Reply To: Why You've Never Heard of the Great Depression of 1920


Economic historian Jeff Hummel, an Austrian sympathizer but not himself an Austrian, writes:

“[Kuehn] ends up mainly nit-picking details about timing and such. To the extent that the Austrians believe the ’21 depression was a necessary result of previous wartime malinvestment, I agree with Kuehn and the monetarists, that instead the Fed’s sudden tight monetary policy was the primary cause. But nothing Kuehn writes contravenes any of the essential points made by the three Austrians: that here is a depression, with significant deflation, that was quickly over without any offsetting government intervention.

“Indeed, Kuehn’s most significant historical disagreement is not with the Austrians but with Milton Friedman, Anna Schwartz, and other monetarists. They attribute the Fed’s postwar tightening to concerns about gold flows whereas Kuehn argues that Benjamin Strong and other policy makers were only concerned about regaining price stability. But this strikes me as a distinction without much of a difference. None of the American policy makers at this time were advocating or even considering U.S. abandonment of the gold standard. Within that context, talking about price stability must implicitly invoke considerations about gold flows.

“A second theme of Kuehn’s paper is that the U.S. government’s handling of the ’21 depression is not inconsistent with the views of Keynes. As we know, the “correct” interpretation of Keynes’s GENERAL THEORY has been endlessly debated by economists, given the work’s ambiguity. By emphasizing Keynes’s early writings and even citing Hayek, Kuehn enters the fray and does make an intriguing case that Keynes distinguished between two types of depressions: one, during which interest rates and investment are low, requiring fiscal policy: the other, during which interest rates and investment are high, allowing flexible wages to restore full employment. But unless I missed something, Kuehn seems to obscure the critical difference between a disinflation that restores price stability after wartime inflation and actual deflation that nearly returns prices to their prewar level. While I’m prepared to accept that Keynes advocated the former, I am unconvinced that he really believed that the severe U.S. deflation of the early 1920s (steeper than that of the Great Depression) was necessary or desirable.

“Kuehn chides the three Austrians for neglecting some recent technical literature in which modern Keynesians attribute the 1921 depression, at least in part, to a supply-side shock. But a negative supply shock only reinforce the Austrians’ main point. Other things equal, such a shock would have raised the equilibrium price level. That would have required an even more massive downward shift in aggregate demand than otherwise to account for the drastic fall in nominal GDP in the early 1920s. Which makes still more telling the economy’s ability to quickly recover without government intervention. Moreover, the fact that the ’21 downturn was one of the few recessions (another being the Great Depression) in which real wages were actually counter-cyclical rather than pro-cyclical suggests that any supply shock was hardly a dominant factor.

“Kuehn minimizes the extent of Herbert Hoover’s support for government intervention, implying that there was no crucial ideological difference between him and Warren Harding or Calvin Coolidge. But this seems to rest entirely on a reading of the report of Harding’s Conference on Unemployment, which Hoover chaired. As far as I can tell, Kuehn is unfamiliar with the extensive historical literature on Hoover, which emphatically and firmly situates him as the Progressive Republican.

“On the Harding tax cuts, Kuehn contends that the Revenue Act of 1921, while reducing marginal tax rates considerably, simultaneously shifted tax brackets downward. While this is literally true, the shift did NOT increase the marginal tax rate at any income level. Kuehn relies on an IRS historical table that shows that ‘while the top bracket’s rate was reduced by 15 percentage points from 1921 to 1922 in Harding’s Revenue Act of 1921, the income taxable at that rate was expanded from all income over $1,000,000 to all income over $200,000.’ But the IRS table shows rates solely for the highest and lowest tax brackets, and nothing in between. Prior to the 1921 Act, there were three brackets above $200,000. The highest was reduced from 73 to 58 percent. The lowest, covering incomes between $200,000 and $500,000, was reduced from 68 to 58 percent.

“Kuehn goes on to report that ‘the percent of individual income collected as revenue through the income tax actually increased’ not only after the first revenue act passed but also from 1923 to 1925. I think this is correct. If so, I can only attribute it to the fact that rising incomes were driving people already paying income taxes (still less than a majority of the working population) into higher tax brackets.”