Depression of 1920–1921
Factors identified as contributing to the downturn include returning troops, which created a surge in the civilian labor force and problems in absorbing the veterans; Spanish flu;[3][4][5] a decline in labor union strife;[6] changes in fiscal and monetary policy; and changes in price expectations.
[2][10] There is no formal definition of economic depression, but two informal rules are a 10% decline in GDP or a recession lasting more than three years, and the unemployment rate climbing above 10%.
[13] Factors that economists have pointed to as potentially causing or contributing to the downturn include troops returning from the war, which created a surge in the civilian labor force and more unemployment and wage stagnation; a decline in agricultural commodity prices because of the post-war recovery of European agricultural output, which increased supply; tighter monetary policy to combat the postwar inflation of 1919; and expectations of future deflation that led to reduced investment.
[2] The Spanish flu pandemic in the United States began in spring 1918 and returned in waves into 1920, killing about 675,000 Americans.
Work by economists Robert Barro and Jose Ursua suggests that the flu was responsible for declines in gross domestic product of 6 to 8 percent worldwide between 1919 and 1921.
"[2] Milton Friedman and Anna Schwartz, in A Monetary History of the United States, consider mistakes in Federal Reserve policy as a key factor in the crisis.
In response to post–World War I inflation the Federal Reserve Bank of New York began raising interest rates sharply.
Under the gold standard, a period of significant inflation of bank credit and paper claims would be followed by a wave of redemptions as depositors and speculators moved to secure their assets.
This would lead to a deflationary period as bank credit and claims diminished and the money supply contracted in line with gold reserves.
[2] President Woodrow Wilson's slow response to the depression was criticized by those in the Republican party, catapulting them into the White House under the banner of Warren Harding.
According to a 1989 analysis by Milton Friedman and Anna Schwartz, the recession of 1920–1921 was the result of an unnecessary contractionary monetary policy by the Federal Reserve Bank.
[17] Paul Krugman agrees that high interest rates due to the Fed's effort to fight inflation caused the problem.
"[20][page needed] Thomas Woods, a proponent of the Austrian School, argues that President Harding's laissez-faire economic policies during the 1920–1921 recession, combined with a coordinated aggressive policy of rapid government downsizing, had a direct influence on the rapid and widespread private-sector recovery.
Woods argued that, as there were massive distortions in private markets due to government economic influence related to demands of World War I, an equally massive correction to the distortions needed to occur as quickly as possible to realign investment and consumption with the new peacetime economic environment.
[21] In a 2011 article, Daniel Kuehn, a proponent of Keynesian economics, questions many of the assertions Woods makes about the 1920–1921 recession.
[22] Kuehn notes the following: Britain initially enjoyed an economic boom between 1919–1920, as private capital pent-up over four years of war was invested into the economy.
James Mitchell, Solomos Solomou and Martin Weale have estimated that GDP fell sharply by 22% between August 1920 and May 1921.
