Causes of the Great Depression: The Austrian School of Thought

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One of the most often discussed topics in economics is the cause of the Great Depression of the 1930s. It is impossible to pinpoint the exact cause or causes of the depression, but many attempts have been made. The stock market crash, banking panics, an increase in world tariffs, loyalty to the gold standard, and reduced consumption have all been blamed. Each of these reasons probably played a part in the Great Depression. This paper will look at the Austrian School of thought regarding the causes of the Great Depression and look at how the same mistakes are being made today.

According to the Austrians, each depression follows a “boom-bust” cycle caused by multiple errors in economic decision-making. Rothbard explains these common features as a “cluster of errors.” The “boom” of a depression is a time of wasteful investment. This is caused by banks loaning out money at too high a rate. As newly acquired funds pour into businesses, businesses believe the supply of funds for investment has greatly increased and the interest rate falls. Businesses invest this money at a higher rate in the capital goods market, as they have been “tricked” into believing there has been an increase in saving by the consumer. Soon this bank caused inflation will trickle down the economy in the form of higher wages. The consumers, who have not actually increased their preference for saving, rush out to by consumer goods. The investment in capital goods by businesses turns out to be a waste.

The depression period is the economy correcting the errors of the boom. The increase in capital goods will either be abandoned or used in other ways. The economy will readjust itself to the needs of the consumer. The depression period is needed to return the econ...

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...sion will only cause greater harm. This can be seen in the period leading up to the Great Depression. The roaring 20’s seemed to be a time of unlimited prosperity due to Federal Reserve measures which continuously gave money to banks. Instead of realizing the problem, the Fed continued to loan out money until the market ultimately crashed. During the depression period, Hoover (as well as his successors) tried to fix the economy by putting more money into it. Austrians believe this caused further problems, and that those in power should have practiced laissez-faire economic policies while ending all inflationary actions. These same mistakes are still being made today, as explained by the housing bubble example. Until more policy makers realize the nature of the Austrian boom-bust cycle, the same mistakes will be made and the same consequences will have to be felt.

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