The Great Depression
Main article: Causes of the Great Depression
There is much debate over the relationship between laissez-faire economics and the onset of the Great Depression. Some economists and historians (such as John Maynard Keynes) argue that laissez-faire economic policy fostered the conditions under which the Great Depression arose. Other scholars, such as Milton Friedman and Murray Rothbard, say that the Depression was not a result of laissez-faire economic policy but of government intervention on the monetary and credit system. The issue, as outlined below, remains heavily debated in economic, historical, and political spheres.
In Keynes's 1936 work, The General Theory of Employment Interest and Money, Keynes introduced concepts and terms that were intended to help explain the Great Depression. One argument for a laissez-faire economic policy during a recession was that if consumption fell, then the rate of interest would fall. Lower interest rates would lead to increased investment spending and demand would remain constant. However, Keynes believed that there are reasons why investment does not necessarily automatically increase as a response to a fall in consumption. Businesses make investments based on expectations of profit. According to Keynes, if a fall in consumption appears to be long-term, businesses analyzing trends will lower expectations of futures sales. Therefore, the last thing they are interested in doing is investing in increasing future production even if lower interest rates make capital inexpensive. In that case, according to Keynes and contrary to Say's law, the economy can be thrown into a general slump. (Keen 2000:198) Keynesian economists and historians argue that this self-reinforcing dynamic is what happened to an extreme degree during the Depression, where bankruptcies were common and investment, which requires a degree of optimism, was very unlikely to occur. The solution to this problem, was to alleviate market instability through government intervention. In his view, since private actors cannot be counted on to create aggregate demand during a recession, the government has the responsibility to create demand.[15]