A Critique of the Austrian School Interpretation of the 1920-21 Depression

Abstract

A series of recent reviews of the depression of 1920-21 by Austrian School and libertarian economists have argued that the downturn demonstrates the poverty of Keynesian policy recommendations. However, these writers misrepresent important characteristics of the 1920-21 downturn, understating the actions of the Federal Reserve and overestimating the relevance of the Harding administration’s fiscal policy. They also engage a caricatured version of Keynesian theory and policy, which ignores Keynes’s views on the efficacy of nominal wage reductions and the preconditions for monetary and fiscal intervention. This paper argues that the government’s response to the 1920-21 depression was consistent with Keynesian recommendations. It offers suggestions for when Austrian School and Keynesian economics share common ground, and argues that the two schools come into conflict primarily in downturns where nominal interest rates are low and demand is depressed. Neither of these conditions held true in the 1920-21 depression.