White and Hogan on Hayek and Cassel on the Causes of the Great Depression

Lawrence White and Thomas Hogan have just published a new paper in the Journal of Economic Behavior and Organization (“Hayek, Cassel, and the origins of the great depression”). Since White is a leading Hayek scholar, who has written extensively on Hayek’s economic writings (e.g., his important 2008 article “Did Hayek and Robbins Deepen the Great Depression?”) and edited the new edition of Hayek’s notoriously difficult volume, The Pure Theory of Capital, when it was published as volume 11 of the Collected Works of F. A. Hayek, the conclusion reached by the new paper that Hayek had a better understanding than Cassel of what caused the Great Depression is not, in and of itself, surprising.

However, I admit to being taken aback by the abstract of the paper:

We revisit the origins of the Great Depression by contrasting the accounts of two contemporary economists, Friedrich A. Hayek and Gustav Cassel. Their distinct theories highlight important, but often unacknowledged, differences between the international depression and the Great Depression in the United States. Hayek’s business cycle theory offered a monetary overexpansion account for the 1920s investment boom, the collapse of which initiated the Great Depression in the United States. Cassel’s warnings about a scarcity gold reserves related to the international character of the downturn, but the mechanisms he emphasized contributed little to the deflation or depression in the United States.

I wouldn’t deny that there are differences between the way the Great Depression played out in the United States and in the rest of the world, e.g., Britain and France, which to be sure, suffered less severely than did the US or, say, Germany. It is both possible, and important, to explore and understand the differential effects of the Great Depression in various countries. I am sorry to say that White and Hogan do neither. Instead, taking at face value the dubious authority of Friedman and Schwartz’s treatment of the Great Depression in the Monetary History of the United States, they assert that the cause of the Great Depression in the US was fundamentally different from the cause of the Great Depression in many or all other countries.

Taking that insupportable premise from Friedman and Schwartz, they simply invoke various numerical facts from the Monetary History as if those facts, in and of themselves, demonstrate what requires to be demonstrated: that the causes of the Great Depression in the US were different from those of the Great Depression in the rest of the world. That assumption vitiated the entire treatment of the Great Depression in the Monetary History, and it vitiates the results that White and Hogan reach about the merits of the conflicting explanations of the Great Depression offered by Cassel and Hayek.

I’ve discussed the failings of Friedman’s treatment of the Great Depression and of other episodes he analyzed in the Monetary History in previous posts (e.g., here, here, here, here, and here). The common failing of all the episodes treated by Friedman in the Monetary History and elsewhere is that he misunderstood how the gold standard operated, because his model of the gold standard was a primitive version of the price-specie-flow mechanism in which the monetary authority determines the quantity of money, which then determines the price level, which then determines the balance of payments, the balance of payments being a function of the relative price levels of the different countries on the gold standard. Countries with relatively high price levels experience trade deficits and outflows of gold, and countries with relatively low price levels experience trade surpluses and inflows of gold. Under the mythical “rules of the game” under the gold standard, countries with gold inflows were supposed to expand their money supplies, so that prices would rise and countries with outflows were supposed to reduce their money supplies, so that prices fall. If countries followed the rules, then an international monetary equilibrium would eventually be reached.

That is the model of the gold standard that Friedman used throughout his career. He was not alone; Hayek and Mises and many others also used that model, following Hume’s treatment in his essay on the balance of trade. But it’s the wrong model. The correct model is the one originating with Adam Smith, based on the law of one price, which says that prices of all commodities in terms of gold are equalized by arbitrage in all countries on the gold standard.

As a first approximation, under the Smithean model, there is only one price level adjusted for different currency parities for all countries on the gold standard. So if there is deflation in one country on the gold standard, there is deflation for all countries on the gold standard. If the rest of the world was suffering from deflation under the gold standard, the US was also suffering from a deflation of approximately the same magnitude as every other country on the gold standard was suffering.

The entire premise of the Friedman account of the Great Depression, adopted unquestioningly by White and Hogan, is that there was a different causal mechanism for the Great Depression in the United States from the mechanism operating in the rest of the world. That premise is flatly wrong. The causation assumed by Friedman in the Monetary History was the exact opposite of the actual causation. It wasn’t, as Friedman assumed, that the decline in the quantity of money in the US was causing deflation; it was the common deflation in all gold-standard countries that was causing the quantity of money in the US to decline.

To be sure there was a banking collapse in the US that was exacerbating the catastrophe, but that was an effect of the underlying cause: deflation, not an independent cause. Absent the deflationary collapse, there is no reason to assume that the investment boom in the most advanced and most productive economy in the world after World War I was unsustainable as the Hayekian overinvestment/malinvestment hypothesis posits with no evidence of unsustainability other than the subsequent economic collapse.

So what did cause deflation under the gold standard? It was the rapid increase in the monetary demand for gold resulting from the insane policy of the Bank of France (disgracefully endorsed by Hayek as late as 1932) which Cassel, along with Ralph Hawtrey (whose writings, closely parallel to Cassel’s on the danger of postwar deflation, avoid all of the ancillary mistakes White and Hogan attribute to Cassel), was warning would lead to catastrophe.

It is true that Cassel also believed that over the long run not enough gold was being produced to avoid deflation. White and Hogan spend inordinate space and attention on that issue, because that secular tendency toward deflation is entirely different from the catastrophic effects of the increase in gold demand in the late 1920s triggered by the insane policy of the Bank of France.

The US could have mitigated the effects if it had been willing to accommodate the Bank of France’s demand to increase its gold holdings. Of course, mitigating the effects of the insane policy of the Bank of France would have rewarded the French for their catastrophic policy, but, under the circumstances, some other means of addressing French misconduct would have spared the world incalculable suffering. But misled by an inordinate fear of stock market speculation, the Fed tightened policy in 1928-29 and began accumulating gold rather than accommodate the French demand.

And the Depression came.

20 Responses to “White and Hogan on Hayek and Cassel on the Causes of the Great Depression”

  1. 1 lewisb2014 December 28, 2020 at 10:12 am

    Your explanation, which I think makes a lot of sense, is congruent with that of Charles Kindleberger in his classic work Manias, Panics, and Crashes: A History of Financial Crises, in which he directly connected the U.S. Great Depression with international conditions (including falling farm prices).

  2. 2 nottrampis December 28, 2020 at 5:58 pm

    another educative article. Many thanks

  3. 3 marcus nunes December 30, 2020 at 9:37 am

    Unlike Keynes or Hayek, Cassel explained both how a country could get into a depression (deflation due to tight monetary policies) and how it could get out of one (monetary expansion).
    In other words, Cassel/Hawtrey didn´t have to wait for a depression to attribute it to previous “malinvestment”. The fact that all countries on the gold standard succumbed at the same time (differences in intensity are another topic) and “got out” in the order they abandoned the gold standard should have given a clue to White & Hogan.
    Cassel´s views are also relevant to Europe´s monetary union:

  4. 4 marcus nunes December 30, 2020 at 9:46 am

    If Cassel had participated in the “Keynes-Hayek debate”, he would have won hands down. This Cassel quote from 1933 “kills” Keynes:
    “considering what governments have done and still do to deter private investment by high and arbitrary taxation, by all sorts of restrictions, national and international, and by bad monetary policy, it is, to say the least of it, curious that such mistakes should be exploited as a ground for widening the functions of governments as entrepreneurs”

  5. 6 Henry Rech December 30, 2020 at 7:19 pm

    It always puzzles me that those that comment on the causes of the Great Depression seem to focus on one or other explanation. It seems to me there was a process at play that involved a multitude of factors that fed off each other and played out over a period of time.

    The deflationary tendencies inherent in the Gold Standard system provided the underlying context. The technological discoveries of the early 20th century created a boom in investment (and over-investment) during the course of the 1920s, which eventually had to bust. The 1928 and 1929 tightening of policy by the Fed broke the back of the investment boom. The boom was financed by bank created credit, the collateral for which evaporated virtually overnight, pressurizing the banking system. The overvaluation of the Pound and the undervaluation of the Franc complicated an already unstable and precarious world financial situation. The collapse of agricultural industries in the US owing to persistent drought was devastating.

    It was the perfect storm in the making.

  6. 7 marcus nunes December 31, 2020 at 10:58 am

    y, was the housing “boom” in the US destined to bust in 2007? Why did an even bigger housing boom in Australia did not bust? One reason is that monetary policy in Australia did not let NGDP crash

  7. 8 Henry Rech December 31, 2020 at 3:01 pm


    “Why did an even bigger housing boom in Australia did not bust?”

    The main and overwhelming reason was that there was a massive fiscal stimulus that was applied.

  8. 9 marcus nunes January 1, 2021 at 1:23 pm

    Henry, Couldn´t find the fiscal stimulus. In 2008, for example, government consumption and investment expenditures DECREASED!

  9. 11 marcus nunes January 1, 2021 at 5:59 pm

    Henry, Expansionary fiscal policy in Australia arrived much later than in most other countries. It was not helpful in those countries because monetary policy was tightening! Not so in Australia. There monetary policy made the difference.

  10. 12 Henry Rech January 2, 2021 at 4:15 am


    I’m not sure which countries you are referring to but in the US the policy rate was being pushed down before that in Australia but by the end of 2008 the policy rate in both Australia, the US and Europe had been taken down to low levels. While this may have stabilized the financial system to some extent it was not enough to get the respective economies going.

    The US had some fiscal stimulus – some say it wasn’t large enough and ill designed. And of course the US property market had the structural problems of sub prime lending and interest rate reset contracts.The fiscal stimulus in Australia was unprecedented. In Europe, they practiced fiscal austerity. The collapse in European interest rates had very little positive impact on European economic activity.

  11. 13 marcus nunes January 3, 2021 at 5:21 am

    Interest rates do not define the stance of monetary policy! The only countries that did not have a recession in 200809 were Australia, Israel and Poland. Those are exactly the countries that did not allow nominal aggregate spending (NGDP) to drop!

  12. 15 Henry Rech January 3, 2021 at 12:26 pm


    “Interest rates do not define the stance of monetary policy! ”

    How would you characterize any particular stance on monetary policy?

    What defines whether it is loose or tight?

  13. 17 Henry Rech January 3, 2021 at 5:58 pm


    Thanks for the links.

    It seems to me that taking this line of thought will drive monetary policy makers into a morass.

    I think we should distinguish between policy tightening (or loosening) and the effect of that policy change. To me a change in the interest rate setting is a clear change in policy.

    However, what the effect of that change on the macroeconomy might be cannot with certainty be predicted.The macroeconomy is too complex a beast to say categorically what the effect of a policy change might be.

    Just because NGDP continues on its merry way after a rise in interest rates does not mean that policy has not been tightened, I would argue. It just means there are other more powerful forces at play.

  14. 18 marcus nunes January 3, 2021 at 6:58 pm

    Henry, I promise this is the last one! Should make you think about what monetary policy really is. Cheers

  15. 19 Henry Rech January 4, 2021 at 11:09 am


    Thanks for the link.

    I am afraid I am not convinced by Scott Sumner’s argument.

    During the 1980s, monetary aggregates targeting was the game. In the 1990s it was interest rate targeting. Now it’s NGDP targeting.

    Monetary theorists are not willing to accept that monetary policy is not always efficacious as they want it to be. So they define the problem away.

    Next we will be hearing that monetary policy should be effected by targeting the length of Donny Trump’s tweets. Why not?

    Sumner, at one point in the paper, used several measures to signal that monetary policy was contractionary (his seven points). There could be a multitude of reasons to explain these observations that have nothing to do with monetary policy.

    It seems people are born either monetarists, fiscalists, expectationists, catastrophists etc. and never shall they meet.

  1. 1 Nightcap | Notes On Liberty Trackback on December 27, 2020 at 8:17 pm

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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.


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