In 2009, Lee Ohanian published the article, “What—or Who—Started the Great Depression,” in the prestigious Journal of Economic Theory (JET) in which he cited Murray Rothbard. For this article, Ohanian spent four years poring over wage data and culling information from sources related to Hoover and his administration. Based on his research, Ohanian argued that Hoover’s policy of propping up wages and encouraging work sharing “was the single most important event in precipitating the Great Depression” and resulted in “a significant labor market distortion.” In a Mises Daily article in September 2009, I called attention to the importance of Ohanian’s article. Here is part of what I wrote:
Ohanian contends that Hoover’s policy of propping up wages and encouraging work sharing “was the single most important event in precipitating the Great Depression” and resulted in “a significant labor market distortion.”
Thus, “the recession was three times worse — at a minimum — than it otherwise would have been, because of Hoover.”
The main reason is that in September 1931 nominal wage rates were 92 percent of their level two years earlier. Since a significant price deflation had occurred during these two years, real wages rose by 10 percent during the same period, while gross domestic product (GDP) fell by 27 percent. By contrast, during 1920–1921 — a period that was accompanied by a severe deflation — “some manufacturing wages fell by 30 percent. GDP, meanwhile, only dropped by 4 percent.”
As Ohanian notes, “The Depression was the first time in the history of the US that wages did not fall during a period of significant deflation.” Ohanian estimates that the severe labor-market disequilibrium induced by Hoover’s policies accounted for 18 percent of the 27 percent decline in the nation’s GDP by the fourth quarter of 1931.
Regarding the now-conventional explanations of the Great Depression, such as widespread bank failures and the severe contraction of the money supply, Ohanian points out that these two events did not occur to a significant extent until mid-1931, which was two years after the implementation of Hoover’s industrial labor market policies.
Moreover, Ohanian argues,
any monetary explanation of the Depression requires a theory of very large and very protracted monetary nonneutrality. Such a theory has been elusive because the Depression is so much larger than any other downturn, and because explaining the persistence of such a large nonneutrality requires in turn a theory for why the normal economic forces that ultimately undo monetary nonneutrality were grossly absent in this episode.
The conclusion of Ohanian’s paper is quite — one is tempted to say “hardcore” — Rothbardian.
The Great Depression that quickly superseded and distorted the benign recession-adjustment process was not in any sense caused by monetary deflation but by government-induced nominal wage rigidities, which of course can be temporarily circumvented by surreptitiously reducing real wages via unanticipated monetary expansion. Thus writes Ohanian:
I conclude that the Depression is the consequence of government programs and policies, including those of Hoover, that increased labor’s ability to raise wages above their competitive levels. The Depression would have been much less severe in the absence of Hoover’s program. Similarly, given Hoover’s program, the Depression would have been much less severe if monetary policy had responded to keep the price level from falling, which raised real wages. This analysis also provides a theory for why low nominal spending — what some economists refer to as deficient aggregate demand — generated such a large depression in the 1930s, but not in the early 1920s, which was a period of comparable deflation and monetary contraction, but when firms cut nominal wages considerably.
