The Great Depression

The Great Depression

The Great Depression is probably one of the most misunderstood events in American history. It is routinely cited as proof that unregulated capitalism is bad, and that only a massive welfare state, huge amounts of economic regulation, and other interventions, can save capitalism from itself. Among the many myths surrounding the Great Depression are that Herbert Hoover was a laissez faire president and that FDR brought us out of the depression.

What caused the Great Depression? To get a handle on that, it's necessary to look at previous depressions and compare. The Great Depression was by no means the first depression this country ever had, but it was clearly the worst. What made it different than the rest? At the time of the Great Depression, government intervention in the economy was higher than it had ever been and a special government agency had been set up specifically to prevent depressions and their associated problems, such as bank panics. This agency was the Federal Reserve Board and it was to have been the loaner of last resorts for banks in order to prevent collapses as had happened during earlier depressions. But as we'll see, there is good reason to believe that the Fed's actions explain a lot of the problems that lead up to the Stock market crash and the subsequent depression.

Although there are many macroeconomics schools of thought, I'll be concentrating on two initially, Keynesian economics and Austrian School economics. Keynesian economics got its start during the Great Depression with the publication in 1936 of The General Theory of Employment, Interest, and Money, by John Maynard Keynes. Austrian School economics began much earlier, most notably with the publication in 1871 of Carl Menger's Principles of Economics. While the Austrian theory has never been mainstream (economist Paul Krugman refers to it as the economic equivalent of the phlogiston theory), its adherents are some of the harshest critics of Keynesian interventions, so it will serve as a good counterbalance until I can bone up on other schools of thought.

The exact cause of business cycles is one of the biggest problems in economics. There are several explanations. The current Keynesian models rely on what is referred to as "sticky wages" (or "sticky prices") to explain why the cycles occur. Under these