Ten years after Lehman Brothers’ failure, Schumpeter’s analysis of the Great Depression and his warnings to posterity are as timely as they are prophetic, writes Natasha Piano of the UChicago Department of Political Science.


In 1949, Joseph Schumpeter became increasingly concerned by the way that his contemporaries were returning to the study of the Great Depression. “History, if we would but listen,” he claimed, “would teach us all the essentials” about the processes causing all depressions (Schumpeter 1951-1). And yet, Schumpeter complained, despite the uncanny similarity of the historical circumstances that cause such crises, even the short distance of 10 years makes economists willing to ignore and/or rationalize what seemed so obvious closer to the event itself.


Motivated by Schumpeter’s insistence that all depressions are caused by the same avoidable circumstances, and his plea “to let history teach us,” in what follows I revisit his analysis of the Depression, and suggest that, 10 years later, our own response to the Great Recession of 2008 may already exhibit some of the same intellectual tendencies he warned against.


Depressions, Business Cycles, and History

Although Schumpeter devotes many chapters of Business Cycles (1939) to the Depression, the resurgence of interest in the 1929 crash during the late 1940s prompted him to write a series of more pointed articles dispelling the myths, in his view, that had begun to gain traction. In these targeted pieces, especially “The Decade of the Twenties” and “Approach to the Analysis of Business Cycles,” Schumpeter speaks directly to economists and implores them to take history into greater account than disciplinary trends then allowed. He contends that economists have forgotten what is critical about understanding the Depression—that is, understanding the causes themselves—and have instead confused the causes with ex post facto responses.


As his starting point, Schumpeter insists that (1) all depressions (as opposed to recessions) are not inevitable features of the capitalistic business cycle, and that (2) sound government intervention can effectively prevent such circumstances from occurring in the first place without causing substantial harm to either the business cycle itself or long-term economic growth (Schumpeter 1951a, 220; 1951b, 323). Let’s first review the so-called “adventitious circumstances” of the Great Depression, which bear striking similarity to the conditions that generated the Great Recession a decade ago—and then look to what Schumpeter considers both effective and irrelevant policy intervention.


Adventitious Circumstances: Speculative Mania, Inefficient Banking Systems, and the Mortgage Situation


Joseph Schumpeter, CC BY-SA 3.0


Schumpeter begins his discussions by emphasizing the role of “speculative mania” during 1927 to 1929. He cautions economists against dismissing this reckless borrowing and lending as an essential feature of capitalistic development. While he admits that stock and land speculation are a “natural” and “even necessary” component of business prosperity, he considered the “wild” excesses and the consequent financial practices of the twenties to be entirely abnormal (Schumpeter 1951a, 212). Throughout the twenties, households habitually overspent and regularly covered deficits by borrowing and drawing on unrealized capital gains—practices which, he says, were bound to end in catastrophe (Schumpeter 1951a, 220).


This maniacal borrowing, however, was entirely avoidable as reckless lending could have been curtailed. Thus, the most important “adventitious circumstance” was the inefficient US banking system that allowed such irresponsible lending in the first place. Schumpeter asserts that the wild lending enabled by unregulated Lilliput banks caused the banking epidemics, and consequently, produced the subsequent unemployment and economic distress (Schumpeter 1951a, 220). A larger, more efficient banking system with greater regulatory oversight, he argues, was easily attainable and could have kept lending habits within the constraints of generally salutary business practice.1


Finally, Schumpeter tells us that depressions are all about mortgage environments. An over-levered mortgage situation constitutes an essential ingredient for depressions—more so than the stock market speculation that came to define the Depression in the public imaginary (Schumpeter 1951a, 220). In fact, Schumpeter considered the stock market boom and crash as epiphenomenal to the other causal factors that he considered (Klausinger 1995). He stresses that highly levered mortgage environments create depressions not only because the psychological effects of homelessness are more acute than other types of insolvency, but also, relatedly, because people are able to weather other types of economic storms without “permanent injury” (Schumpeter 1951a, 220). Obviously, Schumpeter writes, the most serious and preventable features of the mortgage crisis were the results of reckless borrowing and lending (Schumpeter 1951a, 220). Over-levered mortgage situations create conditions that may turn a normal recession into a “catastrophe,” but these “avoidable deviations” can be entirely controlled through sound policy intervention: A nation that does not contain agrarian and urban mortgage debt, he declares, “has only itself to blame for the consequences” (Schumpeter 1951b, 325).


A Convenient Distraction: Monetary Policy and Hysteria


History therefore instructs us that reckless borrowing and lending, an inefficient and unregulated banking system, and a highly leveraged mortgage environment are the three ingredients that create depressions. When these three infelicitous circumstances do indeed combine, Schumpeter proposes neither laissez-faire nor austerity forms of redress, nor any other type of liquidationist approach (Legrand and Hageman 2017): once such an abnormal depression is initiated, he insists that central banks intervene through monetary easing (quantitative easing). When catastrophic depressions arise, the monetary system must make enough credit available to finance innovation and investment in order to overcome the possibility of a vicious downward cycle in a period of deflation (Schumpeter 1939, 999). Additionally, he considered deficit spending to be an effective remedy against downward spirals. 


Essentially, an economist’s preferred central banking approach reflects the general values that the economist prioritizes—for example, the importance that he thinks should be given to easing unemployment versus liquidating insolvent institutions, etc. 

The true objection, he says, is not against “income-generating government expenditure in emergencies once they have arisen but to policies that create the emergencies in which such expenditure imposes itself” (Schumpeter 1947, 397-8 emphasis mine). In order to create policies that prevent such depressions from occurring, economists must not confuse responses to the crises with ex ante causes.


Monetary policy provides the best example of such confusion. While in isolated discussions most economists would agree that it is not possible to contain “speculative excess” through interest-rate and credit-rationing guidelines, Schumpeter complains that economists spill considerable ink on how the Federal Reserve caused the depression, or conversely, how it could have prevented it with different policies in the 1920s (Schumpeter 1951b, 324-5). In truth, he writes, monetary policy made little difference one way or another (Schumpeter 1951a, 215).


So why do economists spend so much time debating the purported role of monetary policy in causing the Depression? Schumpeter declares wryly that the discussion provides a seemingly objective forum for economic theorists to argue about their normative preferences.2 Essentially, an economist’s preferred central banking approach reflects the general values that the economist prioritizes—for example, the importance that he thinks should be given to easing unemployment versus liquidating insolvent institutions, etc. The temptation to attribute causal importance to the economists’ preferred policy response seems to lend credibility to his own worldview, but in actuality, Schumpeter implies, these debates only occlude the real causal factors.


Schumpeter also argues that distance from the crisis encourages economists to worry about exaggerated investor and regulator responses to financial panic—as opposed to the conditions that caused the panic in the first place. Of course, he concedes, “hysteria” aggravates financial crises, and he laments the way that panic more wildly exacerbates economic crises than would more moderate or “reasonable” attitudes (Schumpeter 1951b, 323). But when economists shift analytic focus to emotional responses to crises–albeit responses that can legitimately make things worse–they shift focus away from causal conditions, and, more importantly, away from efforts to enact policies that actually prevent depressions. Attention to behavioral responses encourages economists to think that responses to panics can be controlled in the future—that is to say, they assume that if models are created to demonstrate how investor and regulator responses made crises more acute in the past, then investors and regulators won’t behave so hysterically “next time around.”


Instead, Schumpeter suggests, responses to financial panics are hysterical to the degree that initial behavior was reckless and speculative—and no amount of scientifically grounded persuasion can inhibit this reaction from occurring in the future. Economists must resist the temptation to intellectualize or rationalize behavioral responses, and they ought to soberly keep attendant causes of these responses present, even with the distance of time. Doing so, Schumpeter intimates, is the key to enacting preventative measures, as opposed to mere antidotes to catastrophic depressions.


Schumpeter and the Great Recession 


In the late 1940s, economists attributed the Great Depression to a myriad of influences: faulty monetary policy, Gold Standard inadequacy, and unprecedented stock market participation were believed to be the most consequential factors contributing to the 1929 crash. Moreover, these debates maintained a stronghold on the discipline throughout the 20th century and well into the 21st. Peter Temin insisted upon the Gold Standard explanation well into the 1990s. More famously, Milton Friedman invigorated the conversation over monetary policy and the Depression in the early 1960s, a debate taken up by Ben Bernanke, and one that continues to this day among economists and popular writers alike (Friedman and Schwartz 2008 [1963]; Bernanke 2002, 2012).


 As early as 1949, Schumpeter was not only able to identify reckless lending, unregulated banking systems, and highly levered mortgage environments generated as the causes of the 1929 crash, but also that these three unfortunate circumstances, when taken together, generate all depressions in capitalist economic arrangements. But what makes Schumpeter’s analysis so impressive is not that he was right in our own time—that is, that he was able to isolate the three factors that generated the Great Recession with such precision. More remarkably, he was able to prophesize the distractions from causal factors and focus on ex ante responses that would come to define the behavior of the economic discipline. In light of the 10th anniversary of Lehman Brothers’ failure, perhaps this time we should heed Schumpeter’s warning and avoid dwelling on investor/regulator responses that only distract us from enacting the policies that would prevent these “adventitious circumstances” from emerging in the future.  


Natasha Piano is a political theorist and PhD candidate in the Department of Political Science at the University of Chicago.



Ben Bernanke, Remarks by Governor Ben S. Bernanke at the Conference to Honor Milton Friedman. University of Chicago, Chicago, Illinois. November 8, 2002 https://www.federalreserve.gov/BOARDDOCS/SPEECHES/2002/20021108/

Ben Bernanke, Five Questions about the Federal Reserve and Monetary Policy, Indianapolis, Indiana. https://www.federalreserve.gov/newsevents/speech/bernanke20121001a.htm. October 2012

Milton Friedman and Andrea Schwartz. 2008 [1963].  A Monetary History of the United States, 1867-1960. Princeton: Princeton University Press.

Hanjorg Klausinger, 1995. “Schumpeter and Hayek: Two Views of the Great Depression Re-examined” History of Economic Ideas, 3: no. 3.

Muriel dal Pont Legrand and Harald Hagemann. 2017. “Business Cycles, Growth, and Economic Policy: Schumpeter and the Great Depression.” Journal of the History of Economic Thought. 3:1.

Joseph Schumpeter. 1939. Business Cycles. A Theoretical, Historical, and Statistical Analysis of the Capitalist Process, New York-London: MacGraw-Hill. 

__. 1947.Capitalism, Socialism and Democracy. New York: Harper Perennial.

__. 1951a. “The Decade of the Twenties,” in Essays on Entrepreneurs, Innovations, Business Cycles, and the Evolution of Capitalism, ed. Richard Clemence. New Brunswick, Transaction Publishers.

__. 1951b.“Approach to the Analysis of Business Cycles” in Essays on Entrepreneurs, Innovations, Business Cycles, and the Evolution of Capitalism, ed. Richard Clemence (New Brunswick, Transaction Publishers, 1951).

Peter Temin, Lessons from the Great Depression. 1989. Cambridge, Massachusetts: MIT Press.


For further discussion of the 2008 financial crisis, listen to this episode of the Capitalisn’t podcast: 



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  1. We now know that Schumpeter was quite wrong to think that the organizational management of larger banks would not permit reckless credit habits, as the Great Recession proved even the biggest banks could engage in irresponsible lending without proper regulation. Nevertheless, his diagnostic point still stands: depressions occur when banks are permitted to engage in reckless lending.[]
  2. “The wider question whether more resolute inflation or else more resolute deflation would have been indicated call for completely different answers according to the scheme of values of the man who asks them. The various ‘rigidities’ in the system, real or alleged, seem to me to have been of minor causal importance in the economic processes of the twenties” (Schumpeter 1951, 220).[]