The Great Depression of the 1930s ranks as one of the greatest disasters in American history. The economy shrank for four years, and output languished far below its potential throughout the decade. Consequently, millions were unemployed or depended on public assistance. Investment not only failed to rise, it did not even keep up with depreciation. No area of economic activity was unaffected by the Depression.

The explanation for a disaster of this magnitude will be of profound importance. As Bernanke (1986, 82) puts it, “seismologists learn more from one large earthquake than from a dozen small tremors. On the same principle, the Great Depression of the 1930s would appear to present an important opportunity for the study of the effects of business cycles on the [macroeconomy].” Thus, macroeconomists have searched, and continue to search, for possible causes. One leading explanation (the monetary hypothesis) views an exogenous reduction of the money supply as the primary culprit; another prominent interpretation (the spending hypothesis) blames the collapse of the economy on an exogenous fall in spending on capital goods, consumer goods, and exports. For some economists, the validity of the Keynesian school and the monetarist school rests on which of these explanations of the Great Depression is correct.

The chief standard bearers of the monetary hypothesis are Milton Friedman and Anna Schwartz, authors of A Monetary History of the United States, 1867–1960 (1963).