A question came up in the combox down yonder about the Great Depression and how it can be accounted for undr different economic theories.
Tom Woods posted a comment linking to some resources on the question that I thought folks might want to check out, so con permiso here is what guestblogger Tom Woods had to say:
Just a little comment on the Depression: it certainly did not occur
at the height of free-market thought [as one commenter suggested]. The American Economic Association
had been all but hijacked by statist thinking coming out of Germany.
Promoting "associationism," which consisted of "voluntary"
government-business partnerships, was the order of the day. (See Butler
Shaffer’s book In Restraint of Trade for all the details of just how
anti-market the intellectuals and even the business executives were at
the time.) And in the 1920s you had so-called economists gleefully
suggesting that permanent prosperity was here, that the Federal Reserve
could fine-tune the economy. Well, the Federal Reserve is not a market
institution! It is created and sustained by government, and it
consitutes an intervention into the market for money.
I discuss the causes of the Depression both in The Church and the Market and in this video, toward the beginning:
Also audio:
The Austrian School, for my money, has by far the best explanation for economic depressions.
I’m not exactly sure what the Austrian school’s explanation is (as I don’t have an 1 and a half to watch that video) but from what I know there was a confluence of reasons that caused the great depression, not just one. One of the main factors, however, was the ineptitude of the Federal Reserve as they continually misconstrued the situation and did the exact opposite of economic theory would suggest that you do.
While certainly monetary policy could explain the entry into recession or depression, it does not explain other things such as the depth and the breadth. Additionally, captialism is not supposed to be dependent upon government for its stability, e.g. it is a self correcting system. The economy did not self correct though in the Great Depression. This is not necessarily to argue against Friedman, but his explanation was an ex post facto novelty that free market theorists would not necessarily have subscribed to.
To argue that we weren’t under a pure free market system is to argue about something that never was and never will be. The utility of any system is based solely on its ability to predict the future. President Wilson’s advisors were rather confident that this would be a short blip; needless to say, they were wrong. President Bush’s advisors and his apologists like Kudlow have been prognosticating for 6 years now that the jobs uptick would occur in the next quarter or maybe 6 months. This simply hasn’t occured.
I’m not disputing economic truths like Supply and Demand. I dispute the efficacy of Free Market economics. If I told you that the trajectory of a ball could be reasonably modeled within certain bounds based on some equation, and the calculations did not match the real world observations, you would rightly call me a kook. At some point, free market economic’s models are going to have to work in the world, or the field will continue to deserve its status as a humanity and not a science.
Austrians don’t claim that their theory, which blames Federal Reserve manipulation of the interest rate and the resulting discoordination of capital markets and consumer goods industries, explains breadth and depth. Government policy explains that. The Austrian theory simply explains the origins of the downturn.
The video I linked to spends about ten minutes explaining the Austrian theory of the cycle. I’d say it’s ten minutes well spent — not because I’m any great shakes, but because the theory is so compelling.
This is a very short version of the theory:
http://www.mises.org/story/606
This is a longer version, though still not the 100% ideal explication of the theory:
http://www.mises.org/story/1905
Incidentally, this is NOT the Friedman explanation, which is that the Federal Reserve didn’t do enough. The Austrian position is that the Fed did too much.
I assume you mean President Hoover, not President Wilson. In any event, to say that the economy didn’t correct itself, and that this therefore proves the free market to be silly and ineffectual, is I think about as wrong as wrong can be. You might advance such an argument if the U.S. government had responded with laissez faire and the economy hadn’t turned around. To the contrary, beginning with Hoover and accelerating through the New Deal, the government did just the opposite — the most radical and sustained program of state intervention in U.S. history. And the free market then takes the blame when it fails! Good grief.
Excerpt from the longer version Dr. Woods cited:
As you know, Keynes heavily disputed this assertion. Keynes would argue that by reducing spending you would further suppress demand. (Demand being expressed as private + public spending.) Continuing with Keynes, he would further assert that businesses won’t invest money unless they have an expectation of profit. The classical solution would further exacerbate this issue. While certainly not universally held, Keynes is generally credited with getting us out of that mess.
As an ancilliary note, I appreciate you interacting with my comments. You have extended a courtesy to an ameteur that was unnecessary, but appreciated.
I think it’s important to note that the Federal Reserve System was put into place primarily because of the huge increase in “financial panics” that occured earlier in 1873, 1884, 1890, 1893, and 1907. Similar panics also occurred earlier, but were becoming worse as industrialization removed people from the support of family farm life. In 1907, the market system was so overwhelmed, that JP Morgan took it upon himself to control private banking to try to manage the crisis.
To classify Hoover as some sort of statist is an interesting hypothesis, and one I’ve noticed is increasingly popular with conservatives who wish to excuse their theories with anything regarding the Depression, but I think it obscures more than it reveals. Clearly the Fed and the tariff contributed to the Depression, but there was widespread market failure as well. There is such a thing as incentive traps where individual actions to better yourself creates a worse condition so that all, including you, are worse off.
By the time FDR assumed office and began the New Deal, the country had fallen apart. FDR’s intervention did not end the Depression – it took a much more massive state intervention in the form of the war economy in the 1940’s to do that – but it did alleviate the worse conditions so much that people once again had faith in the country and no longer looked to fascism or communism as the answer.
While certainly not universally held, Keynes is generally credited with getting us out of that mess.
Actually, no. World War II is generally credited with getting us out of the mess that a decade and a half of Keynesianism couldn’t “fix.”
World War II would not have been possible without rejecting the classicalists’ insistence on balanced budgets. Defecit spending allowed the production for WWII machinery. At this point, the only debate is where the additional demand was created. Keynes’s point was merely that demand needed to be created. Lest the poor man be libeled, he advocated repayment of debt incurred during good economic times. Hence, Keynes still deserves credit. The joy of debt was not classicalist at all and has only been recently adopted by what are called neo-classicalists.
The myth that World War II lifted us out of the Depression is a tough one to shake. Consider my piece “The Myth of Wartime Prosperity”:
http://fee.org/vnews.php?nid=6467
On the issue of “demand,” this is one of Keynes’s worst fallacies. The idea that saving is bad for the economy because it means we’re not buying consumer goods is full of fallacies, I’m afraid. Some of this is covered in The Church and the Market.
To say that Keynesian has fallacies is to sidetrack from the primary issue. Up until Keynes, economists believed the axiom that “Supply creates its own demand.” This is still present today in supply-side economics. This is why Hoover’s advisors and the rest of the classical community believed that even a severe culling would pass. It didn’t though until Keynes.
1. Per Capita income had by 1941 returned to the 1929 level. The country was out of the depression in these terms but was suffering from labor market dysfunction manifested in elevated unemployment rates.
2. There were during those years two periods of contraction (1929-33 & 1937-38) followed by two periods of fairly rapid economic growth. The economic contraction of 1929-33 was exceptionally severe, with industrial production falling more than 30% v. the 3% one might find in an ordinary post-war business recession. That full recovery was a long time in coming is not necessarily surprising.
3. I believe economists of a variety of persuasions fault the Federal Reserve for passivity during the years running from 1929-33. Sir Alan Walters identified the maintenance of the gold standard and the failure of the central bank to maintain M1 during the liquidity crisis which hit the United States in 1931 as the salient factor in rendering the depression as severe as it was.
4. The notion that an appropriate response to a business recession is overall reductions in public expenditure is a corollary of certain schools within contemporary economic theory (rational expectations, &c.), but the premises and conclusions of these schools are by no means undisputed. The professors who taught me rudimentary macroeconomics had a great respect for markets. I can think of only one who would have disputed the empirical observation that aggregate demand can be stimulated by various means during a business recession (or the normative judgment that it should be, up to a point).
From Brad DeLong of Berkeley:
Source
Hey MZ Forrest…
Have you checked out the quarterly employment numbers over the last coupla years, and the overall unemployment rate? What do you want?
Mike E.,
They are pathetic by historical standards. Even 4 years after the first tax cut, the job creation/jobs lost had just reached the breakeven point. Yes I know there are a plethora of excuses of why this didn’t happen, the war and 9/11, even though a lot of the rosy projections were made after both events commenced. Not to be uncharitable, but I would like see better than “weaker than in any comparable period in a recovery since the 1930s.
Look, I know everyone has biases (including, you, me, Mr. DeLong, Mr. Kudlow, Mr. Bowyer, etc.) but still… Sperling worked for an evil-crat adminsitration! Of course he says that. If a (R) weren’t in the White House, the 4.9% unemployment and 5 Million new jobs would be a
‘big deal’, wouldn’t it?
Oddly enough I’m still a Republican, although I don’t know how much longer I will hold that affiliation. There is a reason the household survery isn’t used, and that is because it is always inflated. The theory is that many will respond that they are self-employed rather than admit they are unemployed. I do think 4 mil jobs, regardless, is a good thing. From the same table you link, you should concede the correlation of the tax cuts and jobs numbers are not obvious. I would go further and say they are absent.
Don’t want to interrupt the great back and forth going on, I just want to say that I really love it when Jimmy inserts the spanish into his posts. The ‘con permiso’ was a great touch, keep it up.
Cuidate,
HP