The Depression of 1920. Government spending enabled swift recovery.

The depression of 1920-21 was a very sharp downturn with a rapid, robust recovery that started the roaring twenties. You see and hear very little about this recession. However, it has some received some attention on the internet, usually from subscribers of the Austrian school of economics, as well as some general libertarians and conservatives, who have cited this recession as proof their theories work.

I was walking through Barnes & Noble recently when I saw a book on the topic: “The Forgotten Depression: 1921: The Crash That Cured Itself” by James Grant. The first mention I’ve personally seen of this recession outside the internet, and it rekindled my interest in the topic.

The story goes like this: During this recession the government cut taxes, cut spending, then did nothing else. Without government interference, the recession bottomed out and rapidly recovered. Due to it’s short nature and/or the fact it was resolved without government action, it’s been called the “forgotten depression”, and “the depression you’ve never heard of.” [1][2]

The Austrian take is best summed up in “America’s Great Depression” by Murray Rothbard. “There is one thing the government can do positively, however: It can drastically lower its relative role in the economy, slashing its own expenditures and taxes, particularly taxes that interfere with savings and investment.” “Any reduction in taxes, or of any regulations interfering with the free market, will stimulate healthy economic activity.” “In sum, the proper governmental policy in a depression is strict laissez-faire including stringent budget slashing, and couple perhaps with positive encouragement for credit contraction.” (Rothbard) He quotes a Benjamin M. Anderson as having said this was “our last natural recovery to full employment.” (Rothabrd. p 186)

So, according to the Austrians during the recession the government cut taxes, spending, kept their hands off after that and we had rapid, robust recovery. There’s a few issues with this story however:

1: The tax cut was passed on Nov 23, 1921 [3] while the  recession ended in July 1921[4]. So the tax cut could not have helped end the recession, since it was already over by then.

2: Most of the spending cuts occurred before the recession ever started, (January 1920) as seen in the graph below. [5] So, this could not have ended the recession.

wwi gov scale down

3: While there was no fiscal stimulus the government did intervene in a couple of ways: A tariff was passed, (The Emergency Tariff of 1921) and the Fed cut interest rates.

All this and other issues have been largely discussed already however. Here is a link to a wonderful collection of posts about the topic, and also a paper by Daniel Kuehn who first discussed how it was Woodrow Wilson who is responsible for most of the cuts to government expenditure, before the recession ever started, as well as some other points of critique. I encourage everyone to read these works, but for now  I instead want to look at a new aspect:

Private spending 

From 1920 – 1922 there was a surge in private spending. Using data compiled by Steve Keen, I estimate the private debt level rose from 53 to 69% of GDP in that span. This is an estimation, but as seen in the graph below clearly there was a big spike in private spending from 1920-22.

US private debt 1920-22

After the horror of WWI there was a want to return to “normalcy” and given the fact wages soared during the war, thanks to full employment and strong union positions, there would’ve been plenty of money to spend spend spend. This is strengthened when we look at the period right before.

From about 1915 – 1919 private debt falls from 75 to 51% of GDP  a 24% drop. This put the private debt level the lowest it’s been in nearly 20 years. As seen in the graph below.

US private debt 1915-19

It appears there really was “pent up demand” after WWI. Years of less spending lead to a boom in spending, aided by a high savings rate and high wages. This is what fueled rapid, robust recovery. This is not shocking in any way. Consumption is the major driver of our economy. People spending on air flights to take vacations, appliances, cars, houses all boost the economy. In economic terms: Y= C + I + G+ NX. With most else stable, the massive increase in C will lead to a large increase in Y.

However, it’s not enough to simply say the private sector spent its way out of the recession. There’s another piece to the story.

That fall in private debt, 24%, is a massive number, you can see how large it is on the graph above. Usually, falls in private debt correlate with recessions/stagnation. This makes sense, it’s the reverse of the process described above. Just to verify this, I checked the list of US recessions and compared it to the graph, which yielded this result:


Most of the very large drops in private debt correlate with recessions, some of them are our longest and worst ones: The depression of 1839-43, 1873-79, the Great Depression, the Great Recession. Even the  early 90s recession, while not terrible, was followed by low growth and lingering unemployment lasting until around 1995, which correlates with a drop in private debt.

So, why did the 24% fall in private debt from 1915-19 not have similar results and in fact saw an economic boom? Government debt rose from 2.7% to 30%[6], a 27.3% increase. This spike in government spending boosted the economy, allowing people to save without feeling an economic crunch. So when the scale back came the population had plenty of savings ready to be spent, buoying the economy.

Some say the slashing of government quickly ended the 1920 recession and fueled robust growth, but it was actually the previous build up of government spending, that laid the foundation for recovery!







Rothbard, Murray. America’s Great Depression. 1963. The Ludwig von Mises Institute. Auburn, AL.   Daniel Kuehn paper    Private debt data and chart Info on 1920-21 recession








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