Causes of the Great Depression
Second, there are the monetarists, who believe that the Great Depression started as an ordinary recession, but that significant policy mistakes by monetary authorities (especially the Federal Reserve) caused a shrinking of the money supply which greatly exacerbated the economic situation, causing a recession to descend into the Great Depression. Related to this explanation are those who point to debt deflation causing those who borrow to owe ever more in real terms.
Causes of the Great Depression
Before the "Keynesian Revolution", such a liquidationist theory was a common position for economists to take and was held and advanced by economists like Friedrich Hayek, Lionel Robbins Joseph Schumpeter, Seymour Harris and others. According to the liquidationists a depression is good medicine. The function of a depression is to liquidate failed investments and businesses that have been made obsolete by technological development in order to release factors of production (capital and labor) from unproductive uses. These can then be redeployed in other sectors of the technologically dynamic economy. They asserted that deflationary policy minimized the duration of the Depression of 1920–21 by tolerating liquidation which subsequently created economic growth later in the decade. They pushed for deflationary policies (which were already executed in 1921) which – in their opinion – would assist the release of capital and labor from unproductive activities to lay the groundwork for a new economic boom. The liquidationists argued that even if self-adjustment of the economy took mass bankruptcies, then so be it. Postponing the liquidation process would only magnify the social costs. Schumpeter wrote that it