I started this as a long comment on the Hayek and deflation thread, but figured I'd make it separate post.
Yes, during 1920-21 we had deflation and yes we didn't have a Great Depression. But we did have a significant drop in GDP and unemployment of around 12%, and a recession that lasted about two years. It's possible that better monetary policy could have prevented such a steep recession. I know free banking could have. (And it's worth mentioning for all this debate about what the Fed should and shouldn't do that it's all about the world of the second best.)
And I absolutely agree on the importance of Hoover's wage policies for the depth of the Great Depression. I make that argument in my recent EJW piece. Part of the point is that the combination of government-generated severe wage rigidity and a falling money supply is a particularly deadly one. However, either alone is also bad. Put them together and you, not surprisingly, get 25% unemployment and all the rest.
Put differently: the 1920-21 episode was, in fact, a severe, though not particularly long, recession. Allowing the money supply to fall isn't painless. Allowing the money supply to fall in an environment of severe downward wage rigidity is VERY "not painless." The 1920-21 episode doesn't demonstrate that deflation is harmless. It DOES demonstrate that if you have deflation, it will be less bad if you have nominal wages that are flexible downward. That recession is the best example of why Hoover's wage policies were such a mistake. Hoover, as Secretary of Commerce, wanted to intervene in that recession but Harding held him off and we had "only" a severe recession. The 1920-21 episode does not, in my view, show that deflation by itself is painless. Read the rest... Steve Horwitz at Boettke's blog
