1Counterfactual Histories of the Great Depression1

As Professor Balderston notes in his introduction to this volume, history is necessarily written in terms of a model, whether implicitly or explicitly, and a model invariably suggests counterfactuals. In this note, we first review our model of the Great Depression (“the ET model ” as it is referred to by Balderston) and then explore the counterfactual that flow from its application to the monetary, macroeconomic and political history of the 1930s. 1. The Depression as It Was It is necessary to understand the causes of the Great Depression in order to answer the question of whether things could have turned out differently. The simultaneous fall in production and prices in the early 1930s strongly suggests that the initiating factor for the Great Depression was a series of negative aggregate demand shocks. But how could so many countries have experienced a negative demand shock at the same time? The answer is that all of these countries, faithful to the dictates of the gold standard, pursued deflationary policies at the same time. The essence of the gold standard was the free flow of gold between individuals and countries, the maintenance of fixed values of national currencies in terms of gold and therefore one another, and the absence of an international coordinating and lending organization like the International Monetary Fund.2 Under these conditions, when the United States and Germany adopted deflationary policies,