The Proper Role of Government During Depressions
(An Austrian Economic Analysis)

Featured Article: Sat, 3 January 2009 by Adam Murdock 

I must preface this discussion by saying that this article assumes an understanding of the Austrian theory of the business cycle and the culpability of the central bank in creating booms and busts. For an introduction, click here.

As I discussed in a previous article, the cause of depressions is related to the central bank and government interference in the market. Therefore, it is logical to conclude that to avoid the excesses and contractions in the market a wise course of action would be to follow a laissez-faire monetary policy. Firstly, this includes stopping the credit expansion that not only layed the seed for the future depression but prolongs and worsens the depression if continued. Secondly, another course of action would be to declare that the practice of institutionalized inflation through fractional-reserve banking is fraudulent. This would require banks to actually store your money like storage depositories for all other goods are required to do. Thirdly, the removal of the "lender of last resort" (ie. the central bank) would ensure that banks practice a more secure policy of lending because of the fear of bankruptcy instead of having the security of the central bank to fall back on to. Finally, the best way to curb the inflationary policy of governments and the central bank is to institute 100 % gold-backing of the currency. As I have discussed in a previous article, the most important limitation on the power and foreign adventurism of the government is having a gold-backed currency because the supply of gold is limited and therefore is hard to inflate.

Although the above policies would be the most prudent ones to prevent depressions they are not often followed by government. Therefore, if we are going to remain active participants in the business cycle, what should be the policy of our government during a depression in order to end it as soon as possible?

The answer is that in order to end a depression as soon as possible, the market should be allowed to return to its unhampered condition quickly and without delay. In other words, a return to the policies that prevent depressions as listed above will quickly end a current depression and prevent future ones from occuring.

According to the eminent Austrian theorist Murray Rothbard:

If government wishes to see a depression ended as quickly as possible, and the economy returned to normal prosperity, what course should it adopt? The first and clearest injunction is: don't interfere with the market's adjustment process. The more the government intervenes to delay the market's adjustment, the longer and more grueling the depression will be, and the more difficult will be the road to complete recovery. Government hampering aggravates and perpetuates the depression. Yet, government depression policy has always (and would have even more today) aggravated the very evils it has loudly tried to cure. If, in fact, we list logically the various ways that government could hamper market adjustment, we will find that we have precisely listed the favorite "anti-depression" arsenal of government policy. 
What has been the "anti-depression" policy of the Bush administration and what will be the likely policy of the Obama administration? Not surprisingly, they are currently using and in the case of Obama are proposing to use the very instruments that "hamper" the market adjustment.  As I have previously discussed, the end result of this will be a prolonged and deepened depression.

What anti-market policies are they pursuing?

1) Propping up bad companies to prevent liquidation: the current administration is trying to prevent a market correction by preventing the liquidation of poorly run businesses that have participated in the market excesses. These include the auto companies and the big banking interests. In fact, it has gone a step further. It has called for increased lending to the same unwise investments and businesses. As I have shown in my introduction, this only worsens the likely correction later. This very policy was followed by Japan in the 1990s and has caused that country to be stuck in a virtual recession for nearly 20 years.

2) Print More Money: not long ago it was revealed that the Federal Reserve has now acquired obligations of up to  $8.5 trillion. This expansion of credit further prolongs and worsens the depression as we have discussed previously. It may also lead to the dreaded "hyperinflation" later down the road.  

3) Wage controls: in order to placate the population during a depression, the government is hesistant to permit unemployment and the lowering of wages. The result of a policy of wage controls and resisting unemployment is actually higher umemployment. No greater example of this can be found than with the examples of GM, Ford, and Chrysler. They have been held ransom by their government-supported unions and therefore prevented from a necessary correction of wages and employment to reflect current market conditions. The end result of the unions stance will be fewer high-salaried employees instead of more low-salaried employees and therefore higher overall unemployment.

4) Price Controls: during the current crisis, we have been continually told by commentators and government that the source of the problem with the current bust is the fall in housing prices. As I have shown previously, the real problem is not the fall but the inflationary build-up promolgated by central banking. Without the artificially low interest rates and easy money of the Greenspan Federal Reserve, there would not have been a run-up and therefore no need for a correction of the housing bubble. Unfortunately, the current administration wants to reinflate housing prices and reaggravate the same problem.

5) Encourage consumption/discourage savings: this is perhaps the favorite propoganda tool I have seen from pundits and from government. If only we as consumers would just keep spending well beyond our means then everything would be okay. In order to promote this misadventure, they want to give us stimulus money and don't want us to save it. Unfortunately, American's already spend all their money. As I have discussed in previous articles, we already save less than 1% of our income. Encouraging further spending will only put us more in the hole later and prepare us for a more massive collapse in the future.

6) Create phony jobs: a program of job-creation has been proposed by Obama. Unfortunately, the jobs created by these programs are temporary and tax the employment of the rest of the economy. In addition, creating artificial jobs prevents the natural shift of workers to fields where jobs are available.


In conclusion, the best course of action for government during a depression is to remove itself as far as possible from intervention in the economy and to allow a swift correction to be made. All the above policies, as has been shown, will lead to worsening and prolonging of the depression. Ultimately, it would be better to practice preventative medicine by instituting policies that will not lead to a depression in the future. Let us hope that through proper education we can as a people begin to demand the laissez-faire monetary policy that will accomplish this very goal.