I have recently learnt about the depressions in the American history, and one of the most obvious indicator was that the money supply shrunk dramatically. I’m not talking only about the great depression (1930-), but also about the depression after the cilvil war. I understood that the money supply shrunk in 66%.
According to the austrian economics, when there is a recession, like we have right now in the U.S., it is a good thing that the interest rate will go up, since it will allow the asset prices to go down, people would begin save again, and bad businesses will go out of business.
So, on the one hand, a shortage in the money supply create recessions, and on the other hand, in a recession a high interest rate is a good thing. so really, how it is all fit together?
and one more thing - if the money supply shrunk in the depession, at some point the assets and prices should adjust to the limited money supply, and after a year or two the economy should be in the right balance again, to reset .let’s say, all prices went down in 50% - at some point there is a balance and the economy is going out of recession. Nevertheless, it created a depression, and there seems to be no reset. even after the civil war.
You haven’t identified the cause of the depression. Both depressions you speak of have something in common. What is it? Why it is legal tender of course.
According to Austrian theory, what catalyzed the recession was an increase in the money supply, not a decrease. Deflation comes about during the boom due to the necessary credit contraction.
I’m not sure most Austrians support the artificial increase of interest rates. I am sure that most support interest rates returning to their market value, based on the real rate of savings. On the other hand, many Austrians like to use the recession of 1920 as an example of a recession “solved” by allowing the market to reallocate resources. The Federal Reserve notably increased interest rates in 1920. But, I think that the recession of 1920 is not a perfect example, just an example of the Fed doing the exact opposite of what it is doing today and showing that the economy returned to normalcy much sooner.
I tell you what are my questions, my theory about it, and you tell me yours.
the Fed has increased the interest rate dramatically in the great depression, as far as I know. So, the contraction have happened and yet the depression worsen. isn’t that true?
The Milton Friedman’s always mentioning the depression that America had during the civil war. I dont’ think it was a boom-bust cycle, but a contraction.
Milton Friedman cited saying:
I know of no severe depression, in any country or any time, that was not accompanied by a sharp decline in the stock of money and equally of no sharp decline in the stock of money that was not accompanied by a severe depression.
What can you say to this claim?
I’m totally Austrian, but I tell you what I think.
There is a big difference between deflation of lowering prices (which is good and natural), vs deflation of severe contraction by credit drawings.
I do believe, that you can create depression not only by boom-bust and then intervention (like what is happening now), but also by a sharp contraction in money for over a long period of time.
I think that if the banks would suddenly demand their loans, and raise interest rate very high, there would be two things:
massive bankrupts - of business, and people. since they need credit to operate, in combination with very high interest rates.
exchangeability - I do believe there is that the market is also based upon exchangebility. when people are being demanded loans they were given in the boom period, not given any credit, and also have a too much high incentive to save and not buy - it damaging the exchangeability of the market.
If you prolong that period, by keep drawing back money & high interest rate, it damages this property.
Any thoughts? because it is make sense in some level that strong contraction could damage the economy, and again, after the civil war the money contracted in 66%, and in the Great Depression, from Friedman: " (the Fed) presided over a decline in the quantity of money by one-third from 1929 to 1933 …"
pretty confusing for Austrian like me.