Monday, February 3, 2014

Debt Deflation: 1920–1921 versus 1929–1933

The issue of why the price deflation of 1920 to 1921 did not prove a more serious problem for the US economy, as compared with 1929 to 1933, is explained by two factors:
(1) the level of private debt in 1929 was much higher than in 1920–1921.

In particular, the 1920s (after 1921) saw an explosion in credit-financed consumption spending such as “instalment credit” and margin borrowing for asset speculation.

(2) the price deflation of 1920–1921 was preceded by a massive wartime inflation (1915–1918) and the inflation of the boom of 1919.
Factor (2) can be seen in the graph below (with data from

From 1915 there was a huge price (and wage) inflation that reduced the real value and burden of private debt (Kuehn 2012: 159). Even the deflation of 1920 to 1921 is not great relative to the preceding inflation.

Furthermore, the relative stability of the price level in the 1920s can also be seen above.

The rising private debt in the 1920s occurred in the context of a stable price level, and when the deflation came in 1929–1933 it was much more serious in its cumulative effects – along with all the other factors in this period such as the banking crises, mass loss of deposits, wage cuts, collapsing asset prices, the shocks to aggregate demand and so on.

Moreover, the 1920s had seen a fundamental change in the composition of private debt involving an explosion in private household debt to finance purchases of consumer durables through credit from “consumer lending institutions” (Brown 1997: 619).

Rather than commercial banks, it was consumer finance companies that accounted for this growth in credit: in 1919 there were very few consumer finance companies, but by 1925 there were around 1,500 such institutions (Brown 1997: 619).

Brown (1997: 624–633) points to a severe type of “household-debt deflation” that affected the US economy in 1929–1930, as households lost confidence and cut consumer spending to liquidate accumulated debt. This was but part of a broader debt deflationary trend, but was an important factor in the severity of the US depression in its initial years.

Brown, Christopher. 1997. “Consumer Credit and the Propensity to Consume: Evidence from 1930,” Journal of Post Keynesian Economics 19.4: 617–638.

Kuehn, Daniel. 2012. “A Note on America’s 1920–21 Depression as an Argument for Austerity,” Cambridge Journal of Economics 36.1: 155–160.


  1. Great piece LK. This is one of those Zombie arguments that get made again and again-partiuclarly by Internet Austrians-that the 1920-21 deflation proves that 'deflation works.'

    Here is another zombie argument that has just been dismantled-it's by a student of Miles Kimball-the claim that excess savings has not been a problem during this recession and slow recovery.

    I discuss it here.

    1. Thanks for this comment.

      Yes, people increased their savings from 2008 partly owing to uncertainty and partly in order to pay down debt: increased repayment of debt, however, does not necessarily translate into increased investment at all.

      And if one looks at what banks did with most of the excess reserves from QE 1, QE 2, etc. -- namely, hoard them at the Federal Reserve -- one can speak of this as massive bank savings