Posted by Joseph Y. Calhoun, III

Art Laffer has an Op-Ed in the WSJ today that blames the length of the Great Depression on high taxes and currency devaluation. If he’s correct, Bernanke learned nothing from his years of studying the Depression. The tax increases of the Hoover and FDR administrations are well known and the effect obvious, but the role of monetary policy in the Depression is misunderstood in my opinion. It is relevant today because while we aren’t on a gold standard, the Fed and Treasury do seem intent on devaluing the dollar. As Laffer points out, the devaluation in the 30s produced inflation even in an environment of high unemployment and low capacity utilization:

The 1933-34 devaluation of the dollar caused the money supply to grow by over 60% from April 1933 to March 1937, and over that same period the monetary base grew by over 35% and adjusted reserves grew by about 100%. Monetary policy was about as easy as it could get. The consumer price index from early 1933 through mid-1937 rose by about 15% in spite of double-digit unemployment. And that’s the story.

The lessons here are pretty straightforward. Inflation can and did occur during a depression, and that inflation was strictly a monetary phenomenon.

I highlight this because Bernanke and the other members of the Fed, as I’ve pointed out many times before, susbcribe to the output gap theory of inflation. They believe that if unemployment is high and the economy is operating at less than potential, inflation won’t be a problem. As Laffer makes clear, that just isn’t true. If monetary policy can produce inflation with unemployment well over 10% during the Great Depression, then it surely can today.

For a great primer on the gold manipulations of FDR, read this article by Jim Powell at The Future of Freedom Foundation.