[ExI] Sudden outbreak of democracy baffles US pundits

gts gts_2000 at yahoo.com
Sun Oct 12 16:43:44 UTC 2008

--- On Sun, 10/12/08, Stathis Papaioannou <stathisp at gmail.com> wrote:

> But what lead to the great depression rather than
> an ordinary recession was the inaction of government and
> the central bank after the crash, allowing banks to fail and 
> the money supply to contract...

Your statement above seems consistent with the Monetarist School as espoused by Milton Friedman. Barbara Lamar's comments seem more consistent with the Austrian School as espoused by Ludwig von Mises and Friedrich Hayek.

According to the Austrians, the Fed's loose money policies before 1929 caused a speculative asset bubble that could not have ended in anything but a "big crash". The Austrians predicted the depression in those terms in real time. (The Monetarists did not 'predict' the depression until decades after it happened.)

Also according to the Austrians, by the time the Fed started to contract the money supply in 1928, it was already too late to stop the crash. And according to Austrian economist Murray Rothbard, expansion of the money supply after could not have prevented the depression (the Monetarist argument) because, among other things, fear of bank runs tied the Fed's hands.

>... because using fiscal and monetary policy to correct it was
> anti-free market.

The dismal science of modern economics still stood in its infancy. John Maynard Keynes did not publish his _General Theory of Employment, Interest and Money_ until 1936. Monetarism had not yet even appeared on the scene, except as a relatively minor and undeveloped element of Keynesianism. 

Keynes practically begged FDR to stimulate the world out of the depression with deficit spending, but not until the massive deficit spending of WWII did Keynes' theories finally get put to a serious test. His theories seemed to pass with flying colors, and to this day most economists mark WWII as the end of the great depression.

Post-war economists crowned Keynes King. He remained King until the 70's, when Keyensian theory seemed to offer contradictory antidotes to stagflation. Milton Friedman and the Monetarists then took the crown. Economists consider recent and current Fed philosophy a modified form of Monetarism. 

A question on my mind these days concerns how exactly to explain the radical growth in GDP during WWII without recourse to Keynes' theories. The Monetarists claim money supply is the answer, but I note that money supply bottomed in 1933 and trended almost straight up to the war. Unemployment never dropped below ~14% until the war, marking the end of the depression.

If Keynes had the wrong idea and Friedman had the right idea (the conventional view in 2008) then I wonder 1) why did it take 7-8 years of monetary expansion to end the great depression, and 2) why did the depression end so *radically* if not because of the similarly radical growth in deficit spending during WWII? 

If this current global financial crisis leads to (more) disaster then Friedman's theories may come under fire. It may be time for a global paradigm shift.


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