The Great Depression
This article is part of the Intermediate course on Libertarianism and the Austrian School of Economics -> Keynesianism
Last updated: 2026-08-18
The Austrian explanation of the Great Depression (mainly that of the United States, 1929–late 1930s) is based on the Austrian theory of the business cycle (ABCT) of Mises and Hayek, explained in detail by Murray Rothbard in the book America’s Great Depression (1963).
They do not attribute the disaster to an inherent failure of market capitalism nor to a spontaneous “insufficiency of aggregate demand.” They see two distinct phases: an artificial boom caused by easy credit and a prolonged depression caused by interventions that prevented the adjustment.
1. The boom of the 1920s: the seed of the problem
The Federal Reserve (the Central Bank of the United States, also called “the Fed”) expanded credit (that is, it lowered the interest rate) significantly during the decade (especially 1924–1927, in part to help Great Britain maintain the parity of the pound).
Although consumer prices remained relatively stable (the Fed was pursuing “price stabilization”), that expansion artificially lowered interest rates below the natural rate (the one that reflects real time preference).
According to the scheme of the Hayek triangle:
- The structure of production was lengthened in an unsustainable way.
- Resources were diverted toward stages farther from consumption (capital goods, construction, the stock market, certain industrial sectors).
- Unsustainable Investments were created: projects that only seemed profitable with cheap credit and that were not backed by real saving.
The “boom” of the 1920s was not healthy, sustainable prosperity, but an intertemporal imbalance. Mises and Hayek warned of this before the crash.
2. The crash of 1929
When credit expansion could not continue at the same pace (the Fed tightened policy a little), the Unsustainable Investments were revealed.
The stock-market crash of October 1929 was the beginning of the correction, not its ultimate cause.
The recession that followed was, in principle, the process of liquidating errors: reconversion of resources, falling prices in overexpanded sectors, and reallocation toward uses more consistent with consumers’ real preferences.
3. Why it became the Great Depression
Here is the core of the critique of the Austrian School of Economics.
A typical recession (like that of 1920–21, which was very sharp but brief) would have been resolved relatively quickly if the market had been allowed to act. Instead, the later policies prevented the adjustment.
Herbert Hoover was not a pro-free-market president. He intervened in a way unprecedented for the time:
- He pressured firms not to cut wages (in order to “maintain purchasing power”). Because prices fell more than nominal wages, real wages rose, which enormously aggravated unemployment.
- He promoted public works, the Federal Farm Board (to support agricultural prices), the Reconstruction Finance Corporation, etc.
- He signed the Smoot-Hawley tariff (1930), which provoked retaliation, collapsed international trade, and worsened the situation.
These measures blocked the fall in relative prices and wages needed to rebalance the economy, prevented the liquidation of the unsustainable investments, and created uncertainty. Rothbard (and later work such as Ohanian’s) argue that Hoover’s high-wage policy was especially damaging.
Franklin D. Roosevelt intensified and expanded those same lines (the National Recovery Administration, with price and wage controls). The New Deal was not a radical break with Hoover, but its continuation on a larger scale. The result was a deeper and much longer depression.
Contrast with other interpretations
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Against Keynesianism: it was not an economy that got “stuck” for lack of spending. The problem was a distorted structure of production and policies that rigidified the markets.
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Against monetarism (Friedman-Schwartz): the Austrians recognize later errors of the Fed (monetary contraction), but they hold that the root cause lies in the expansion of the 1920s and that a certain price deflation was a necessary part of the adjustment. The prescription of “letting liquidation take place” is not passive indifference, but avoiding new distortions.
In short, for the Austrian School the Great Depression illustrates two chained errors:
- First, the easy credit that generates an unsustainable boom
- Second, the policies that prevent the market from correcting those distortions. The market did not “fail”; it was distorted and prevented from adjusting.
This article is part of the Intermediate course on Libertarianism and the Austrian School of Economics -> Keynesianism
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Last updated: 2026-08-18
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