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THE DEBT-DEFLATION THEORY
OF GREAT DEPRESSIONS
BY IRVING FISHER
INTRODUCTORY

IN Booms and Depressions, I have developed, theoretically and statistically, what may be called a debt-deflation theory of great depressions. In the preface, I stated that the results "seem largely new,"
I spoke thus cautiously because of my unfamiliarity with the vast
literature on the subject. Since the book was published its special conclusions have been widely accepted and, so far as I know, no one has
yet found them anticipated by previous writers, though several, including myself, have zealously sought to find such anticipations. Two
of the best-read authorities in this field assure me that those conclusions are, in the words of one of them, "both new and important."
Partly to specify what some of these special conclusions are which
are believed to be new and partly to fit them into the conclusions of
other students in this field, I am offering this paper as embodying, in
brief, my present "creed" on the whole subject of so-called "cycle
theory." My "creed" consists of 49 "articles" some of which are old
and some new. I say "creed" because, for brevity, it is purposely expressed dogmatically and without proof. But it is not a creed in the
sense that my faith in it does not rest on evidence and that I am not
ready to modify it on presentation of new evidence. On the contrary,
it is quite tentative. It may serve as a challenge to others and as raw
material to help them work out a better product.
Meanwhile the following is a list of my 49 tentative conclusions.
"CYCLE THEORY" IN GENERAL

1. The economic system contains innumerable variables—quantities
of "goods (physical wealth, property rights, and services), the prices
of these goods, and their values (the quantities multiplied by the
prices). Changes in any or all of this vast array of variables may be
due to many causes. Only in imagination can all of these variables remain constant and be kept in equilibrium by the balanced forces of
human desires, as manifested through "supply and demand."
2. Economic theory includes a study both of (a) such imaginary,
ideal equilibrium—which may be stable or unstable—and (b) disequilibrium. The former is economic statics; the latter, economic dynamics. So-called cycle theory is merely one part of the study of economic dis-equilibrium.
3. The study of dis-equilibrium may proceed in either of two ways.



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We may take as our unit for study an actual historical case of great
dis-equilibrium, such as, say, the panic of 1873; or we may take as
our unit for study any constituent tendency, such as, say, deflation, and
discover its general laws, relations to, and combinations with, other
tendencies. The former study revolves around events, or facts; the
latter, around tendencies. The former is primarily economic history;
the latter is primarily economic science. Both sorts of studies are proper and important. Each helps the other. The panic of 1873 can only
be understood in the light of the various tendencies involved—deflation and other; and deflation can only be understood in the light of
the various historical manifestations—1873 and other.
4. The old and apparently still persistent notion of "the" business
cycle, as a single, simple, self-generating cycle (analogous to that of a
pendulum swinging under influence of the single force of gravity) and
as actually realized historically in regularly recurring crises, is a myth.
Instead of one force there are many forces. Specifically, instead of one
cycle, there are many co-existing cycles, constantly aggravating or
neutralizing each other, as well as co-existing with many non-cyclical
forces. In other words, while a cycle, conceived as a fact, or historical
event, is non-existent, there are always innumerable cycles, long and
short, big and little, conceived as tendencies (as well as numerous noncyclical tendencies), any historical event being the resultant of all the
tendencies then at work. Any one cycle, however perfect and like a
sine curve it may tend to be, is sure to be interfered with by other tendencies.
5. The innumerable tendencies making mostly for economic dis-equilibrium may roughly be classified under three groups: (a) growth or
trend tendencies, which are steady; (b) haphazard disturbances, which
are unsteady; (c) cyclical tendencies, which are unsteady but steadily
repeated.
6. There are two sorts of cyclical tendencies. One is "forced" or imposed on the economic mechanism from outside. Such is the yearly
rhythm; also the daily rhythm. Both the yearly and the daily rhythm
are imposed on us by astronomical forces from outside the economic
organization; and there may be others such as from sun spots or transits
of Venus. Other examples of "forced" cycles are the monthly and weekly rhythms imposed on us by custom and religion.
The second sort of cyclical tendency is the "free" cycle, not forced
from outside, but self-generating, operating analogously to a pendulum or wave motion.
7. It is the "free" type of cycle which is apparently uppermost in
the minds of most people when they talk of "the" business cycle. The
yearly cycle, though it more nearly approaches a perfect cycle than



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any other, is seldom thought of as a cycle at all but referred to as
"seasonal variation."
8. There may be equilibrium which, though stable, is so delicately
poised that, after departure from it beyond certain limits, instability
ensues, just as, at first, a stick may bend under strain, ready all the
time to bend back, until a certain point is reached, when it breaks.
This simile probably applies when a debtor gets "broke,"or when the
breaking of many debtors constitutes a "crash," after which there is
no coming back to the original equilibrium. To take another simile,
such a disaster is somewhat like the "capsizing" of a ship which, under
ordinary conditions, is always near stable equilibrium but which, after
being tipped beyond a certain angle, has no longer this tendency to
return to equilibrium, but, instead, a tendency to depart further from it.
9. We may tentatively assume that, ordinarily and within wide
limits, all, or almost all, economic variables tend, in a general way, toward a stable equilibrium. In our classroom expositions of supply and
demand curves, we very properly assume that if the price, say, of
sugar is above the point at which supply and demand are equal, it
tends to fall; and if below, to rise.
10. Under such assumptions, and taking account of "economic friction," which is always present, it follows that, unless some outside
force intervenes, any "free" oscillations about equilibrium must tend
progressively to grow smaller and smaller, just as a rocking chair set
in motion tends to stop. That is, while "forced" cycles, such as seasonal, tend to continue unabated in amplitude, ordinary "free" cycles
tend to cease, giving way to equilibrium.
11. But the exact equilibrium thus sought is seldom reached and
never long maintained. New disturbances are, humanly speaking, sure
to occur, so that, in actual fact, any variable is almost always above
or below the ideal equilibrium.
For example, coffee in Brazil may be over-produced, that is, may
be more than it would have been if the producers had known in advance that it could not have been sold at a profit. Or there may be a
shortage in the cotton crop. Or factory, or commercial inventories
may be under or over the equilibrium point.
Theoretically there may be—in fact, at most times there must b e over- or under-production, over- or under-consumption, over- or underspending, over-or under-saving, over-or under-investment, and over
or under everything else. It is as absurd to assume that, for any long
period of time, the variables in the economic organization, or any part
of them, will "stay put," in perfect equilibrium, as to assume that the
Atlantic Ocean can ever be without a wave.
12. The important variables which may, and ordinarily do, stand




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ECONOMETRICA

above or below equilibrium are: (a) capital items, such as homes, factories, ships, productive capacity generally, inventories, gold, money,
credits, and debts; (b) income items, such as real income, volume of
trade, shares traded; (c) price items, such as prices of securities, commodities, interest.
13. There may even be a general over-production and in either of
two senses: (a) there may be, in general, at a particular point of time,
over-large inventories or stocks on hand, or (b) there may be, in general, during a particular period of time, an over-rapid flow of production. The classical notion that over-production can only be relative as
between different products is erroneous. Aside from the abundance or
scarcity of particular products, relative to each other, production as a
whole is relative to human desires and aversions, and can as a whole
overshoot or undershoot the equilibrium mark.
In fact, except for brief moments, there must always be some degree of general over-production or general under-production and in
both senses—stock and flow.
14. But, in practice, general over-production, as popularly imagined,
has never, so far as I can discover, been a chief cause of great dis-equilibrium. The reason, or a reason, for the common notion of over-production is mistaking too little money for too much goods.
15. While any deviation from equilibrium of any economic variable
theoretically may, and doubtless in practice does, set up some sort of
oscillations, the important question is: Which of them have been sufficiently great disturbers to afford any substantial explanation of the
great booms and depressions of history?
16. I am not sufficiently familiar with the long detailed history of
these disturbances, nor with the colossal literature concerning their alleged explanations, to have reached any definitive conclusions as to
the relative importance of all the influences at work. I am eager to
learn from others.
17. According to my present opinion, which is purely tentative, there
is some grain of truth in most of the alleged explanations commonly
offered, but this grain is often small. Any of them may suffice to explain small disturbances, but all of them put together have probably
been inadequate to explain big disturbances.
18. In particular, as explanations of the so-called business cycle, or
cycles, when these are really serious, I doubt the adequacy of overproduction, under-consumption, over-capacity, price-dislocation, maladjustment between agricultural and industrial prices, over-confidence,
over-investment, over-saving, over-spending, and the discrepancy between saving and investment.
19. I venture the opinion, subject to correction on submission of




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FISHER

341

future evidence, that, in the great booms and depressions, each of the
above-named factors has played a subordinate role as compared with
two dominant factors, namely over-indebtedness to start with and deflation following soon after; also that where any of the other factors
do become conspicuous, they are often merely effects or symptoms of
these two. In short, the big bad actors are debt disturbances and pricelevel disturbances.
While quite ready to change my opinion, I have, at present, a strong
conviction that these two economic maladies, the debt disease and the
price-level disease (or dollar disease), are, in the great booms and depressions, more important causes than all others put together,
20. Some of the other and usually minor factors often derive some
importance when combined with one or both of the two dominant factors.
Thus over-investment and over-speculation are often important; but
they would have far less serious results were they not conducted with
borrowed money. That is, over-indebtedness may lend importance to
over-investment or to over-speculation.
The same is true as to over-confidence. I fancy that over-confidence
seldom does any great harm except when, as, and if, it beguiles its victims into debt.
Another example is the mal-adjustment between agricultural and
industrial prices, which can be shown to be a result of a change in the
general price level.
21. Disturbances in these two factors—debt and the purchasing power of the monetary unit—will set up serious disturbances in all, or nearly all, other economic variables. On the other hand, if debt and deflation are absent, other disturbances are powerless to bring on crises
comparable in severity to those of 1837,1873, or 1929-33.
THE ROLES OF DEBT AND DEFLATION

22. No exhaustive list; can be given of the secondary variables affected by the two primary ones, debt and deflation; but they include
especially seven, making in all at least nine variables, as follows: debts,
circulating media, their velocity of circulation, price levels, net worths,
profits, trade, business confidence, interest rates.
23. The chief interrelations between the nine chief factors may be derived deductively, assuming, to start with, that general economic equilibrium is disturbed by only the one factor of over-indebtedness, and,
in particular, assuming that there is no other influence, whether accidental or designed, tending to affect the price level.
24. Assuming, accordingly, that, at some point of time, a state of
over-indebtedness exists, this will tend to lead to liquidation, through




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the alarm either of debtors or creditors or both. Then we may deduce
the following chain of consequences in nine links: (1) Debt liquidation
leads to distress setting and to (2) Contraction of deposit currency, as
bank loans are paid off, and to a slowing down of velocity of circulation. This contraction of deposits and of their velocity, precipitated
by distress selling, causes (3) A fall in the level of prices, in other words,
a swelling of the dollar. Assuming, as above stated, that this fall of
prices is not interfered with by reflation or otherwise, there must be
(4) A still greater fall in the net worths of business, precipitating bankruptcies and (5) A like fall in profits, which in a " capitalistic," that
is, a private-profit society, leads the concerns which are running at a
loss to make (6) A reduction in output, in trade and in employment of
labor. These losses, bankruptcies, and unemployment, lead to (7) Pessimism and loss of confidence, which in turn lead to (8) Hoarding and
slowing down still more the velocity of circulation.
The above eight changes cause (9) Complicated disturbances in the
rates of interest, in particular, a fall in the nominal, or money, rates and
a rise in the real, or commodity, rates of interest.
Evidently debt and deflation go far toward explaining a great mass
of phenomena in a very simple logical way.
25. The above chain of causes, consisting of nine links, includes
only a few of the interrelations between the nine factors. There are
other demonstrable interrelations, both rational and empirical, and
doubtless still others which cannot, yet, at least, be formulated at all.1
There must also be many indirect relations involving variables not included among the nine groups.
26. One of the most important of such interrelations (and probably
too little stressed in my Booms and Depressions) is the direct effect of
lessened money, deposits, and their velocity, in curtailing trade, as
evidenced by the fact that trade has been revived locally by emergency
money without any raising of the price level.
27. In actual chronology, the order of the nine events is somewhat
different from the above "logical" order, and there are reactions and
repeated effects. As stated in Appendix I of Booms and Depressions:
The following table of our nine factory, occurring and recurring (together with
distress selling), gives a fairly typical, though still inadequate, picture of the
1

Many of these interrelations have been shown statistically, and by many
writers. Some, which I have so shown and which fit in with the debt-deflation
theory, are: that price-change, after a distributed lag, causes, or is followed by,

corresponding fluctuations in the volume of trade , employment, bankruptcies,
and rate of interest. The results as to price-change and unemployment are contained in Charts II and III, pp. 352-3. See references at the end of this article;
also footnote 2, page 345, regarding the charts.



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cross-currents of a depression in the approximate order in which it is believed
they usually occur. (The first occurrence of each factor and its sub-divisions is
indicated by italics. The figures in parenthesis show the sequence in the original
exposition.)
I. (7)
(8)
(1)
II. (9)
(9)
III. (2)
(7)
(3)
(1)
(3)
IV. (9)
(7)
(1)
(2)
(8)
V. (2)
(2)
(3)
VI. (4)
(4)
(7)
(8)
(1)
VII. (5)
(5)
(7)
(8)
(1)
(6)
VIII. (6)
(6)
(6)
(6)
(7)
IX. (8)
X. (8)
(8)
(8)
(8)
(7)
(8)
(1)
(2)
(3)




Mild Gloom and Shock to Confidence
Slightly Reduced Velocity of Circulation
Debt Liquidation
Money Interest on Safe Loans Falls
But Money Interest on Unsafe Loans Rises
Distress Selling
More Gloom
Fall in Security Prices
More Liquidation
Fall in Commodity Prices
Real Interest Rises; REAL DEBTS INCREASE
More Pessimism and Distrust
More Liquidation
More Distress Selling
More Reduction in Velocity
More Distress Selling
Contraction of Deposit Currency
Further Dollar Enlargement
Reduction in Net Worth
Increase in Bankruptcies
More Pessimism and Distrust
More Slowing in Velocity
More Liquidation
Decrease in Profits
Increase in Losses
Increase in Pessimism
Slower Velocity
More Liquidation
Reduction in Volume of Stock Trading
Decrease in Construction
Reduction in Output
Reduction in Trade
Unemployment
More Pessimism
Hoarding
Runs on Banks
Banks Curtailing Loans for Self-Protection
Banks Selling Investments
Bank Failures
Distrust Grows
More Hoarding
More Liquidation
More Distress Selling
Further Dollar Enlargement

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ECONOMETRICA

As has been stated, this order (or any order, for that matter) can be only approximate and subject to variations at different times and places. It represents
my present guess as to how, if not too much interfered with, the nine factors
selected for explicit study in this book are likely in most cases to fall in line.
But, as has also been stated, the idea of a single-line succession is itself inadequate, for while Factor (1) acts on (2), for instance, it also acts directly on (7),
so that we really need a picture of subdividing streams or, better, an interacting
network in which each factor may be pictured as influencing and being influenced
by many or all of the others.

Paragraph 24 above gives a logical, and paragraph 27 a chronological, order of the chief variables put out of joint in a depression when
once started by over-indebtedness.
28. But it should be noted that, except for the first and last in the
"logical" list, namely debt and interest on debts, all the fluctuations
listed come about through a fall of prices.
29. When over-indebtedness stands alone, that is, does not lead to a
fall of prices, in other words, when its tendency to do so is counteracted by inflationary forces (whether by accident or design), the resulting "cycle" will be far milder and far more regular.
30. Likewise, when a deflation occurs from other than debt causes
and without any great volume of debt, the resulting evils are much
less. It is the combination of both—the debt disease coming first, then
precipitating the dollar disease—which works the greatest havoc.
31. The two diseases act and react on each other. Pathologists are
now discovering that a pair of diseases are sometimes worse than either
or than the mere sum of both, so to speak. And we all know that a
minor disease may lead to a major one. Just as a bad cold leads to
pneumonia, so over-indebtedness leads to deflation.
32. And, vice versa, deflation caused by the debt reacts on the debt.
Each dollar of debt still unpaid becomes a bigger dollar, and if the
over-indebtedness with which we started was great enough, the liquidation of debts cannot keep up with the fall of prices which it causes.
In that case, the liquidation defeats itself. While it diminishes the
number of dollars owed, it may not do so as fast as it increases the
value of each dollar owed. Then, the very effort of individuals to lessen
their burden of debts increasesit,because of the mass effect of the stampede
to liquidate in swelling each dollar owed. Then we have the great para-

dox which, I submit, is the chief secret of most, if not all, great depressions: The more the debtors pay, the more they owe. The more the

economic boat tips, the more it tends to tip. It is not tending to right
itself, but is capsizing.
33. But if the over-indebtedness is not sufficiently great to make
liquidation thus defeat itself, the situation is different and simpler.
It is then more analogous to stable equilibrium; the more the boat



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345

rocks the more it will tend to right itself. In that case, we have a truer
example of a cycle.
34. In the "capsizing" type in particular, the worst of it is that real
incomes are so rapidly and progressively reduced. Idle men and idle
machines spell lessened production and lessened real income, the central factor in all economic science. Incidentally this under-production
occurs at the very time that there is the illusion of over-production.
35. In this rapid survey, I have not discussed what constitutes overindebtedness. Suffice it here to note that (a) over-indebtedness is always relative to other items, including national wealth and income
and the gold supply, which last is specially important, as evidenced
by the recent researches of Warren and Pearson; and (b) it is not a
mere one-dimensional magnitude to be measured simply by the number of dollars owed. It must also take account of the distribution in
time of the sums coming due. Debts due at once are more embarrassing than debts due years hence; and those payable at the option of
the creditor, than those payable at the convenience of the debtor. Thus
debt embarrassment is great for call loans and for early maturities.
For practical purposes, we may roughly measure the total national
debt embarrassment by taking the total sum currently due, say within
the current year, including rent, taxes, interest, installments, sinking
fund requirements, maturities and any other definite or rigid commitments for payment on principal.
ILLUSTRATED BY THE DEPRESSION OF 1929-33*

36. The depression out of which we are now (I trust) emerging is an
example of a debt-deflation depression of the most serious sort. The
2

Note the charts, pp. 352-7:
Chart I shows: (1) the price level (P) and (2) its percentage rate of rise or fall
(P'). When the last named is lagged with the lag distributed according to a
probability curve so that the various P"s overlap and cumulate we get , as
in Charts II and III. This is virtually a lagged average of the P"s.
Charts II and III show:
contrasted with employment (E).
may be considered as what employment would be if controlled entirely by price-change.
Chart IV shows the Swedish official (retail) weekly index number contrasted
with the American weekly wholesale and monthly retail indexes.
Chart V shows the estimated internal debt in the United States contrasted
with the estimated total money value of wealth. The unshaded extensions of the
bars upward show what the 1933 figures would be if enlarged 75 per cent to
translate them into 1929 dollars (according to the index number of wholesale
commodity prices).
Chart VI shows estimated "fixed" annual charges (actually collected) contrasted with estimated national income. The unshaded extensions of the bars

upward show what the 1932figureswould be if enlarged 56 per cent to translate
them into 1929 dollars.
Charts VII and VIII show the chief available statistics before and after
March 4,1933, grouped in the order indicated in Article 27 above.




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ECONOMETRICA

debts of 1929 were the greatest known, both nominally and really, up
to that time.
They were great enough not only to "rock the boat" but to start it
capsizing. By March, 1933, liquidation had reduced the debts about
20 per cent, but had increased the dollar about 75 per cent, so that the
real debt, that is the debt as measured in terms of commodities, was
increased about 40 per cent [(100%-20%)X(100%+75%)=140%].
Note Chart V.
37. Unless some counteracting cause comes along to prevent the
fall in the price level, such a depression as that of 1929-33 (namely
when the more the debtors pay the more they owe) tends to continue,
going deeper, in a vicious spiral, for many years. There is then no
tendency of the boat to stop tipping until it has capsized. Ultimately,
of course, but only after almost universal bankruptcy, the indebtedness must cease to grow greater and begin to grow less. Then comes recovery and a tendency for a new boom-depression sequence. This is
the so-called "natural" way out of a depression, via needless and cruel
bankruptcy, unemployment, and starvation.
38. On the other hand, if the foregoing analysis is correct, it is always economically possible to stop or prevent such a depression simply by reflating the price level up to the average level at which outstanding debts were contracted by existing debtors and assumed by
existing creditors, and then maintaining that level unchanged.
That the price level is controllable is not only claimed by monetary
theorists but has recently been evidenced by two great events: (1)
Sweden has now for nearly two years maintained a stable price level,
practically always within 2 per cent of the chosen par and usually
within 1 per cent. Note Chart IV. (2) The fact that immediate reversal of deflation is easily achieved by the use, or even the prospect of
use, of appropriate instrumentalities has just been demonstrated by
President Roosevelt. Note Charts VII and VIII.
39. Those who imagine that Roosevelt's avowed reflation is not the
cause of our recovery but that we had "reached the bottom anyway"
are very much mistaken. At any rate, they have given no evidence, so
far as I have seen, that we had reached the bottom. And if they are
right, my analysis must be woefully wrong. According to all the evidence, under that analysis, debt and deflation, which had wrought
havoc up to March 4, 1933, were then stronger than ever and, if let
alone, would have wreaked greater wreckage than ever, after March 4.
Had no "artificial respiration" been applied, we would soon have
seen general bankruptcies of the mortgage guarantee companies, savings banks, life insurance companies, railways, municipalities, and
states. By that time the Federal Government would probably have be


IRVING FISHER

347

come unable to pay its bills without resort to the printing press, which
would itself have been a very belated and unfortunate case of artificial respiration. If even then our rulers should still have insisted on
"leaving recovery to nature" and should still have refused to inflate
in any way, should vainly have tried to balance the budget and discharge more government employees, to raise taxes, to float, or try to
float, more loans, they would soon have ceased to be our rulers. For
we would have insolvency of our national government itself, and probably some form of political revolution without waiting for the next
legal election. The mid-west farmers had already begun to defy the law.
40. If all this is true, it would be as silly and immoral to "let nature
take her course" as for a physician to neglect a case of pneumonia. It
would also be a libel on economic science, which has its therapeutics
as truly as medical science.
41. If reflation can now so easily and quickly reverse the deadly
down-swing of deflation after nearly four years, when it was gathering
increased momentum, it would have been still easier, and at any time,
to have stopped it earlier. In fact, under President Hoover, recovery
was apparently well started by the Federal Reserve open-market purchases, which revived prices and business from May to September
1932. The efforts were not kept up and recovery was stopped by various circumstances, including the political "campaign of fear."
It would have been still easier to have prevented the depression almost altogether. In fact, in my opinion, this would have been done
had Governor Strong of the Federal Reserve Bank of New York lived,
or had his policies been embraced by other banks and the Federal Reserve Board and pursued consistently after his death.8 In that case,
there would have been nothing worse than the first crash. We would
have had the debt disease, but not the dollar disease—the bad cold
but not the pneumonia.
42. If the debt-deflation theory of great depressions is essentially
correct, the question of controlling the price level assumes a new importance; and those in the drivers' seats—the Federal Reserve Board
and the Secretary of the Treasury, or, let us hope, a special stabilization commission—will in future be held to a new accountability.
43. Price level control, or dollar control, would not be a panacea.
Even with an ideally stable dollar, we would still be exposed to the
3

Eventually, however, in order to have avoided depression, the gold standard would have had to be abandoned or modified (by devaluation); for, with the
gold standard as of 1929, the price levels at that time could not have been maintained indefinitely in the face of: (1) the "scramble for gold" due to the continued
extension of the gold standard to include nation after nation; (2) the increasing
volume of trade; and (3) the prospective insufficiency of the world gold supply.




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ECONOMETRICA

debt disease, to the technological-unemployment disease, to over-production, price-dislocation, over-confidence, and many other minor diseases. To find the proper therapy for these diseases will keep economists busy long after we have exterminated the dollar disease.
DEBT STARTERS

44. The over-indebtedness hitherto presupposed must have had its
starters. It may be started by many causes, of which the most common
appears to be new opportunities to invest at a big prospective profit, as

compared with ordinary profits and interest, such as through new inventions, new industries, development of new resources, opening of
new lands or new markets. Easy money is the great cause of overborrowing. When an investor thinks he can make over 100 per cent
per annum by borrowing at 6 per cent, he will be tempted to borrow,
and to invest or speculate with borrowed money. This was a prime
cause leading to the over-indebtedness of 1929. Inventions and technological improvements created wonderful investment opportunities,
and so caused big debts. Other causes were the left-over war debts,
domestic and foreign, public and private, the reconstruction loans to
foreigners, and the low interest policy adopted to help England get
back on the gold standard in 1925.
Each case of over-indebtedness has its own starter or set of starters.
The chief starters of the over-indebtedness leading up to the crisis of
1837 were connected with lucrative investment opportunities from developing the West and Southwest in real estate, cotton, canal building
(led by the Erie Canal), steamboats; and turnpikes, opening up each
side of the Appalachian Mountains to the other. For the over-indebtedness leading up to the crisis of 1873, the chief starters were the exploitation of railways and of western farms following the Homestead
Act. The over-indebtedness leading up to the panic of 1893 was chiefly relative to the gold base which had become too small, because of
the injection of too much silver. But the panic of 1893 seems to have
had less of the debt ingredient than in most cases, though deflation
played a leading r61e.
The starter may, of course, be wholly or in part the pendulum-like
back-swing or reaction in recovery from a preceding depression as commonly assumed by cycle theorists. This, of itself, would tend to leave
the next depression smaller than the last.
45. When the starter consists of new opportunities to make unusually profitable investments, the bubble of debt tends to be blown
bigger and faster than when the starter is great misfortune causing
merely non-productive debts. The only notable exception is a great
war and even then chiefly because it leads after it is over to productive

debts for reconstruction purposes.


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46. This is quite different from the common naive opinions of how
war results in depression. If the present interpretation is correct, the
World War need never have led to a great depression. It is very true
that much or most of the inflations could not have been helped because
of the exigencies of governmental finance, but the subsequent undue
deflations could probably have been avoided entirely.
47. The public psychology of going into debt for gain passes through
several more or less distinct phases: (a) the lure of big prospective
dividends or gains in income in the remote future; (b) the hope of selling at a profit, and realizing a capital gain in the immediate future;
(c)thevogue of reckless promotions, taking advantage of the habituation
of the public to great expectations; (d) the development of downright
fraud, imposing on a public which had grown credulous and gullible.
When it is too late the dupes discover scandals like the Hatry, Krueger, and Insull scandals. At least one book has been written to prove
that crises are due to frauds of clever promoters. But probably these
frauds could never have become so great without the original starters
of real opportunities to invest lucratively. There is probably always
a very real basis for the "new era" psychology before it runs away
with its victims. This was certainly the case before 1929.
48. In summary, wefindthat: (1) economic changes include steady
trends and unsteady occasional disturbances which act as starters for
cyclical oscillations of innumerable kinds; (2) among the many occasional disturbances, are new opportunities to invest, especially because of new inventions; (3) these, with other causes, sometimes conspire to lead to a great volume of over-indebtedness; (4) this, in turn,
leads to attempts to liquidate; (5) these, in turn, lead (unless counteracted by reflation) to falling prices or a swelling dollar; (6) the dollar
may swell faster than the number of dollars owed shrinks; (7) in that
case, liquidation does not really liquidate but actually aggravates the
debts, and the depression grows worse instead of better, as indicated
by all nine factors; (8) the ways out are either via laissez faire (bankruptcy) or scientific medication (reflation), and reflation might just
as well have been applied in the first place.
49. The general correctness of the above "debt-deflation theory of
great depressions" is, I believe, evidenced by experience in the present
and previous great depressions. Future studies by others will doubtless check up on this opinion. One way is to compare different countries simultaneously. If the "debt-deflation theory" is correct, the infectiousness of depressions internationally is chiefly due to a common
gold (or other) monetary standard and there should be found little
tendency for a depression to pass from a deflating to an inflating, or
stabilizing, country.




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SOME NEW FEATURES

As stated at the outset, several features of the above analysis are,
as far as I know, new. Some of these are too unimportant or self-evident to stress. The one (No. 32 above; also 36) which I do venture to
stress most is the theory that when over-indebtedness is so great as to
depress prices faster than liquidation, the mass effort to get out of debt
sinks us more deeply into debt.4 I would also like to emphasize the
whole logical articulation of the nine factors, of which debt and deflation are the two chief (Nos. 23, 24, and 28, above). I would call
attention to new investment opportunities as the important "starter" of
over-indebtedness (Nos. 44, 45). Finally, I would emphasize the important corollary, of the debt-deflation theory, that great depressions
are curable and preventable through reflation and stabilization (Nos.
38-42).
Yale University
4

This interaction between liquidation and deflation did not occur to me until
1931, although, with others, I had since 1909 been stressing the fact that deflation
tended toward depression and inflation toward a boom.
This debt-deflation theory was first stated in my lectures at Yale in 1931,
and first stated publicly before the American Association for the Advancement
of Science, on January 1,1932, It is fully set forth in my Booms and Depressions,
1932, and some special features of my general views on cycle theory in "Business
Cycles as Facts or Tendencies" in Economische Opstellen Aangehoden aan Prof.
C. A. Verrijn Stuart, Haarlem, 1931. Certain sorts of disequilibrium are discussed
in other writings. The role of the lag between real and nominal interest is discussed in The Purchasing Power of Money, Macmillan, New York, 1911; and
more fully in The Theory of Interest, Macmillan, New York, 1930, as well as the
effects of inequality of foresight. Some statistical verification will be found in
"Our Unstable Dollar and the So-called Business Cycle," Journal of the American Statistical Association, June, 1925, pp. 179-202, and "The Relation of Employment to the Price Level" (address given before a section of the American
Association for the Advancement of Science, Atlantic City, N. J., December 28,
1932, and later published in Stabilization of Employment, edited by Charles
F. Roos, The Principia Press, Inc., Bloomingdale, Ind., 1933, pp. 152-159). See
Charts I, II, III. Some statistical verification will be found in The Stock Market
Crash and After, Macmillan, New York, 1930.
A selected bibliography of the writings of others is given in Appendix III
of Booms and Depressions, Adelphi Company, New York, 1932. This bibliography
omitted Veblen's Theory of Business Enterprise, Charles Scribner's Sons, New
York, 1904, Chapter VII of which, Professor Wesley C. Mitchell points out,
probably comes nearest to the debt-deflation theory. Hawtrey's writings seem
the next nearest. Professor Alvin H. Hansen informs me that Professor Paxson,
of the American History Department of the University of Wisconsin, in a course
on the History of the West some twenty years ago, stressed the debt factor and
its relation to deflation. But, so far as I know, no one hitherto has pointed out

how debt liquidation defeats itself via deflation nor several other features of the
present "creed." If any clear-cut anticipation exists, it can never have been
prominently set forth, for even the word "debt" is missing in the indexes of the
treatises on the subject.



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CHARTS

The following eight charts are all on the "ratio scale" excepting
Charts II, III, V, VI, and curve P' of Chart I. The particular ratio
scale used is indicated in each case.
It will be noted that in Charts VII and VIII all curves have a
common ratio scale, as indicated by the inset at the right in both
charts, except "Brokers' Loans" in Chart VII and "Failures Numbers," "Failures Liabilities," and "Shares Traded" in Chart VIII,
which four curves have another, "reduced" i.e., smaller, common scale,
as indicated by the inset at the left of Chart VIII.
It will be further noted that "Money in Circulation," "Failures
Numbers," and "Failures Liabilities" are inverted.
The full details of how
in Charts II and III is derived from P'
in Chart I and also how P' in Chart I is derived from P are given in
"Our Unstable Dollar and the So-Called Business Cycle," Journal of
the American Statistical Association, June, 1925.




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