Friday, December 26, 2008

Rothbard on The First Great Deflation (1839-1843)

One of my Christmas presents was Murray Rothbard's "A History of Money and Banking in the United States". He writes about a period between 1839 to 1843 where the United States experienced deflation on a massive scale. Prices were estimated to have dropped by 42 percent, or 10.5 percent per year. According to the Keynesians, this should destroy the economy in a liquidity trap. Rothbard writes about what actually happened.

In a fascinating analysis and comparison with the deflation of 1929-1933 a century later, Professor Temin shows that the percentage of deflation over the comparable four years (1839-1843 and 1929-1933) was almost the same. Yet the effect of real production on the two deflations were very different. Whereas in 1929-1933, real gross investment fell catastrophically by 91 percent, real consumption by 19 percent, and real GNP by 30 percent; in 1839-1843, investment fell by 23 percent, but real consumption increased by 21 percent and real GNP by 16 percent. The interesting problem is to account for the enormous fall in production and consumption in the 1930s, as contrasted to the rise in production and consumption in the 1840s. It seems that only the initial months of the contraction worked a hardship on the American public and that most of the earlier deflation was a period of economic growth. Temin properly suggests that the reason can be found in the downward flexibility of prices in the nineteenth century, so that massive monetary contraction would lower prices but not particularly cripple the world of real production on standards of living. In contrast, in the 1930s government placed massive roadblocks on the downward fall of prices and wage rates and hence brought about severe and continuing depression of production and living standards.

The economy went on. Economic calculation was not inhibited by deflation.


dave said...

Brian ,
As I watch the auto bailout unfold so that wages can remain higher than markets would set them,and the never ending talk of bailing out the home owners so that the prices in the housing market won't fall further, I wonder what mistakes the "students" of the depression are making sure they avoid this time?

Brian Shelley said...

Oh yes, we are making a whole series of new mistakes that will take economic historians years to decipher all of them. It's an unfortunate time. Perhaps if the failure of stimulus is great enough Keynesianism will be dead forever.

Brian said...


Nice blog and greetings from an old classmate. It seems like one thing that is missing from your discussion of this is the effects on prices and output from the Industrial Revolution. Without putting a lot of thought into it that is my guess for an explanation of the difference between 1839 and 1929.

Brian Segers

Brian Shelley said...

Thanks for the complement Brian, and no I never did finish that rock song based on Walras' law (If you remember the conversation I'll be amazed).

As to your comment, I'm not sure what you mean. Are you suggesting that the economic rules changed between those two time periods? Or is it something else?