I was pleasantly surprised to see you seriously entertain the notion that "depressions" — for younger readers, the term economists used to use for what we now call "recessions" — might serve a socially useful function. This is a crucial issue, as the government has already committed more than one trillion dollars, and assumed incredible powers, in an attempt to skirt the current slump. Virtually every financial commentator takes it for granted that boom periods are good while recessions are bad, and that government policies ought to foster booms while minimizing recessionary periods.
The Austrian School of economics rejects government intervention in economic events altogether. As we will explain below, the Austrians do not accept the standard view — held even by famous proponents of the free market, such as Milton Friedman — that the business cycle is a normal feature of capitalism. On the contrary, Ludwig von Mises and subsequent Austrians developed the theory that the business cycle is an unintended consequence of government intervention in the monetary and banking system. Specifically, the central bank (the Federal Reserve in the United States) pushes the interest rate down below its "natural" level by injecting new money into the banking system. This artificial stimulus sets in motion an unsustainable boom period of illusory prosperity.
During the subsequent (and inevitable) recession, resources are reallocated in light of the "malinvestments" made during the boom. Far from being "bad," the recession is part of the process of recovery, where entrepreneurs make the best of the untenable situation created during the boom. It is in this sense that Austrians say that recessions are a good thing. They are the recognition of the previous mistakes that entrepreneurs have made investing scarce resources, when they were misled by the distorted price signals reverberating from the Fed’s interventions.
If the Austrians are right in their diagnosis of the boom-bust cycle, then the typical policy prescriptions offered by most economists are harmful. These "countercyclical" measures try to prevent the recession from unfolding, by stamping down on unemployment and propping up insolvent businesses. Yet these actions simply prolong the agony, and ensure that even more resources are squandered while the economy tries to adjust to a sustainable configuration. To adopt a biological metaphor: Of course nobody likes vomiting. But if someone has ingested poison, throwing it up is a good thing. Efforts by physicians to numb the person’s gag reflex and settle his stomach will lead to disaster.