apparent that the core capitalist economies are experiencing secular stagnation, characterized by slow growth, rising unemployment and underemployment, and idle productive capacity. Consequently, mainstream economics is finally beginning to recognize the economic stagnation tendency that has long been a focus in these pages, although it has yet to develop a coherent analysis of the phenomenon. Accompanying the long-term decline in the growth trend has been an extraordinary increase in economic inequality, which one of us labeled “The Great Inequality,” and which has recently been dramatized by the publication of French economist Thomas Piketty’s Capital in the Twenty-First Century. Taken together, these two realities of deepening stagnation and growing inequality have created a severe crisis for orthodox (or neoclassical) economics.

Read rest here.

For other posts on Piketty, see here, here, here, here, here, and here.

Keynes (1930) on Economic Possibilities for Our Grandchildren

Below is an excerpt from Keynes' "Essays In Persuasion" (1930), in which he provides his invaluable insights on human potentialities concerning human freedom during the Great Depression.  Notice that the overall message is quite relevant to the turbulence of today. (h/t to Nate Cline for noticing that in the first part of the essay Keynes, in fact, is very un-Keynesian in the sense that he accepts the 'natural rate' theory of capital & unemployment).

We are suffering just now from a bad attack of economic pessimism. It is common to hear people say that the epoch of enormous economic progress which characterised the nineteenth century is over; that the rapid improvement in the standard of life is now going to slow down – at any rate in Great Britain; that a decline in prosperity is more likely than an improvement in the decade which lies ahead of us. I believe that this is a wildly mistaken interpretation of what is happening to us. We are suffering, not from the rheumatics of old age, but from the growing-pains of over-rapid changes, from the painfulness of readjustment between one economic period and another. The increase of technical efficiency has been taking place faster than we can deal with the problem of labour absorption; the improvement in the standard of life has been a little too quick; the banking and monetary system of the world has been preventing the rate of interest from falling as fast as equilibrium requires. And even so, the waste and confusion which ensue relate to not more than 7½ per cent of the national income; we are muddling away one and sixpence in the £, and have only 18s. 6d., when we might, if we were more sensible, have £1; yet, nevertheless, the 18s. 6d. mounts up to as much as the £1 would have been five or six years ago. We forget that in 1929 the physical output of the industry of Great Britain was greater than ever before, and that the net surplus of our foreign balance available for new foreign investment, after paying for all our imports, was greater last year than that of any other country, being indeed 50 per cent greater than the corresponding surplus of the United States. Or again-if it is to be a matter of comparisons – suppose that we were to reduce our wages by a half, repudiate four fifths of the national debt, and hoard our surplus wealth in barren gold instead of lending it at 6 per cent or more, we should resemble the now much-envied France. But would it be an improvement? The prevailing world depression, the enormous anomaly of unemployment in a world full of wants, the disastrous mistakes we have made, blind us to what is going on under the surface to the true interpretation. of the trend of things. For I predict that both of the two opposed errors of pessimism which now make so much noise in the world will be proved wrong in our own time – the pessimism of the revolutionaries who think that things are so bad that nothing can save us but violent change, and the pessimism of the reactionaries who consider the balance of our economic and social life so precarious that we must risk no experiments. My purpose in this essay, however, is not to examine the present or the near future, but to disembarrass myself of short views and take wings into the future. What can we reasonably expect the level of our economic life to be a hundred years hence? What are the economic possibilities for our grandchildren? 

Read rest here.

On why the Golden Age of Capitalism was better than this revived Gilded Age

No need for a lot of discussion. The Golden Age of Capitalism (in the graph 1947-79)--the world that resulted from the reforms to deal with the Great Depression (the New Deal) and the reorganization of the world after the victory against Fascism, with strong unions, high taxes for the rich, and a string of social programs for the poor and minorities--was a better world.

The use of history for political purposes: on the New Deal and the last recession

It is increasingly common to hear stories of how government intervention led the economy astray during the Great Depression, and how FDR’s New Deal actually delayed a recovery that was on its way, e.g. the popular book my Amity Shlaes The Forgotten Man. This view is at odds with the conventional notion in the accepted historiography of the period and with old Keynesian views as exposed by Galbraith (1954), but not with the mainstream of the economic profession. It is important to note that not only old Monetarists like Friedman and Schwartz (1963) or Meltzer (2003), but also New Keynesians like Romer (1992) suggest that the recovery was essentially caused by monetary policy and that the fiscal policies associated with the New Deal were essentially of secondary importance for the recovery.

Read the post here.

Keynes on the causes of the Great Depression

By 1932 a draft of the General Theory (GT) was basically finished, including the central concept of effective demand, and Keynes have moved away from the Wicksellian framework of the Treatise on Money (TM). From a policy point of view the new view implied that the cause of the Great Depression was less the high rates of interest (above the natural rate), and the emphasis on the Gold Standard, that had dominated his views in the TM, to a more straightforward blame on reduced spending in the US.

In The Means to Prosperity from 1933, in which most of his policy views were expounded (and published before the GT) Keynes argues that:

Note that he clearly suggests that the global crisis had its epicenter in the US. Also, even though he is concerned with the role of expenditure in the level of activity, he still refers to the recovery as having price effects ('raising world prices').

PS: Arguably those authors like Eichengreen and Temin that emphasize the role of the Gold Standard remain closer to the TM and its Wicksellian framework (which would make sense for New Keynesian authors), while Romer, even though she remains firmly wedded to the idea of a natural rate, would be closer to the Keynes of The Means to Prosperity and the GT. See older post here.

Economic History blog dedicates space to the Great Depression

Echoes is an Economic History blog worth visiting. Here Philip Scranton's take on the early phase of the recovery and how FDR and the often forgotten Hugh Johnson wanted a wage-led recovery.

As in earlier economic recoveries, in 1933, U.S. production began increasing more quickly than workers could find jobs. A 50 percent increase in industrial output from March to July generated just 14 percent more factory employment. With orders rising, manufacturers commonly extended current employees’ weekly hours instead of rehiring those who had been laid off.

Hugh "Iron Pants" Johnson, director of the National Recovery Administration, focused on closing this gap as President Franklin D. Roosevelt's first 100 days in office came to an end in June. The purpose of the National Industrial Recovery Act was simple: "Wages are to be increased and hours of work curtailed in order to distribute more widely the available employment," according to the Economist.

"The Administration has made no secret of its belief that if the slump is to be overcome, employment and wages must rise much faster in the initial stages of the recovery than output and prices."

Read thing whole thing here.

How fast has been the recent recovery? Faster than the Depression

But that is not really saying much in favor of the current crisis. Krugman has recently shown how bad the European crisis is comparing the index of industrial output in the Great Depression and the Great Recession. The same exercise for the US is shown below.

Note that the recovery was faster this time around (21against 43 months, incidentally both associated to changes in fiscal policy, in early 1933 and mid-2009 respectively). Further, due to the more active fiscal and monetary policy (besides specific policies like the rescue of the Big 3 auto makers) now we are at the same level than in late 2007, while back then 72 months into the recession industrial output remained some 25% below its previous peak.

What can we learn from the Depression?

Free Exchange has discussed in a recent post the academic views on the Great Depression. They suggest that recent research (say the last 20 years or so) has produced a different view, and "that many traditional views about the causes of the Depression have been overturned by academics in recent decades." In particular, they suggest that neither protectionism nor the financial crash are seen as central anymore. They correctly note that the dominant view, associated to Barry Eichengreen and Peter Temin,* now puts an emphasis on the effects of the Gold Standard (note that Keynes also emphasized the role of the Gold Standard, to which he referred to as a 'barbarous relic'). 

And by the way that means that the consensus is that a demand shock caused the Depression. Note that a few authors have pushed the Real Business Cycle (RBC) story in recent times. For example, Prescott argues that:

“In the 1930s, there was an important change in the rules of the economic game. This change lowered the steady-state market hours. The Keynesians had it all wrong. In the Great Depression, employment was not low because investment was low. Employment and investment were low because labor market institutions and industrial policies changed in a way that lowered normal employment.”

In other words, the changes in incentives led to less supply of labor and less demand for investment goods by firms. Same ideas have been put forward by Cole and Ohanian, and by popularizers like Amity Shlaes in her The Forgotten Man. However, most of the New Deal regulations that the revisionists abhor, actually came to late to have caused the Depression. They generally try to explain the 'slow' recovery (growth averaged 8% in the first FDR term) as a result of the New Deal, and leave the question of what was the supply side shock that caused the Depression.

Lucas, who converted to RBC at some point in the 1980s, asked (cited here) poignantly: "Where is the productivity shock that cuts output in half in that period? Is it a flood or a hurricane? If it really happened, shouldn't we be able to see it in the data?" For that reason Lucas still believes, like Friedman, that the Fed did it. And if one is going to blame regulation for the duration of the Depression, one must deal with the fact that in the 1950s, if anything, labor and financial regulations were as stringent, if not more, than in the 1930s and unemployment was fairly low.

A more subtle critique of the conventional view, and its emphasis on the Gold Standard comes from Christina Romer. She suggests that the path of American output and unemployment before 1931 can be explained quite well with only domestic factors, and that even after 1931, international factors affected American economic conditions mainly through their impact on American policy decisions. Note that that this is not incompatible with Kindleberger's view that the US, in the process of becoming the hegemon, was central for the global economic collapse.

This should cast some doubts on FE's conclusion that:

"putting all the blame on Wall Street for the Great Depression -- or on bankers in the current crisis -- does not stand up to historical scrutiny. The responsibility may more properly lie in a complex combination of factors, like how global financial systems are structured."

Romer notes that in the US the collapse in consumption was more important than in other economies (harking back to Peter Temin's reply to Friedman that it was the collapse in consumption, not monetary policy, that caused the Depression). And the collapse in the demand for consumer durables, which depended on credit for their purchase, was affected by financial conditions. Romer argues:

“Both the initial recession in the United States in the summer of 1929 and the acceleration of the decline in late 1929 and 1930 are ultimately attributable to the stock market boom and bust of the late 1920s. The stock market boom is the prime explanation for why the Federal Reserve was pursuing tight monetary policy starting in 1928. The stock market crash is the prime source for the collapse in durable goods purchases starting in November 1929.”

So the financial bubble and the crash did matter, and John Kenneth Galbraith (among others) was correct about it. I would add that income distribution, which we know from Piketty and Saez, was as bad in the 1920s as now, did also play a role in the bubble and the expansion of private indebtedness. So Wall Street was to blame indeed, as much as it should be too in the recent Great Recession.

* Kindleberger, in his classic The World in Depression, goes further and suggests that it was the absence of an hegemon that acted as a source of demand in situations of crises (distressed markets), as a stabilizer of exchange rates, and as a source of international finance (an international lender of last resort) that caused  the Depression, since the UK was incapable and the US unwilling to assume that position. The Depression was essentially an hegemonic crisis.

PS: For further reading my forthcoming paper in the Cambridge Journal of Economics here.