Interventionism Turns Crisis into Depression

Austrian economists have a well-developed theory that explains the boom, bubble, bust, and recovery. A good introduction to the Austrian theory of the business cycle can be found in Larry Sechrest’s article «Explaining Malinvestment and Overinvestment.» Larry wrote the article to provide a pedagogical device for economics students, but academic economists will probably be able to understand it as well.

Here we examine the case of business cycles where instead of recovery, the economy enters a prolonged economic depression or recession. The types of intervention that cause business cycles are restricted to money and credit. The types of intervention that cause depressions can be of a monetary, fiscal, or regulatory nature. Even moral suasion can contribute to the making of a depression, as was the case with Herbert Hoover.

The most effective depression-producing program would include a variety of interventions. The only necessary requirement is that the interventions help to forestall the correction process and that the interventions collectively undermine the ability of the price system and the system of profit and loss to properly reallocate resources. Austrians find that the cycle is the result of monetary intervention and that depressions emerge as the result of subsequent interventions designed to forestall the corrective processes of the bust.

Among all business cycles, few have degenerated into prolonged depressions or recessions. Most business cycles come and go so quickly that received wisdom recommends that the government do nothing except for minor adjustments to monetary and fiscal policy along with so-called «automatic stabilizers.» The exceptions to this rule include the Great Depression, the stagflation of the 1970s, Japan’s Lost Decade, and possibly the [Great Recession].

What makes the difference between the ordinary business cycle and an extraordinary depression? The one factor that is consistent in all four of the major crises is massive government intervention to address the initial economic crisis. In all four cases, the government responded not in the traditional laissez-faire manner of leaving things alone but instead with policies that attempted to reverse the economic crisis.

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