In his writings, Professor Milton Friedman blamed central bank policies for causing the Great Depression. According to Friedman, the Federal Reserve failed to pump enough reserves into the banking system to prevent a collapse in the money stock. In response to this failure, Friedman argued the money stock M1, which stood at $28.264 billion in October 1929; fell to $19.039 billion by April 1933 — a decline of almost 33%.1
Because of the fall in the money stock argued Friedman, economic activity followed suit. By July 1932 year-on-year industrial production fell by over 31%. Also, year-on-year the consumer price index (CPI) had plunged. By October 1932, the CPI fell by 10.7%.
Contrary to Friedman’s conclusions, the fall in the money stock was a result — and not the cause — of the shrinking pool of wealth brought about by the previous loose monetary policies of the central bank.
The Essence of the Pool of Wealth
Essentially, the pool of wealth is the quantity of consumer goods available in an economy to support future production. In the simplest of terms — a lone man on an island is able to pick 25 apples an hour. With the aid of a picking tool, he is able to raise his output to 50 apples an hour. Making the tool, however, takes time.
During the time he is busy making the tool the man will not be able to pick any apples. In order to have the tool, therefore, the man must first have enough apples to sustain himself while he is busy making it. His pool of wealth is his means of sustenance for this period — the quantity of apples he has saved for this purpose.
The size of this pool determines whether or not a more sophisticated means of production can be introduced. If it requires one year of work for the man to build this tool, but he has only enough apples saved to sustain him for one month, then the tool will not be built — and the man will not be able to increase his productivity.
The island scenario is complicated by the introduction of multiple individuals who trade with each other and use money. The essence, however, remains the same — the size of the pool of wealth sets a brake on the introduction of more productive stages of production.
