Friday, January 23, 2009


Did Deflation Cause the Great Depression?

Yet another sneak peek at my upcoming book. The standard mythology of the Depression holds that one of the main causes was (price) deflation: Falling prices make consumers reluctant to spend, but this just feeds on itself, blah blah blah.

So you probably think that the most severe deflation in U.S. history occurred in the early 1930s, right?

Nope, it actually occurred during the 1920-1921 depression. From June 1920 - June 1921, CPI fell 15.8%. In contrast, starting at November 1929 and going forward in 12 month increments, the greatest deflation was 10.4% from November 1930 - November 1931.

You know, the 1920-1921 depression, the one caused by laissez-faire reactionaries in the White House that you spent a week in history class discussing? Boy, I don't know about you, but I got so sick of how much class time we wasted going over the causes of the 1920-1921 depression. They didn't even have an SEC or Social Security back then. No wonder it was so awful!

Holy smokes! This graph seems like it should be the QED against Friedmanite view; I've never seen this before. How do monetarists respond to this?
Well, I guess one could make the argument that the early '30s deflation was more sustained than in '20/'21. This becomes evident when you plot the percent change in CPI from 3 years ago.
Let me guess, is the book title:
'The Politically Incorrect Guide to the Great Depression'?
Great data point. I am looking forward to reading your book!
I've been reading Rothbard's History of Money and Banking, where he shows how the deflation between 1839 and 1843 was a period of falling prices, but soaring economic growth.

I'm starting to get a little worried, I see you and the other Mises folks (like Frank Shostak even) tossing around this "(price) inflation" and "(price) deflation" stuff lately. This seems like a real divergence from the economic language the Mises institute scholars have typically tried to put forth in an effort to separate the concepts of cause (inflation/deflation) and effect (price movements).

I don't know if I understand it or like it. Was there some secret meeting of you LvMI people recently where you all agreed to start using inflation/deflation a bit more loosely, with the "(price)" caveat in place?

Aren't you worried about feeding the ignorance beast with this stuff?

Your thoughts?
I thought the "bad deflation" referenced by the mainstream was debt deflation (and bank failures ala Irving Fisher), more so than price deflatoin.

Can you email me (or post here if it's not long) a juicy Rothbard quote summarizing this? I don't need data, just him stating that there was price deflation coupled with prosperity for several years in US history.

(And I need full citation too.)

It may work for the book.


Taylor, no secret meeting, at least not one I was invited to. I am using the terms the average person does. It's like "public school." Yeah I try to say government school at, but if I'm doing a radio interview then I might slip because I'm talking to average people.
Well, I guess one could make the argument that the early '30s deflation was more sustained than in '20/'21.

OK, but it's still uncomfortable for their position. The only reason the "sustained" deflation in the 30s ended up bigger was because it lasted so much longer. The initial shock was much larger in 1921 than in 1930. But the economy quickly bounced back during the earlier episode. So it's very weird to blame the depths of the Depression on falling prices.
Hey Bob,

The secret meeting thing was kind of a joke, but still... how much do we help "average" people in their understanding of these economic issues if we cater to their ignorance by reinforcing the belief that inflation/deflation have to do with prices and not amounts of money/credit?

I guess why I got so peeved with this particular post is that the two things that stand out most are the title, asking about deflation, and the CPI graph, which a person who isn't reading too closely (say, your "average" reader) might take and put 2 and 2 together and come out with a (price) inflationary 5!

I was reading the Rothbard letter to the Volker Fund over at the new site and it got me thinking about this topic and what I think would be the implications of Rothbard's message in this case. Obviously, this is your blog and you are free to spread the word how you like, I just think personally that this is such an integral part of the liberty message and Austrian econ that it'd be more sensible to take a harder line on all of this.

Either way, I have a feeling Reisman is rolling on the floor of his hillside Laguna home right now, reading all these Misesians conflating price changes with the terms inflation/deflation!

Alright then, carry on for now Bob-o, but if I catch you slipping up too much and advocating something loopy like a wage-price spiral or cost-push inflation, there will be hell to pay!

I don't really see the sense in clinging onto the old meanings of words after the definition has shifted in the minds of the public. If I told somebody I was a liberal, that would technically be true (in its classical sense), but it would still most likely be pretty misleading. We can still communicate our ideas using today's language.
Hi Jeff,

I see what you're saying but how far do you let that concept go? In the mind of the "public" these days, an ideological, deregulated/unregulated, laissez-faire free market is what we have here in the United States right now.

Do we let the politicians and the ignorant public control the words and define our terms for us, or do we realize that ideas are important (as Rand said?), and that ideas are communicated through words, and thus the definition and validity and purity of our words is important to successfully communicating our ideas.

War is peace. Freedom is slavery.

Do you see where I am going with this?

I sure hope no one here is going to start calling me a radical... you wouldn't want to stroke my ego at a moment like this!

A corollary to the points I just raised would be the following: if you're going to cede to the politicians and the ignorati the right to redefine perfectly good words, do you find altogether new and different words to make sure people understand you're talking about different ideas, or do you turn to half measures like (parenthetical clarification)?

Yeah, I see what you're saying. I'm actually experiencing some of that frustration reading the Shock Doctrine by Naomi Klein. Throughout the book she attacks (and does a great job of it) the sort of government-contracts-with-"private"-firms-style-corporatism that we've been living under for the last little while, but then she calls it "radical free market ideology". It makes me want to yell at the book, "No! I'm a radical free-marketeer, and I agree that those things are horrible!" The book never responds.

So that's using words in a way that ultimately confuses the reader... but I don't think anybody is confused when they hear about inflation in its modern sense.

In the end, the purpose of words is for clear communication. If you think that "inflation" communicates the idea better than "expansion in the money supply", then that's fine. But in the circles I hang in, that would just confuse people.

Yes, I've felt the same way when reading books like "Confessions of an Economic Hitman." Ignoring the author's questionable personal morality and integrity for a moment, it was distracting to no end to see him describe some fascistic set-up between the US govt and a Latin American gov and watch him call it "capitalism," but the worst part was probably that, because of his confusion about what capitalism is, his conclusion throughout the book was more fascism/socialism, more statism and interventionism. Argh!

One other, final quibble about "inflation" specifically. If you let people define inflation as a rise in prices, you get into a situation where it's harder for people to understand that ONLY the central bank is responsible for inflation, and people can end up blaming all kinds of people and organizations BESIDES the central bank for inflation.

You get people blaming businesses (cost-push, "windfall profits"/extortionism), workers (wage price spiral), and any other number of things that, at the end of the day, can't sustain on their own a general, economy-wide rise in prices. George Reisman makes a point of this in his book "Capitalism" and I highly recommend the section for other arguments about maintaining a proper, Austrian definition for inflation/deflation.

I believe, also, that the Austrian definition is the historic definition, and that the change in definition occured recently and for expressly political purposes.
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