The old monetarist tale of the Great Depression, thoroughly refuted in the Austrian literature, is that the Federal Reserve failed to provide enough inflation (i.e., money supply) when the market started to weaken and it allowed the money supply to collapse, and, as a result, the banks failed and the economy went into a tailspin of depression.
They believe that the Federal Reserve acted properly during the 1920s in maintaining price-level stability by providing the banking system with regular injections of money. This despite the fact that the decade was called the "Roaring Twenties," that unemployment was unnaturally low, and that anyone looking at a graph of the stock market could clearly see a bubble in the making.
The new chairman of the Federal Reserve, Professor Ben Bernanke, is a student of the Great Depression and has written extensively on the subject. He famously said (as vice chairman of the Fed) at Milton Friedman's 90th birthday, not to worry, Milton, "We won't let it happen again."
He covers all the negatives: the dollar is low, gold and oil are high and inflation is rising. Then he covers the Term Auction Facility that Bernanke is using to force reserves into the banking system. Most of you won't be interested in the details, but the bottom line is that the Fed is trying to inflate their way out of a mess of their own making. They've found a new way to do it, but its the same old story. The TAF has allowed the banks a new way to borrow from the Fed without everyone knowing about:
Lower rates and the cover of darkness — this is a nice deal for the banks. Bank borrowing from the Fed is so large that it is actually greater than their total reserves on hand.
The important question is, who's right and who's wrong. Can Bennie make the banks and the bad debts ageless? Can he live up to his promise to Milton Friedman and maintain his inflation targeting promises? It would seem that he has put the faith in monetarism and government-managed money on the line. So stick around to find who's right and who's wrong.
I suspect the Fed will be succesful in their efforts. It's not the right way to run the economy - as if we needed someone in DC to run it - but it will probably work in the short run. There will come a day when the Austrians will be right and everything will collapse, but I don't think we're there yet.