The recession of 1921

After my post on the Great Depression, I was discussing with Bryan the predictions that Cole and Ohanian made at the drough of the recession. Bryan was surprised to see that they predicted a nearly 50% increase in one year. My answer was that it was not uncommon at that time, especially if we looked at the 1921-1923 recession. I told him I would post data very soon regarding that recession, especially since it is not well known.

From a paper by one of my professor at LSE, I extracted the following graph that used the Index of Industrial Production by Christina Romer and Jeffrey Miron (link to the index here) which was then compared to the a 2% trend in growth. It gave the following graph. Take a good look at the beginning of the graph for the 1921-1923 recession.

There was a gigantic and rapid drop in industrial production which was quickly erased by 1923. It may not seem much on a graph, but in a year industrial production falls by over 40% and then goes back up in less than two years. The same story is told by the Federal Reserve Bank Index of Manufacturing.

The explanation is the following: money supply. In 1921, the monetary base fell by 9% (largest single-year drop in the history of the United States) and price level fell by 18.5% in 1921 and real output per capita declined by 3.4% relative to trend. In both the Great Depression and the 1921-1923 recession, monetary policy seem to have a very important factor.

The prices were still falling in the 1921 recession when the economy began to recover and once they stabilized, the economy grew at a very fast pace. By 1923, real output per capita was 8% above trend and private investment was 70% above its 1921 level. So why did a drop in monetary base caused a price level decline and a decline in output which was then followed by a rapid recovery in the 1921 recession but not in the Great Depression?

As Friedman and Schwatrz note, the gigantic decline of the money supply by a third (they call it the Great Contraction) did contribute to the beggining the Great Depression, but why didn't the economy act like in the recession juste before? Why was the recovery so slow when the two recessions have so many logical similarities when it comes to monetary policy?
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Ritschl, Albrecht, and Tobias Straumann. Forthcoming. « Business Cycles and Economic Policy, 1914-1945 ». In Kevin O'Rourke and Stephen Broadberry (eds.), Economic History of Europe (working title), Cambridge: Cambridge University Press.

Friedman, Milton and Anna J.Schwartz. 1963. A monetary history of the United States: 1867-1960. Princeton: Princeton University Press.