Monetary Policy in the 1920s and 1930s

To the Editor:

I have followed with much interest the articles and rejoinders by Richard Timberlake and Joseph Salerno concerning the role of inflation in the boom-bust cycle of the 1920s and early 1930s (April, May, June, and October 1999 and September 2000), and thought I might be allowed to get a few words in.

Although I concur with Professor Timberlake’s view that one ought to give words like “inflation” and “the money stock” their current, conventional meanings, and agree that according to these meanings the 1920s were not an “inflationary” period, it seems to me that this conclusion does not by itself warrant rejection of the Austrian claim that Fed policy helped to fuel a boom-bust cycle. Rather than object to standard usage, as Professor Salerno does, in attempting to defend the Austrian view, I think it more helpful to observe that, in assessing whether monetary expansion has been excessive or not, one ought to look, not at the price level or at any measure of the nominal money stock, but at the behavior of some measure of aggregate nominal spending, such as the growth of nominal GNP over time. In principle, even a declining money stock and price level can be consistent with excessive money growth if the velocity of money (the turnover rate of the money stock) and real productivity (the rate of real output per unit of factor input) are increasing. The proof of excess money growth is that the public’s money balances are growing more rapidly than their demand for idle money balances. Hence, more money is spent on goods (including financial assets) and services.

So, what are the facts concerning the progress of aggregate spending during the 1920s? In 1921, U.S. nominal GNP was $61.763 billion; by 1929, the figure was $90.320 billion—a 46.7 percent increase in less than a decade. If one chooses instead to look at per capita spending (to allow for the possibility that some overall spending growth may have been justified to provide for the needs of a growing labor force), the corresponding figure is 30.4 percent. Either measure represents a substantial increase in unwanted money balances, which failed to give rise to rising prices only because increased expenditures were more than matched by improvements in productivity.

Although a letter is no place to try to delve into the theory (but see my article, “‘Zero Inflation’: A Flawed Ideal,” in the May 1995 issue), a strong case can be made that, by allowing such rapid growth in spending, instead of more aggressively limiting money growth (and thereby allowing prices to decline more rapidly), Fed policy gave rise to an excess demand for goods and financial assets, including stock shares, and thereby helped to fuel the “great bull market.” When increased spending finally began to be reflected in rising factor prices (another set of statistics worth taking a look at), euphoria gave way to panic on Wall Street.

That, at least, is a story grounded in statistics and standard terminology, but consistent with the Austrian theory. Whether the boom-and-crash sequence contributed in a significant way to the subsequent depression is another matter which, as Professor Timberlake rightly points out, is still crying out for convincing empirical proof.

—George Selgin
Department of Economics
University of Georgia

Smith a Moral Determinist?

To the Editor:

A point that I think needed to be discussed in James R. Otteson’s November 2000 essay, “Adam Smith: Moral Philosopher,” is why it is that if “all human beings innately have something [Smith] called a desire for ‘mutual sympathy’ of sentiments,” there are so many people who lack these big time. Put it differently, where does evil arise from if good is innate in us?

Any kind of deterministic conception of human morality must contend with the evident fact that some folks are pretty awful and that this is not so with other kinds of animals that are guided in their behavior by innate motives (instincts). It does not seem to me that Otteson’s version of Smith makes clear sense of the phenomena of moral evil.

—Tibor R. Machan
Chapman University

James R. Otteson replies:

I thank Professor Machan for providing an opportunity for me to elaborate on an aspect of Smith’s moral philosophy. Smith does not claim, nor did I say in my article, that “good is innate in us.” Rather, Smith thinks that the desire for mutual sympathy of sentiments is simply a motivation to see one’s own sentiments—whatever they are—reflected in those around one. It is not an instinct to be good; it is merely an explanation for mankind’s social impulse and the process by which people tend to adopt the behavioral standards of those in their communities.

I am not sure what Professor Machan means by “deterministic conception of morality,” but Smith certainly does not think that there is no choice involved in acting on the desire for mutual sympathy of sentiments or on any other desire. Indeed, Smith champions the Stoic virtue of “self-command” as the virtue that gives all the other virtues “their principal lustre.” This shows his understanding of and reliance upon the role of free will in human social life.

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