Re: the Great Depression controversy. Hayek in Unemployment and Monetary Policy: Government as Generator of the "Business Cycle" (1979, 13) argues, "The chief conclusion I want to demonstrate is that the longer the inflation [the increase in the effective quantity of money] lasts, the larger will be the number of workers whose jobs depend on a continuation of the inflation, often even on a continuing acceleration of the rate of inflation–not because they would not have found employment without the inflation, but because they were drawn by the inflation into temporarily attractive jobs, which after a slowing down or cessation of the inflation will again disappear." Rothbard (America's Great Depression, 2000, xxvii) comes to a similar conclusion, "The longer the inflationary distortions continue, the more severe the recession-adjustment must become."
Notice these are statements about the severity of the maladjustments, not statements about the length of the recession/depression. It is an inappropriate jump in logic to go from the conclusion that the greater the length of the period of artificial credit expansion the greater the degree of malinvestment and thus the greater the necessary reallocation of resources to a prediction about the length of the adjustment period including recovery.
The restructuring of the economy requires a realignment of relative prices and wages and a movement capital resources and labor from the areas where demand had been artificially created by credit expansion to sectors of the economy where demand is consistent with underlying preferences. The crisis─the recession─is the "necessary corrective process by which the market liquidates the unsound investments of the boom and redirects resources from capital goods to consumer goods industries" (Rothbard, 2000, xxvii). How long this adjustment takes is more of an historical rather than a theoretical problem.
As Rothbard (2000, 14) explains, "Since factors must shift from the higher to the lower orders of production, there is inevitable 'frictional' unemployment in a depression, but it need not be greater than unemployment attending any other large shift in production" [emphasis ours]. The adjustment can be quick and the unemployment temporary if markets are allowed to work during the necessary period of liquidation and restructuring.
What then causes or leads to a prolonged depression? Here again Rothbard (2000, 14) provides a clear answer, "Unemployment will progress beyond the ‘frictional’ stage and become really severe and lasting only if wage rates are kept artificially high and are prevented from falling. If wages are kept above the free-market level that clears the demand for and supply of labor, laborers will remain permanently unemployed." Evidence provided in Vedder and Gallaway (1997) support this response for the U.S. in the 1930s and Herbener (1999a and b) shows how the analysis applies to Japan in the 1990s. New research from Cole and Ohanian (AER, May 2002, 32), using neoclassical growth theory model, came to a similar conclusion regarding the experience of both the U.S. and U.K. during the 1930s, "This analysis supports our earlier work that cartelization and labor bargaining account for much of the long-run U.S Great Depression. This analysis also supports our earlier work arguing that unemployment subsidies are a key factor in understanding the long-run U.K. Great Depression."
