Tuesday, January 28, 2014

Soup Kitchens Caused The Great Depression And The Great Recession

Austrian business cycle theory was initially a story about how the boom prior to the Great Depression caused the economy to crash. The theory could not explain the duration of the Great Depression so the Austrians looked for another explanation.  They argued that unemployment benefits and other social services kept workers from accepting lower wages.  If they had accepted lower wages, the economy would return to full-employment.  The Austrian explanation for the Great Depression is very similar to what many conservatives argue today. Government programs prevent the labor market from functioning as it should.  Its the "soup kitchen story" all over again.

Keynes did not agree with that argument.  He suggested that if wages fell for all workers, prices would also fall.  Therefore, real wages would not fall and there was no incentive for business to hire more workers.  Price deflation was one of the more difficult problems to solve in the Great Depression.  Price deflation also meant that dollars were more valuable.  Therefore, debt became more difficult to service.  It had to be repaid with more valuable dollars.  Debt deflation also contributed to the duration of the Great Depression. 

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