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Monday, December 1, 2008

LESSONS OF THE GREAT DEPRESSION CONTINUED: THE RATIONALE FOR FISCAL STIMULI THEN AND NOW

Reasons for Being Thankful

Prof bug hopes everyone had a pleasant Thanksgiving holiday, and heaven knows, we have a lot to be thankful for --- not least, the imminent end of George W. Bush's ham-handed internship as our disastrous president the last 8 years.  Starting with an extravagantly mishandled occupation of Saddamite Iraq after a quick, decisive military victory . . . the misguided, near-calamitous occupational policies clung to, with dumbfounding stubborness until the very end of 2006.  And the economic disaster starting even earlier in the first Bush administration with the appointment of unqualified people to our regulatory agencies, along with the long-standing persistence into most of the Bush era of Alan I'm-in-a-state-of-stunned disbelief Greenspan at the Federal Reserve. . . all contributing mightily to our present financial meltdown.

National Revival 

Well, fortunately, our country has an unusual political way of renewing itself with largely unknown or half-known political leaders, semi-outsiders who start a run for the presidency in party primaries with little financial support or national coverage like Bill Clinton in 1991-92 and Barak Obama in 2007-08.  Or, in the case of Ronald Reagan after the near-disastrous Jimmy Carter era that ended in 1980, with a former governor not holding any political post for six years when he won the presidency in the fall of that year. 

Similarly, relevant to today's topic as you'll see momentarily, there was the replacement of the calamitous Herbert Hoover years of the Great Depression, 1929-33, by the former governor of New York, Franklyn D. Roosevelt . . . the alleged traitor-to-his-class, or so his Republican opponents in high hats called him.  For that matter, a relatively unknown Senator from Missouri, Harry Truman --- in office as Vice President for only two months at the start of FDR's 4th term in 1945 when the president died --- turned out to be a remarkably successful leader too . . . not least in foreign policy, when he and his major appointees shaped our ultimately successful policies for the new menacing era of the nuclear-infested cold war with the totalitarian Soviet Union and global communism.

And if we are lucky, the start of President Obama's administration in less than two months will initiate another era of national rejuvenation too: both at home and on the global scene.

Enter Today's Topic: Back to the Economic Lessons of the Great Depression for Today's Policymaking

About 8 or 9 days ago, prof bug posted a couple of lengthy commentaries at two libertarian web sites of high quality, Carpe Diem run by Prof. Mark Perry of the University of Michigan and Marginal Revolution under the guidance of Prof. Tyler Cowen of George Mason University on the role of fiscal stimuli in the New Deal era of FDR as a critical part of the New Deal recovery after the Hoover era, during which  US GDP fell somewhere between 30-44% --- depending on the inflation/deflation measure used to arrive at real GDP (in constant 1929 dollar or constant and chainlinked 2000 dollars) --- and unemployment soared to over 20%, while serious deflation led the economy's price-level to plunge around 25%. 

Where Art Thou, Oh Brother-Post?

At the Marginal Revolution, the thread started with Prof. Cowen summarizing his New York Times regular article on the lessons of the Great Depression. 

Though it was a good to-do list for an educated readership of the Times with little knowledge of economics, never mind the Great Depression itself, Prof. Cowen pooh-poohed the use of fiscal stimuli in the FDR recovery years --- which was in line with his libertarian commitments --- and restricted his recommendations on that score to Obama's planned tax cuts for the middle class.  Enter the buggy prof.  In a long commentary, he noted how important fiscal stimuli were; noted, too, how Prof. Cowen forgot to mention another critical lesson of the Great Depression era --- the need, so far materializing successfully today, for international cooperation in a highly interdependent global economy across national boundaries; and added a few other comments . . . all set out, so prof bug in his naïveté though, in a respectful semi-scholarly manner.  Or so he thought. 

Alas, after existing on the Marginal Revolution site for three days or so, Prof. Cowen deleted these bugged-out views and sent them into cyberspace oblivion . . . except, ha ha, prof bug (now case-hardened in posting his usual standard-model 1000-2000 word comments full of hard empirical evidence of various sorts) kept a copy on his own harddrive. 

And it will follow soon if you click on the continued link below here.

First Though: Why the Censorship-Execution?

As you'll see, it's a remarkably terse commentary . . . only 852 words-long, hardly enough for the usual buggy prof stuff to warm up and start its introductory preamble.  Which leaves us all wondering, the buggy professor most of all: is prof bug a walking, wind-up wind-machine, or is he a fairly careful, evidence-concerned writer who is also alert to the need not to be superficial and simply lay down obiter-dicta in line with some ideological bias concealed in the decor of a theoretical commitment . . . the latter, of course, further rationalized as rigorously scientific, right?

Well, it's Prof. Cowen's right . . . no two ways about it; certainly not anything to complain about, just to note.  He's a good economist and has a much broader range of literary and artistic interests than your average specializing scholar these days.  And though, as you'll see in another buggy post today or tomorrow, he also guillotined another lengthy buggy commentary in a different thread --- this one dealing with an exchange between two economists there about the viability of the Soviet economy in the late 1980s before the entire Soviet system and Communism collapsed into an historical toxic-dump for good --- prof bug has to add that Prof. Cowen has generally been decent and tolerant about the buggy stuff left on his site. 

So no, no complaints.

Later Today

Oh, almost forgot: the more lengthy bugged-out comments left at Carpe Diem will be linked to later today in a separate buggy post here. 

And as you'll see, any fiscal stimuli have to be accompanied by accomodating monetary policy and be focused on the proper "multiplier effects" --- say, on infrastructure or unemployment insurance --- if they're to have a solid impact on raising aggregate demand.  Then, too, such stimuli are strictly for the short- and mid-term . . . to try buffering the shocks of the financial meltdown and very worrying credit on the real economy's declining aggregate demand, thanks to declining personal consumption, business and residential investment, and exports as the dollar rises in foreign exchange markets and a global recession sets in.

Remember here: Y (GDP) = C + I + G (-taxes) + X-M, where X is exports and M are imports.  With C and I and E falling, the only stimulus to aggregate demand for combatting a decline in Y is increased G (or reduced taxes).

And now, down to the substantive stuff:

                                     THANK YOU TYLER

"The to-do list that you set out, Tyler, is fine . . . especially when you consider that it was written for the average educated reader of the NY Times, who has little knowledge of economics, let alone of the Great Depression.

You could have mentioned, though, a few other policy-guides, even if at the same fast, top-skimming pace that the NY Times article requires. To wit:


1) Fiscal policy and the failure of the New Deal to pursue it vigorously.

Contrary to conventional views, FDR was conservative in matters of deficit spending and hardly pursued fiscal stimuli in the period between 1933 and 1939. His initial budget director, Lewis Douglas, was especially zealous on this score, cutting government spending in several areas in his tenure (1933-34). And Henry Morgenthau, FDR's closest friend in the administration, and his Treasury Secretary until FDR's death in 1945, was only slightly less inflexible than Douglas.

The result?

Click here for a clear graph that traces fiscal stimuli by means of deficit spending between 1929 and 1950; note how it clearly reveals a tight correlation between the rates of unemployment and deficits/surpluses as a percentage of GDP.

 

A few added comments tossed out at lickety-split speed follow:

*  As percentages of GDP, FDR's deficit spending in his first 8 years of office never came close to reaching the record of the Ronald Reagan period of the 1980s. Nor did FDR's biggest deficit in 1934 --- just about 5.0% of GDP--- ever match the Reagan record here of 6.0%. For that matter, FDR's fiscal "irresponsibility" doesn't even begin to parallel the deficits of the Bush-W era.

* If you look at the chart linked to above, you note that the deep recession of 1937-38 (about 13 months) parallels closely the sharp reduction in deficit spending between 1936 and 1937 toward a near-balanced federal budget --- the result of increased taxes (not counteracted) that flowed in from the new Social Security system to the US Treasury. Simultaneously, the Federal Reserve --- run by conservatives for the most part in policymaking --- was fearful of inflation; tightened the monetary base; and reinforced the fiscal cause of a recession.

* In the upshot, unemployment --- which had fallen from 20.6% in 1933 when FDR took office to 9.1 by the start of 1937 (Darby's 1973 statistical analysis) --- shot up to 12.5%, while industrial production plunged about 33% (vs. over 50% between 1929 and 1933). When the recovery came in the summer of 1938 with a very fast growth in GDP over the next three years before we began to rearm and then entered WWII, unemployment stayed at 11.3% in 1939 and 9.5% in 1940.

* Finally, unlike the US, Nazi Germany and militarized Japan engaged in massive deficit spending --- the Japanese Minister of Finance in the 1930s pioneer of Keynesian recipes --- and both moved out of the Depression far faster than the US did. Japan, it's true, never suffered the same plunge in GDP and employment that the US did; but Weimar Germany did, and the combination in Nazi fiscal policy of expanding rapidly the historical German welfare-state (created by Bismarck in the 1880s to blunt the powerful, massively growing German Socialist party) and rearmament took the country fairly quickly out of levels of unemployment and a decline in industrial product and GDP fairly similar to ours.

The Moral?

Those who are currently urging a large government program of spending seem to be drawing a proper lesson from the Great Depression New Deal era.

    

2) International Cooperation Is Crucial

The Great Depression's depth and prolongation in the US --- and elsewhere --- was powerfully influenced by the Hoover administration's adherence to the gold standard. As long as the US$ was tied to it, the Federal Reserve was reluctant to expand the money supply and hence lower interest rates. That would have entailed two things: a slowdown and maybe end of the gold-inflows that were occurring even in the 1929-1933 period, and eventually an outflow of gold to countries with higher interest rates.

In fact, as we know from Eichengreen's and Romer's works --- among others --- it was eventually the combined effects of moving off the gold standard in the FDR year of 1933, depreciating the dollar exchange rate, and attracting gold-inflows from Europe as war began to emerge as a threat in the late 1930s that expanded the US money supply despite the Federal Reserve's continued passive policies.

The problem today is not simply what to do in concert with other industrial and major financial countries, it's also how the Chinese regime will do --- with about $2 trillion of reserves --- with its own exchange rate and willingness or not to switch from export-led growth (and most non-residential investment that China's economy allocates to its firms engaged in it) by not depreciating its own currency and pursuing domestic-led recovery and long-term growth.

 

3) The Best Theoretical Survey of the Causes of the Great Depression Is Found Here.

It's in the Economic History Net Encyclopedia . . . an impressive, fairly detailed, and easy-to-follow analysis, set out in depth.  (Only fair to note that two or three days after prof bug's posted comments here were sent skyhooting into an interstellar black hole, Prof. Cowen set out a link to this article that he had found in those comments.  So, you see: an http:// link managed, contrary to existing astro-physics, to crawl out of its black-hole burial and make it back to earth-bound cyberspace after all.)

...........

Michael Gordon,  AKA the buggy professor