Saturday, October 23, 2010

The US Recession of 1920–1921: Some Austrian Myths

The US recession of 1920–1921 is endlessly cited by Austrians as proof that Keynesian economic policies are not needed to stimulate an economy out of recession or depression. Unfortunately, Austrians are deeply ignorant about the recession of 1920–1921. This recession was atypical, occurred shortly after the WWI, and recent research shows that the GDP contraction was not especially severe.

We can list some basic facts about the 1921 recession below and how these facts do not support the Austrian/libertarian myths one endlessly hears on their blogs:
(1) Duration of the Recession
The recession lasted from January 1920 to July 1921 (a period of 18 months). From January 1920 until July 1920 the recession was mild, and only became severe after July 1920 (Vernon 1991: 573), and the downturn persisted until July 1921.

Libertarians claim that the recession of 1920–1921 was short. Of course, what they don’t say is that a recession lasting 18 months is in fact a very long one by the standards of the post-1945 US business cycle. The average duration of US recessions in the post-1945 era of classic Keynesian demand management (1945–1980) and the neoliberal era (1980–2010) has been about 11 months (see Carbaugh 2010: 248 and the data in Knoop 2010: 13; curiously, there has only been one post-1945 US recession that lasted 18 months: the Great Recession of December 2007–June 2009, which was much worse than the 1920–1921 downturn). The average duration of recessions in peacetime from 1854 to 1919 was 22 months (Knoop 2010: 13), and the average duration of recessions from 1919 to 1945 was 18 months (Knoop 2010: 13).

In the post 1945 period this was cut to about 11 months. Thus the average duration of recessions was essentially cut in half after 1945, because of countercyclical fiscal and monetary policy. Even expansions in the post-1945 business cycle became longer: the average duration of post-1945 expansions was 50 months. By contrast, the average duration of expansions from 1854 to 1919 was 27 months, and the average from 1919 to 1945 was 35 months (Knoop 2010: 13). In other words, the average length of post-1945 expansions became 43% higher compared with that of 1919 to 1945, and 85% higher than between 1854 to 1919.

Macroeconomic performance after 1945 has been superior, without any doubt, to that of the previous gold standard eras. The recession of 1920–1921 with a duration of 18 months was in fact of long duration relative to the average of post-1945 recessions. Keynesian and even neoliberal economic management of the business cycle has been superior to the system that existed before 1933.

The empirical data tells us that, if Keynesian stimulus had been applied early in 1920, there are convincing reasons for thinking that the contraction would have been far shorter than 18 months.

(2) Severity of the Recession
Libertarians seem unaware that recent economic research has shown that the downturn of 1920–1921 was not as severe as previously thought. The widely accepted definition of a depression is a fall of 10% in output or GDP. In past estimates of the fall in national output, official Commerce Department data suggested that GNP fell 8% between 1919 and 1920 and 7% percent between 1920 and 1921 (Romer 1988: 108).

But Christina Romer has argued that actual decline in real GNP was only about 1% between 1919 and 1920 and 2% between 1920 and 1921 (Romer 1988: 109; Parker 2002: 2). So in fact real output moved very little, and this was not a depression on the scale of 1929–1933 or previous 19th century depressions. Libertarians cannot claim that 1920–1921 was an example of the free market quickly ending a downturn where output collapsed by 10% or more (a real depression). In reality, GNP contraction was relatively small, and the growth path of output was hardly impeded by the recession (Romer 1988: 108–112; Parker 2002: 2).

(3) Deflation and Positive Supply Shocks
Although deflation was very severe, one significant cause of the deflation was a positive supply shock in commodities due to the resumption of shipping after the war (Romer 1988: 110). After WWI, there was a recovery in agricultural production in Europe, even though American farmers had continued their production at wartime levels. When primary commodity supplies from other countries were resumed after international shipping recovered, there was a great increase in the supply of commodities and their prices plummeted. As Romer argues,
“Tiffs suggests that a flood of primary commodities may have entered the market following the war and thus driven down the price of these goods. That these supply shocks may have been important in stimulating the economy can be seen in the fact that the response of the manufacturing sector to the decline in aggregate demand in 1921 was very uneven …. The industries that were most devastated by the downturn were those in heavy manufacturing …. On the other hand, nearly all industries… that used agricultural goods or imports as raw materials experienced little or no decline in labour input in 1921 .... That industries related to agricultural goods and imports flourished during 1921 suggests that beneficial supply shocks did stimulate production in a substantial sector of the economy” (Romer 1988: 111).
Vernon (1991) comes to the same conclusion as Romer: the deflation in 1920-1921 was caused not just by a decline in aggregate demand but also by a positive aggregate supply shock. Another factor is that deflationary expectations were high after the war, as prices over the 1914–1920 period had increased by 115% (Vernon 1991: 577). This means that business was expecting deflation. We can contrast this with the 1929–1933 period when severe deflation was largely unexpected, and had much more harmful consequences.

(4) No Major Financial Crisis
The recession of 1920–1921 also had no serious financial crisis: although some bank failures occurred, there were no mass bank runs and collapses in 1920–1921 (Brunner 1981: 44). Stock market prices had been high before 1920 and overvalued and hit a peak 2 months before the onset of the recession. But this stock market bubble does not appear to have been caused by excessive private debt and leveraged speculation as in 1929. We can also note that the explosive rise in consumer credit to households and small businesses only occurred in the course of the 1920s (Parker 2002: 2), and thus large levels of private debt were clearly not a significant factor in 1920/1921. Thus debt deflationary effects were not as serious as in other recessions, and certainly not like the downturn of 1929–1933.

(5) The Federal Reserve’s Role
It is perfectly clear that the Federal Reserve had a role both in contributing to the cause of the recession and in ending it. As Vernon (1991: 573) notes,
“Monetary policy began to shift in December 1919, then changed markedly in January 1920. The Federal Reserve Bank of New York’s discount rate, which had been pegged at 4 percent since April 1919, was raised to 4.75 percent in December 1919, to 6 percent in January 1920, and to 7 percent in June 1920. Similar discount rate increases were made at the other Federal Reserve Banks. Friedman and Schwartz argue that these sharp increases came too late to be responsible for the January 1920 turning point but that they produced the severe contraction and deflation which came after mid-year.”
But, by 1921, there was monetary loosening. In April and May 1921, Federal Reserve member banks dropped their rates to 6.5% or 6%. In November 1921, there were further falls in discount rates: rates fell to 4.5% in the Boston, Philadelphia, New York, and to 5% or 5.5% in other reserve banks (D’Arista 1994: 62).

The role of the Federal Reserve underscores how the recession of 1920–1921 was not like US downturns in the 19th century, since the US had no central bank before 1914 (and after 1836 when the charter of the Second Bank of the United States expired). If we admit that Fed policy contributed to the recession, then it is highly probable that Fed easing of interest rates in 1921 also had a role in ending the recession, because the relatively lower interest rates after May 1921 preceded the expansion that ended the recession (which began in July 1921).

The recovery, then, has to be partly related to central bank policy, not to the pure free market eulogised by Austrian economists. (And in fact one of the reasons why there was no sharp recession after WWII was that the Federal Reserve kept interest rates very low after 1945 [Vernon 1991: 580]).
In light of all this, the recession of 1920–1921 was very different from the contraction of 1929–1933 and various other pre-1914 recessions that were preceded by excessive private debt, and caused by bursting asset bubbles, severe financial crises, demand contractions and debt deflation.

An obvious example of such a 19th century depression was that of 1893-1895. This was set off by a financial crisis in 1893 and caused the US to suffer high involuntary unemployment throughout the 1890s, even after a technical recovery had begun in 1895 (on this depression, see Steeples and Whitten 1998; Akerlof and Shiller 2009: 59-64; Romer 1986: 31).

The belief that the recovery in 1921 proves that a laissez faire or “do nothing” policy will work in other cases of serious recession or depression is utter nonsense. Above all, the empirical data show that modern macroeconomic policies have reduced the durations of recessions after 1945. There is no reason why in principle the 1920–1921 recession could have been alleviated and brought to an end sooner if countercyclical fiscal policy had been used.

I have recently seen an article by Daniel Kuehn called “A critique of Powell, Woods, and Murphy on the 1920–1921 depression.”
This also presents a critique of the Austrian view of the 1920-21 recession:

Kuehn also draws attention to the role of the Federal Reserve, and argues that its high discount rate (the primary policy tool in those days) in 1920 to combat inflation was a major factor in inducing the recession.

UPDATE 2, 18 January, 2011
I have just seen this page on the Mises forum where someone has copied my post above:

A commentator there has in fact unintentionally provided an important counterargument against the Austrians.

If Austrians think that the 1890s recession and high unemployment in that decade do not provide evidence against their theories (since the US had a national banking system and fractional reserve banking in the 1890s, instead of the pure laissez faire they advocate), then why on earth do they endlessly invoke 1920–1921 as if it proves the Austrian position?

If they really believe that 1890s America (where there was no central bank) cannot be invoked as a criticism of Austrian theory, then it is absurd in the extreme for Austrians to invoke 1920–1921 as vindication of their theories, when, in that period, America had a central bank! By your own definition, it was even less of a laissez faire system than 1890s America.

And, of course, given there was no period in recent history when the fantasy Austrian world of no fractional reserve banking, no fiduciary media, no regulation, and no government has ever even existed, there is no empirical evidence whatsoever that such a system would work or be stable.

All one can do is look to real world capitalism in the 19th century: given there was no central bank, a gold standard and minimal regulation in 1890s America, this must give at least an approximation of what their system would look like.
If Austrians think it is not an approximation, then the 1920–1921 period is utterly invalid too, in any attempt to vindicate their theory.

In short, this is another severe logical contradiction running through Austrian analysis.

All GNP figures are merely estimates, since proper data collection was not done before about 1945. There are four important studies on GNP before 1945:

Balke, N. S., and R. J. Gordon, 1986. “The American Business Cycle: Continuity and Change,” in R. J. Gordon (ed.), The American Business Cycle, University of Chicago Press, Chicago.

Balke, N. S., and R. J. Gordon, 1989. “The Estimation of Prewar Gross National Product: Methodology and New Evidence,” Journal of Political Economy 97.1: 38–92.

Romer, C. 1989. “The Prewar Business Cycle Reconsidered: New Estimates of Gross National Product, 1869-1908,” Journal of Political Economy 97.1: 1–37.

Ritschl, A., Sarferaz, S. and M. Uebele, “The U.S. Business Cycle, 1867–2006: Dynamic Factor Analysis vs. Reconstructed National Accounts,” January, 2010

The various estimates for 1920–1921 GNP:

The U.S. Department of Commerce = 6.9% GNP decline

Balke and Gordon = 3.5% GNP decline

Romer = 2.4% GNP decline

Balke and Gordon’s figures support a much lower decline for GDP.

The estimate of Ritschl, Sarferaz, Uebele (2010) is higher than that of Balke and Gordon and Romer.

For data on the persistence of double digit unemployment in the 1890s, see the revised figures in Romer 1986: 31.

Year Unemployment rate
1892 3.72%
1893 8.09%
1894 12.33%
1895 11.11%
1896 11.965
1897 12.43%
1898 11.62%
1899 8.66%
1900 5.00%

The US economy did not return to full employment for nearly a decade after 1893. Contrary to Austrian economic analysis, there is no evidence that the 1890s slump was rapidly ended by a laissez faire economy. In fact, since the US had no central bank in the 1890s, Austrians and other free market libertarians should be doubly embarrassed by the downturn in the 1890s and the persistence of high unemployment and sub-optimum growth.

The other widely used estimate of unemployment in the 1890s is the work of Stanley Lebergott. His estimates of unemployment are much higher than Romer’s, so, even if his estimates are invoked as more accurate than Romer’s, they would only make matters worse for the libertarian position.

And one might argue that Romer’s estimates are questionable (Lebergott 1992), and at least for the period from 1900-1929 (Weir 1986), as the idea that movements in the labour force were procyclical before 1945 can be challenged: if aggregate participation rates were anticyclical, then Lebergott’s estimates for 1900-1929 may be better (Weir 1986: 364; Weir 1992, however, does agree that Lebergott’s figures for 1890-1899 are too volatile). Here are Lebergott’s estimates of the unemployment rate:

Year Unemployment rate
1890 4.0
1891 5.4
1892 3.0
1893 11.7
1894 18.4
1895 13.7
1896 14.5
1897 14.5
1898 12.4
1899 6.5
1900 5.0

Akerlof, G. A. and R. J. Shiller. 2009. Animal Spirits: How Human Psychology drives the Economy, and Why it Matters for Global Capitalism, Princeton University Press, Princeton.

Brunner, K. 1981. The Great Depression Revisited, Nijhoff, Boston and London.

Carbaugh, R. J. 2010. Contemporary Economics: An Application Approach, M.E. Sharpe, Armonk, New York.

D’Arista, J. W. 1994. The Evolution of U.S. Finance, Volume 1: Federal Reserve Monetary Policy: 1915–1935, M. E. Sharpe, Armonk, New York.

Knoop, T. A. 2010. Recessions and Depressions: Understanding Business Cycles (2nd edn), Praeger, Santa Barbara, Calif.

Lebergott, S. 1964. Manpower in Economic Growth: The American Record since 1800, McGraw-Hill, New York.

Lebergott, S. 1992. “Historical Unemployment Series: A Comment,” Research in Economic History 14: 377–386.

Parker, R. E. 2002. Reflections on the Great Depression, Edward Elgar, Cheltenham, Northampton, MA.

Romer, C. 1986. “Spurious Volatility in Historical Unemployment Data,” Journal of Political Economy 94.1: 1–37.

Romer, C. 1988. “World War I and the Postwar Depression: A Reinterpretation based on alternative estimates of GNP,” Journal of Monetary Economics 22.1: 91–115.

Romer, C. 1989. “The Prewar Business Cycle Reconsidered: New Estimates of Gross National Product, 1869-1908,” Journal of Political Economy 97.1: 1–37.

Steeples, D. W. and D. O. Whitten, 1998. Democracy in Desperation: The Depression of 1893, Greenwood Press, Westport, Conn.

Vernon, J. R. 1991. “The 1920–21 Deflation: The Role of Aggregate Supply,” Economic Inquiry 29: 572–580.

Weir, D. R. 1986. “The Reliability of Historical Macroeconomic Data for Comparing Cyclical Stability,” The Journal of Economic History 46.2: 353–365.

Weir, D. R. 1992. “A Century of U.S. Unemployment, 1890–1990: Revised Estimates and Evidence for Stabilization,” Research in Economic History 14: 301–346.


  1. Lord Keynes,

    i wanted to add something on the previous thread that referenced the 1920-1921 recession. it is true of course that the Fed contributed to this recession,by hiking up discount rates, and its end, by slashing them after July 1921.
    But there was much more deflation in that recession than in the great depression. If deflation is so horrible and evil, and there is a nasty one-for one correlation between deflation and depression how in God's good name do you explain the relatively small decline in the real national product? to your credit, you talk about positive aggregate supply shocks. Mainstream economists as far as I know don't care about the difference between "good" deflation of that kind versus "bad" deflation we know about. To them all deflation is terrible, (which is stupid in my opinion) Also Bernanke mentions that there was much more waage and price flexibility in this recession that in the Great Depression, which is a score on the side of the classical school. Also you claim that there was not much debt. But as I said before, the way way enforce debt contracts in this country is INSANE! We pretend that money has a constant value when it doesn't. Nominal Debt should be indexed to a falling price level. (I know that it isn't, but it should!!!) It's a simple solution to the problem of debt deflation. All it requires is a little imagination.
    Also you talk about the nineteenth century as a period where "laissez faire" failed. realtive to the Keynesian era. Um, Lord Keynes, the nineteenth century wasnt a period of laissez faire, not really, Look at the monetary contraction initiated by government, both by Andrew Jackson in his Specie Circular and the "crime of 1873' which demonetized silver. Of Course that will lead to depression. Also, the stickiness of debt contracts during the civil war and the hardships they inflicted ont the farmers played an enormous role. All of which plays into my theory that Say' Law doesn't work in the short run, (which explaisn why depressions happen) but does work in the long run. how do we know Say's Law works in the long run? Because the depressions of the nineteenth century eventually ended, despite the presence of cruel pro-cyclical policies initiated by the government. Government didnt engage in massive deficit spending during the nineteenth century. but yet the economy still recovered. According to you, how? And yes, maybe countercyclical policies would have helped, but as we see now, there is no guarantee that foolish politicians and incompetent central bankers would have the guts pursue a strong countercyclical policy.
    So why not have an automatic stabilizer in the form of long term contracts indexed to a falling price level. It would be more reliable than waiting for the government to help, which is like waiting for godot

  2. Edward,

    Thanks for your comment. You make some intelligent points I agree with, on the Fed's role, deflation, and debt deflation. I did reply on the Krugman in Wonderland blog.

  3. " The widely accepted definition of a depression is a fall of 10% in output or GDP. "

    And Austrians reject GDP as a meaningless indicator. So much for your analysis.

  4. Just continuing our discussion on the "Say's Law" thread. Here's Rothbard on your unintelligent insistence on the word "immediate" as a refutation of Say's Law.

    " It is true, as we have said, that the only use for money is in exchange. From this, however, it must not be inferred, as some writers have done, that this exchange must be immediate. " - Man, Economy and State with Power and Markets, 2009, pp 767

    I was right after all!!

  5. And Austrians reject GDP as a meaningless indicator

    If GDP, GNP, and other aggregates are meaningless, then you have no basis whatsoever to claim that libertarian/laissez faire systems are superior in performance to Keynesian systems.

    Rejection of aggregates by Austrians is self-defeating nonsense.

  6. And Rothbard's analysis is laughable.
    With changing idle money balances, Say's law does not work, and any Austrian defense of Say's law by invoking Rothbard's reservation demand idea is a complete joke.
    Rothbard also says:

    Similarly, a decrease in the money stock
    involves no social loss ... a fall in the money stock increases the purchasing power of each unit
    (Rothbard, 2004 [1962]. Man, Economy, and State, p. 766).

    He has clearly never heard of debt deflation. Another major flaw.

  7. Asertions, assertions and more assertions!! That's not to say that I expected any argument from you.

    What's laughable is your repeated insistence on the same nonsense even after it has been ripped to shreds. Carry on. It's your blog after all. You can say anything you want on it. It, however, does not have to make sense.

    Ah!! Debt deflation...... Blame it on the prior inflation......

  8. That was an interesting article and I agree with most of it. However, I think it should be valid to point out that this recession might also have been just a momentary recession caused by the restructuring of the economy from a war economy to a peace economy. A similar recession occurred after WWII in 1949 and ended even faster.

    This makes it completely different from other recessions because everyone knows where the economy is supposed to go. It was basically one of the rare cases where the Austrian school's theory of malinvestments and resource reallocation is valid, because during the war resources have been allocated to the war effort, which isn't a good long-term investment prospect. So when that war ends, the resources have to be reallocated, and employees are fired by war industries that are winding down and hired quickly by civil industries that are picking up.

    This contrasts with the present recession where every sector of the economy is firing people and no one is really hiring. Which is the same as in 1929. Plus all the factors you point out, especially the debt problems and the financial crisis aspect.

    Still, I think the Keynesian approach can still help in that type of recession a bit, if the reaction is quick enough. Using the momentary lapse in economic activity to make some public investments and use those otherwise idled resources. Then letting go when the private economy picks up again.

  9. OMG, trying to identify Mises with fascism! That is a fascist joke. You are obviously aware and exceedingly embarrassed by the unfortunate fact that the original Lord Keynes' wrote a special foreword to the German edition of his GENERAL THEORY. In that foreword, addressed to the German people, and it is safe to say particularly to Adolph Hitler, Keynes made this appeal: " "The theory of aggregate production, which is the point of the following book, nevertheless can be much easier adapted to the conditions of a totalitarian state than the theory of production and distribution of a given production put forth under conditions of free competition and a large degree of laissez-faire. This is one of the reasons that justifies the fact that I call my theory a general theory." Hitler went on to put into effect many policies called for by Keynes GT in order to achieve the full-employment nirvana, which was the focus of Keynes GT. With a few macabre twists of his own design, Hitler's Germany was the only instance in history where Keynesian economic policies were fully implemented and they did in fact achieve full employment at a cost that only a Keynesian would find acceptable. Hitler's "public-works" programs aimed at Keynes' full-employment included a universal military draft of men from old age to teen age, a massive military-industrial complex to produce munitions at the expense of consumer goods, concentration camps to employ "inferior" workers, genocide to eliminate excess Jewish workers, and war to reduce the workforce to a more manageable level by using men as canon fodder.

    LK, you are a scoundrel. You will do or say anything in you fruitless effort to discredit Ludwig von Mises, whose brilliant works of economic science stand as an impenetrable barrier to the balderdash posing as economics that John Maynard Keynes spouted and you mimic. More than any man of the 20th century, Mises provided the intellectual material to discredit the assertions of communists, fascists, national socialists, syndicalists, Marxists, Keynesians and all of the other proponents of statist collectivism.

  10. Keynes’ foreword to the German edition of the General Theory was in no way a defence of, or support for, fascism. That claim is utterly laughable.
    Keynes was basically saying that an authoritarian state can more easily implement any economic policy it wants, which is correct. Authoritarian states have implemented Friedmanite laissez faire economics (as in Pinochet’s Chile) and command economies (as in the Soviet Union) or even mixed economies with deficit spending. Pointing this out does not constitute a defence of authoritarianism.
    You say:

    Hitler went on to put into effect many policies called for by Keynes GT in order to achieve the full-employment nirvana, which was the focus of Keynes GT

    You have your history wrong. Keynes’ General Theory was published in 1936. Hitler came to power in 1933. Hitler’s public works programs and deficit spending had ALREADY been implemented by 1936. It is utterly ridiculous to say that Keynes’ General Theory “inspired” Hitler when the book didn’t even exist until 1936, long after Hitler had already come to power and implemented his economic program.

    With a few macabre twists of his own design, Hitler's Germany was the only instance in history where Keynesian economic policies were fully implemented and they did in fact achieve full employment

    Perfect nonsense. Keynesian economics was used all over the world after WWII and full employment was the norm in virtually every Western country, through Keynesian fiscal and monetary policies.

    The rest of your comment is rubbish.

    And as for Mises, his contemptible hypocrisy and positive remarks about fascism are clear for all to see:

    It cannot be denied that Fascism and similar movements aiming at the establishment of dictatorships are full of the best intentions and that their intervention has, for the moment, saved European civilization. The merit that Fascism has thereby won for itself will live on eternally in history (Mises 1978: 51).

    Ludwig “Fascism-will-live-on-eternally-in-history” von Mises was utterly wrong and a perfect idiot.

    1. "Keynesian economics was used all over the world after WWII and full employment was the norm in virtually every Western country, through Keynesian fiscal and monetary policies."

      Not according to this economist with respect to the UK economy?

      “Was the low unemployment of the 1950s and 1960s due to 'Keynesian' policies, such as government deficit spending or expansion of the money supply? The answer must be 'no', . . . “ P2

  11. The old Mises hearts fascism agitprop only works when you omit the very next few sentences, which read:

    "But though its policy has brought salvation for the moment, it is not of the kind which could promise continued success. Fascism was an emergency makeshift. To view it as something more would be a fatal error."

    Moreover, if you read the other 95% of the pertinent section of Mises' Liberalism, you'll see that "salvation for the moment" refers to the sparing of untold many Europeans who otherwise would've perished at the hands of the mass-murderous, mass-impoverishing "Marxist Social Democrats."

    For example, the paragraph immediately preceding the one quoted by this Social Democratic blog's editor:

    "This moderation is the result of the fact that traditional liberal views still continue to have an unconscious influence on the Fascists. But however far this may go, one must not fail to recognize that the conversion of the Rightist parties to the tactics of Fascism shows that the battle against liberalism has resulted in successes that, only a short time ago, would have been considered completely unthinkable. Many people approve of the methods of Fascism, even though its economic program is altogether antiliberal and its policy completely interventionist, because it is far from practicing the senseless and unrestrained destructionism that has stamped the Communists as the archenemies of civilization. Still others, in full knowledge of the evil that Fascist economic policy brings with it, view Fascism, in comparison with Bolshevism and Sovietism, as at least the lesser evil. For the majority of its public and secret supporters and admirers, however, its appeal consists precisely in the violence of its methods."

    So, contrary to what this blog's editor claims, Mises was not praising fascism per se: he was appreciating that the fascist regimes, when compared to their communist counterparts, were rather liberal, and that the temporary, relatively disaster- and genocide-averting results ("merit") of their post-communist rule would be remembered forever.

    BTW: When people refer to the 1920–21 depression as being relatively short, they usually are comparing it to the Great Depression. But I'm sure all discerning observers already knew that, too.

    Lord Keynes,
    I just finished reading this book. I don't see any increase of wage rates.
    Oh, and about discount rate.

  13. The discount rate was lowered significantly by the end of November 1921 - completely consistent with the Fed's role in bringing the downturn to an end by loosening monetray policy.

  14. People are waking up to the realities of Keynesianism.

    People are waking up to the fact that the fruits of their labors are unlawfully confiscated, that truly private property and real ownership are increasingly distant.

    More and more citizens are waking up to the reality that Keynsianism, the Federal Reserve and its apologists are enablers for the plutocratic oligarchs that really run this country, allowing them to continue in their despotic and clepto-manic ways on the backs of a formerly free people.

    Just give it up. The paradigm has failed and people are seeing through it. Your time is over.

  15. "More and more citizens are waking up to the reality that Keynsianism, the Federal Reserve and its apologists are enablers for the plutocratic oligarchs, etc ..."

    The current economic system is largely the result of neoclassical thought (whether it is monetarism, new Classical macro, or just the new consensus macro), not Keynesianism.

    Keynes's thought has a big future.

    Libertarianism and Austrian economics will go to the dustbin of history.

  16. Seriously? You're claiming that the Austrians state "myths"? Umm... how's that Keynsian experiment known as Europe doing right about now? What did I see 1 yr Greek bond yields at this morning, was it 240%? Italy on the brink of the same fate...then the rest of Europe, and then probably the U.S. Pretty much teh projected course the Austrians projected all along. You're an idiot.

  17. The Eurozone isn't a "Keynesian" experiment. Quite the reverse.

    You're an ignorant fool, Anonymous.

  18. I have to say thank you for this writ-up. I watched a snippet of Bloomberg found here:

    The guy who's been chosen by Ron Paul to replace Ben Bernanke was glorifying the 1921 recession as a free-market success story and I immediately thought of this post. Well done sir and thank you.

  19. "The country’s tariffs were raised in 1921 specifically to defend U.S. producers against the prospect of Germany and other countries depreciating their currencies under pressure of their foreign debts.19 In May of that year prices began their collapse in the United States, following the drying up of European markets that had been supported by U.S. War and Victory loans. An emergency tariff on agricultural imports was levied, followed in 1922 by the Fordney Tariff which restored the high level of import duties set by the Payne-Aldrich Act of 1909. Tariffs on dutiable imports were raised to an average 38 per cent, compared to 16 per cent in 1920.
    Even more devastating to international trade, the American Selling Price features of
    the 1909 act were also restored as the “equalized cost of production” principle and applied it to a number of commodity categories. This meant that tariffs were levied not according to the value of imports as charged by foreign suppliers, but ccording to the value of similar goods produced in the United States. This legislation made it virtually impossible for other economies to undersell U.S. producers in the American market. The President was authorized to raise tariffs wherever existing duties were insufficient to neutralize the
    comparative advantage of production costs enjoyed by other countries."

  20. "Perfect nonsense. Keynesian economics was used all over the world after WWII and full employment was the norm in virtually every Western country, through Keynesian fiscal and monetary policies."

    This analysis of the UK economy may make you think differently?

  21. The Great Depression lasted 10 years... smh

  22. If the government uses the Keynesian model of economics by pumping money into banks to artificially lower interest rates, then we can predict an artificially boom coming and an inevitable bust to follow it. The only way we can predict how long it will last depends on how quick or long the government will take to stop "preventing" the recession from coming. The longer they take, the harder the bust will be.

    Keynesians always try to somehow disprove that the Austrian Theory of Economics is flawed because we haven't had central banks at times. Fact is, in downturns like in 1819, 1830's, 1857, and 1873 was accompanied by banks alone and the Second Central Bank creating credit. They created more credit than there was Gold in the system. Among other things.

  23. "And, of course, given there was no period in recent history when the fantasy Austrian world of no fractional reserve banking, no fiduciary media, no regulation, and no government has ever even existed, there is no empirical evidence whatsoever that such a system would work or be stable. "

    The "fantasy" is yours, since the Austrian model is not economic anarchy. This is a straw man argument.

  24. You omit, just as does Krugman, the fact that Harding slashed the federal budget during th e relevant time frame--the exact opposite of the prescription of liberals such as the aforementioned. A salient omission!

  25. Dear Lord Keynes,

    First off, thanks for the post. I like to challenge any current opinions or thoughts I have.

    1) "Austerity"

    I thought it was odd that you didn't mention Dr. Woods major point regarding 1920, that Keynesians claim recession cannot be escaped (in the short run) absent government intervention. Considering that from 1919 to 1920, federal spending was slashed from $18.5 billion to $6.4 billion—a 65 percent reduction in one year, the very opposite of a Keynesian policy was implemented, yet the recession was ended after 18 months. Perhaps Dr. Woods is incorrect in his understanding of Keynesian claims?

    2) "Duration of the Recession".

    I think Austrians would look at this from a long term perspective that 18 months is better then a quick fix which only leads to further problems down the road. e.g. replacing bubbles with new ones. Or shortening a recession by 7 months by not curing the root causes.

    3) "Severity of the Recession"

    Let us simply assume that your evidence is correct and the recessions severity has been exaggerated.

    You mentioned GNP. However, you did not address unemployment figures, which jumped from 4% to 12% during 1920. [1] Would you not agree that is severe consequence of the recession? Given that, how does Keynesian economics address that unemployment rate falling to 6.7% in 1922, and 2.4% in 1923, given the implementation of Austerity?

    4) "The Federal Reserves Role"

    Austrians acknowledge the role of the Federal Reserve in contributing to the causes behind the recession.
    Regarding their contribution to ending it…

    ""Despite the severity of the contraction, the Fed did not move to use its powers to turn the money supply around and fight the contraction." [2]

    When looking at your changes in the interest rate, and considering this comment, I believe that Dr. Woods would argue these interest rate changes during 1920-22 were not significant enough to have much impact.

    "The years preceding 1920 were characterized by a massive increase in the supply of money via the banking system, with reserve requirements having been halved by the Federal Reserve Act of 1913 and then with considerable credit expansion by the banks themselves.

    Total bank deposits more than doubled between January 1914, when the Fed opened its doors, and January 1920. Such artificial credit creation sets the boom–bust cycle in motion. The Fed also kept its discount rate (the rate at which it lends directly to banks) low throughout the First World War (1914–1918) and for a brief period thereafter. The Fed began to tighten its stance in late 1919." [1]
    I look forward to you addressing these points in your post. Also, I would like to suggest you change your tone regarding theories you disagree with, or think little of. If you actually want to convince them that they are wrong, you might find them more receptive if you watch the name calling. :)

    [2] Kenneth E. Weiher, America's Search for Economic Stability: Monetary and Fiscal Policy Since 1913 (New York: Twayne, 1992), p. 35.

    1. aleksander pruitt@October 10, 2013 at 12:57 PM,

      (1) "Dr. Woods major point regarding 1920, that Keynesians claim recession cannot be escaped (in the short run) absent government intervention."

      Keynesians do not claim that at all: it is a straw man. Keynesians say that if the private sector cannot provide the aggregate demand, then government stimulus is a good alternative method by which to drive an economy quickly back to full employment, provided the stimulus is large enough.

      However, history teaches us that the private sector is unreliable and recessions last longer and are deeper without stimulus or government stabilisation.

      (2) I take it you do not despite the point that the 1920-1921 recession was not short by post-1945 standards?

      And I do not accept your point because I do not accept the Austrian diagnosis or cure for recessions.

      (3) unemployment recovered *relatively* quickly, yes. But since you seem to believe the straw man in (1) above, it is only you who think that somehow this presents some big problem for Keynesians. It doesn't.

      And it is highly probable that if stimulus had been effected in 1920, the recession would have shorter still and unemployment would never have deepened so much in the first place.

      (4) ""Despite the severity of the contraction, the Fed did not move to use its powers to turn the money supply around and fight the contraction."

      That is plainly wrong.

      The FED did increase the money supply significantly in 1920-1921 and cut interest rates:

      Discount Rate of the Federal Reserve Bank of New York
      Date | Rate
      May | 6%
      June | 7%
      Dec. | 7%
      Jan. | 7%
      Apr. | 7%
      May. | 6.5%
      Jun. | 6%
      Jul. | 5.5%
      Sep. | 5%
      Nov. | 4.5%

      Jan. | 4.5%
      Jun. | 4%.

  26. Dear Lord Keynes,

    Thanks for your speedy reply.

    1) Thanks for the clarification.

    2) I don't have an opinion on the matter, I was simply pointing out why an Austrian wouldn't be moved by the length given other factors. So if your trying to persuade an Austrian you would need to take your analysis further.

    3) You didn't answer my question, how does Keynesian economics explain falling unemployment given the severe austerity program. I know what Austrians say, I want to hear from the other side.

    4) Perhaps the issue here is that Austrians do not see a 2% reduction in the discount rate over a 2 year period as a substantial increase in the money supply, as opposed to say 5% to 0%?

    Have you ever written to Dr. Woods on this issue?


    Aleksander Pruitt

    1. (2) 1920-1921 was unusual recession. There was no debt deflationary collapse. No mass banking failures. There were positive supply shocks.

      The recovery happened as private sector business confidence and investment increased.

      My views on 1920–1921 are given here:

      “The US Recession of 1920–1921: Some Austrian Myths,” October 23, 2010.

      “There was no US Recovery in 1921 under Austrian Trade Cycle Theory!,” June 25, 2011.

      “The Depression of 1920–1921: An Austrian Myth,” December 9, 2011.

      “A Video on the US Recession of 1920-1921: Debunking the Libertarian Narrative,” February 5, 2012.

      “The Recovery from the US Recession of 1920–1921 and Open Market Operations,” October 4, 2012.

      “Rothbard on the Recession of 1920–1921,” October 6, 2012.

      (3) GDP = C + I + G + (X-M)

      If G does not increase, then a recovery will happen by increases in I, and/or C, and/or X-M.

      In 1920-1921, while I have not looked at the breakdown of GDP recently and can't remember the exact stats, I would assume I and C increased, and quite likely exports as well as international trade resumed and Europe was rebuilding.

      (4) interest rate reductions are not the same thing as an increase in the money supply.

      If you are not disputing that the Fed lower rates and helped the recovery, then it is clear that Austrian explanations of 1920-1921 that ignore the role of the Fed are flawed.

    2. I'll add that 1920-1921 was arguably like the depression of 1945-1946: right after a war and unusual or sui generis.

      If you want a more typical pre-Keynesian US recession look at the 1890s:

      There was a double dip recession and serious unemployment that did not end quickly. Romer's unemployment estimates:

      Year | Unemployment Rate
      1892 | 3.72%
      1893 | 8.09%
      1894 | 12.33%
      1895 | 11.11%
      1896 | 11.965
      1897 | 12.43%
      1898 | 11.62%
      1899 | 8.66%
      1900 | 5.00%
      (Romer 1986: 31).

      Vernon’s (1994) figures:

      Year | Unemployment Rate
      1890 | 3.97%
      1891 | 4.34%
      1892 | 4.33%
      1893 | 5.51%
      1894 | 7.73%
      1895 | 6.46%
      1896 | 8.19%
      1897 | 7.54%
      1898 | 8.01%
      1899 | 6.20%
      (Vernon 1994: 710).

      Despite austerity there was no quick recovery in unemployment.