A critique of Powell, Woods, and Murphy on the 1920–1921 depression


A series of recent reviews of the depression of 1920–1921 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 1920–1921 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 1920–1921 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 1920–1921 depression.

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  1. 1.

    Each author presents a slightly different perspective on the 1920–1921 depression, although they have a broad enough similarity to be considered together here as an emerging Austrian and libertarian narrative. The citation of certain authors on specific points below is deliberate and reflects the somewhat different argument of each.

  2. 2.

    Why was a Federal Reserve brake necessary? Why did private banks not staunch the monetary expansion in 1919? What does this imply about how a system of free banking would have fared?

  3. 3.

    Senator Irvine Lenroot, a Republican from Wisconsin, was the preferred Vice Presidential candidate of Warren Harding in 1920, though he lost to Coolidge (Associated Press 1920). Much of Governor Strong’s understanding of monetary policy during the 1920–1921 depression will be drawn from his testimony before the Joint Commission of Agricultural Inquiry (August 2–11, 1921), in which Sen. Lenroot played a prominent role. The Joint Commission was organized in response to public outrage over agricultural price deflation, and provides a comprehensive review of Strong’s understanding of monetary policy during this period.

  4. 4.

    In his discussion of the practical advantages of inflation over nominal wage adjustments, Keynes makes the point that nominal wage adjustments are inherently going to meet with varying degrees of success across industries due to differences in bargaining power and other factors. For this reason, relying exclusively on nominal wage adjustments could actually exacerbate distortions in the market. A change in the price level, on the other hand, should fall far more equally across all workers (Keynes 1936).

  5. 5.

    It is plausible, of course, that Harding himself was never genuinely dedicated to the restoration of pre-war parities, and that his campaign rhetoric on the subject was simply that. If this were the case, then Harding, Strong, and Keynes would have indeed shared the same general outlook on the need for a corrective deflation, without any pious adherence to the value of the dollar before the war.

  6. 6.

    Murphy (2009) explicitly recognizes the policy activism of the Federal Reserve, avoiding Woods’s mistaken characterization of the Reserve as “hardly noticeable.”

  7. 7.

    Substantial government borrowing and demand pressure from the Allied powers began to influence the price level before the United States formally entered the conflict in April 1917, but inflation began in earnest only after the declaration of war.

  8. 8.

    The quarterly wage data of King (1923) is not directly comparable to the monthly wage indices, which can reach lower monthly troughs that would be averaged out in the quarterly data.

  9. 9.

    The Commerce series shows a GNP decline of 15% between 1919 and 1921, compared to a 3% decline in the Kendrick series. These are annual figures and, therefore, are not directly comparable to the monthly industrial production figures cited above.

  10. 10.

    The failure of Woods (2009) to mention the work of these more modern Keynesians and their finding that the 1920–1921 depression was not caused by a demand deficiency is especially egregious, since his article makes a point of highlighting the alleged negligence of modern Keynesians with respect to this episode.

  11. 11.

    See Hayek (1925) for a discussion of this adjustment in monetary policy.

  12. 12.

    A moving average is necessary because tax receipts and government expenditures fluctuated considerably from month to month. Moving averages of greater breadth than 3 months offered no additional smoothing.

  13. 13.

    An anonymous referee raises the concern that Keynes’s position substantially changed between the early 1920s and the General Theory, rendering simultaneous reference to the Tract and the General Theory tenuous. The concern is based on statements attributed to Keynes by Hayek about the shift in his views between 1930 and 1936, and Hayek’s unwillingness to respond to a book (the General Theory) that might be abandoned by its author within a couple years. Hayek’s criticism obscures the fundamental continuities in Keynes’s thought, at least with regard to the topics discussed in this paper. As Caldwell (1998), Howson (2001), and Butos (2003) point out, Hayek furnished several different reasons for not responding to the General Theory over the course of his life. His latest justification, the fear that Keynes would change his mind again, is perhaps a way of distancing himself from earlier justifications that were subsequently discredited (such as Hayek’s 1966 statement of his view in the 1930s that the General Theory was simply a “tract of the times”). Howson (1973) and Moggridge and Howson (1974) demonstrate that Keynes’s views on monetary policy and fiscal policy remained consistent between 1910 and 1946, and that apparent variations in his perspective can be traced not to a substantial difference in his position (although his theoretical framework had matured during this time), but to the circumstances under which certain policies would be appropriate and efficacious. When the facts changed, Keynes changed his mind on the ideal policy response. That is the fundamental conclusion of this paper as well.

  14. 14.

    These differential expectations and the different source of the downturn in the 1930s and in 1920 account for the response in consumer confidence. With no permanent supply shock and no demand deficiency to speak of, there was no reason to expect that consumers or investors would undergo a serious crisis of confidence.

  15. 15.

    A great deal of ink has been spilled over the question of whether a “liquidity trap” is determined by a 0% interest rate, or some low, positive rate; whether “liquidity traps” are best diagnosed with long-term or short-term rates; whether liquidity traps are a symptom of conditions in the loanable funds market or money supply and demand conditions; and whether or not monetary policy is ineffective in a liquidity trap (Boianovsky 2004). Regardless of these points of disagreement, Keynes is at least clear that the effectiveness of nominal wage and interest rate reductions becomes less effective at lower interest rates. Whatever disagreements exist over what Keynesians should advocate in a liquidity trap, Keynesians are in relative agreement about what to do when interest rates are high and a recovery is desirable: allow nominal wages to fall naturally, thereby lowering interest rates.

  16. 16.

    This is certainly evident in the work of Sir John Hicks and Edmund Phelps, who claim inspiration from both the Austrian school and from Keynes.

  17. 17.

    I find much to agree with in the critique of White (2008) of DeLong’s accusations. The label “liquidationist” is almost certainly too harsh, although as White (2008) himself suggests, neither Hayek nor Robbins made an effort to push for a more accommodating monetary policy during the Depression. However, I would argue in response to White (2008) that Hayek’s refutation of the Real Bills Doctrine (as described by White (2008) himself) implicitly suggests an opposition to an accommodating interest rate policy. Why would Hayek, in criticizing banking policy that does not let the interest rate rise with investment demand (relying instead on an expansion of credit), propose expanding the supply of credit even more when the previous problematic expansion begins to crest and collapse? The presentation of White (2008) of Hayek’s critique of the Real Bills Doctrine does not seem consistent with the presentation of White (2008) of Hayek as a theoretical proponent of accommodating monetary policy.


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I would like to thank Wayne Vroman, Tom Woods, Jeffrey Herbener, and two anonymous referees for their helpful comments. I am also grateful to Steve Horwitz for the insights he provided on how to frame this research so that it would be useful for the community of Austrian economists. The standard disclaimer applies.

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Correspondence to Daniel Kuehn.

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Kuehn, D. A critique of Powell, Woods, and Murphy on the 1920–1921 depression. Rev Austrian Econ 24, 273–291 (2011). https://doi.org/10.1007/s11138-010-0131-3

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  • Macroeconomics
  • Economic history
  • Keynesianism
  • Austrian School
  • Monetary policy
  • Fiscal policy

JEL Codes

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  • E12
  • E31
  • E32
  • E58
  • E62
  • N12