OPINION: Robert P. Murphy - The Depression You've Never Heard Of: 1920-21

Big-government Keynesians, such as Paul Krugman, argue for massive fiscal stimulus—that is, huge budget deficits—to fill the gap in aggregate demand. On the other hand, small-government monetarists, who follow in the laissez-faire tradition of Milton Friedman, believe that the Federal Reserve needs to pump in more money to prevent the economy from falling into deep depression.

Yet both sides of the debate agree that it would be utter disaster for the government and Fed to stand back and allow market forces to run their natural course after a major stock market or housing crash.

In contrast, many Austrian economists reject both forms of intervention. They argue that the free market would respond in the most efficient manner possible after a major disruption (such as the 1929 stock market crash or the housing bubble in our own times). As we shall see, the U.S. experience during the 1920–1921 depression—one that the reader has probably never heard of—is almost a laboratory experiment showcasing the flaws of both the Keynesian and monetarist prescriptions.

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