The New York Times / November 23, 2008
Economic View
The New Deal Didn't Always Work, Either
By TYLER COWEN
MANY people are looking back to the Great Depression and the New Deal
for answers to our problems. But while we can learn important lessons
from this period, they're not always the ones taught in school.
The traditional story [by whom?] is that President Franklin D.
Roosevelt rescued capitalism by resorting to extensive government
intervention; the truth is that Roosevelt changed course from year to
year, trying a mix of policies, some good and some bad. It's worth
sorting through this grab bag now, to evaluate whether any of these
policies might be helpful.
If I were preparing a "New Deal crib sheet," I would start with the
following lessons:
MONETARY POLICY IS KEY As Milton Friedman and Anna Jacobson Schwartz
argued in a classic book, "A Monetary History of the United States,"
the single biggest cause of the Great Depression was that the Federal
Reserve let the money supply fall by one-third, causing deflation.
Furthermore, banks were allowed to fail, causing a credit crisis.
Roosevelt's best policies were those designed to increase the money
supply, get the banking system back on its feet and restore trust in
financial institutions.
[This is simplistic, to say the least: the adherence to the gold
standard prevented the use of monetary policy to stimulate the
economy, while banks opposed such policies. The dominant view of the
monetary establishment at the time (the Fed's Board, including the
Secretary of the Treasury, Andrew Mellon) was that the economy would
recover automatically after purging imbalances from the economy. In
other words, the Milton Friedmans of that day _did not want_ to use
monetary policy. Nature would take its course, automatically solving
the economy's problems. (These folks were "Austrian" in their
temperament: the 1929-33 recession was simply punishment for the sins
of over-expansion during the 1920s. Expiation was needed.
Interestingly, there are a lot of so-called "Austrian" economists
where Cowen teaches. I wonder it he's arguing against them.)
[In addition, this story ignores the steep fall in fixed investment
and exports in the 1930s, which could not have been counteracted
easily: fixed investment is hard to stimulate when unused capacity
and/or debt is large (and expectations are pessimistic), while exports
are hard to encourage when there's a trade war going on.
[Once deflation hits, expansionary monetary policy loses its
usefulness. Nominal interest rates can't go below zero, while falling
prices raise the real interest rate. When real interest rates (which
are what counts in affecting the economy's path) rise, that encourages
recession. BTW, this problem is currently on the horizon, cramping
Bernanke's style.
[MF and A.J. Schwartz's Big Book is totally descriptive, by the way.
They really don't posit any understanding of how the money supply
affects the economy or how the Fed controls the money supply. They
don't look at the political economy of the era at all. (Along with
_Capitalism and Freedom_, the book is worshiped by the
Chicago-schoolers like Cowen. This fits the way that MF is seen as
their prophet and the free market as their one true God.)
A study of the 1930s by Christina D. Romer, a professor at the
University of California, Berkeley ("What Ended the Great
Depression?," Journal of Economic History, 1992), confirmed that
expansionary monetary policy was the key to the partial recovery of
the 1930s. The worst years of the New Deal were 1937 and 1938, right
after the Fed increased reserve requirements for banks, thereby
curbing lending and moving the economy back to dangerous deflationary
pressures.
[The economy was also stimulated by government deficits at the time.
It's a mistake to look for only one cause. However, Romer is a good
economist, whose research shouldn't be rejected before reading it.]
Today, expansionary monetary policy isn't so easy to put into effect,
as we are seeing a shrinkage of credit and a contraction of the
"shadow banking sector," as represented by forms of derivatives
trading, hedge funds and other investments. So don't expect the
benefits of monetary expansion to kick in right now, or even six
months from now.
Still, the Fed needs to stand ready to prevent a downward spiral and
to stimulate the economy once it's possible.
[Gee, isn't it doing so already??]
GET THE SMALL THINGS RIGHT It's not just monetary and fiscal policies
that are important. Roosevelt instituted a disastrous legacy of
agricultural subsidies and sought to cartelize industry, backed by
force of law. Neither policy helped the economy recover.
[It was Hoover who started the ag. subsidies, while if expansionary
fiscal and monetary policy aren't being used (as they weren't),
cartels and the like prevent deflation, which was a total disaster.
Cowen wants to put all the weight on monetary policy, it seems.
Cartels aren't pretty, but they're what more sophisticated economists
than Cowen call "second best" solutions.]
He also took steps to strengthen unions and to keep real wages high.
This helped workers who had jobs, but made it much harder for the
unemployed to get back to work. One result was unemployment rates that
remained high throughout the New Deal period.
[This is silly. Serious macroeconomists know that the main factor
determining employment in a depression is aggregate demand and the
amount of production, not the wage. Suppose real wages fall, as Cowen
recommends. Why would an employer hire more workers, if the extra
output can't be sold??]
[In any event, falling wages make matters worse on the demand side, as
Keynes pointed out.]
Today, President-elect Barack Obama faces pressures to make
unionization easier, but such policies are likely to worsen the
recession for many Americans.
[That's Cowen's opinion; he's anti-union.]
DON'T RAISE TAXES IN A SLUMP The New Deal's legacy of public works
programs has given many people the impression that it was a time of
expansionary fiscal policy, but that isn't quite right [as has been
known for a very long time, i.e., since E. Cary Brown's path-breaking
research]. Government spending went up considerably, but taxes rose,
too. Under President Herbert Hoover and continuing with Roosevelt, the
federal government increased income taxes, excise taxes, inheritance
taxes, corporate income taxes, holding company taxes and "excess
profits" taxes.
[right. We should note, however, that raising taxes and government
spending at the same time can stimulate aggregate demand, as in the
famous but forgotten "balanced budget multiplier" theorem.]
When all of these tax increases are taken into account, New Deal
fiscal policy didn't do much to promote recovery. Today, a tax cut for
the middle class is a good idea — and the case for repealing the Bush
tax cuts for higher-income earners is weaker than it may have seemed a
year or two ago.
[Right. In fact, it looks like Obama is not going to abolish the Bush
rewards for being wealthy and well-connected. Instead, he's just going
to let them lapse. If he abolished them (a good thing to do), the
middle-class tax cut or (even better) working-class tax-cuts would
have to be larger to counteract the depressive effects of immediate
abolition.]
WAR ISN'T THE WEAPON World War II did help the American economy, but
the gains came in the early stages, when America was still just
selling war-related goods to Europe and was not yet a combatant. The
economic historian Robert Higgs, a senior fellow at the Independent
Institute, has shown in his 2006 book, "Depression, War, and Cold
War," just how much the war brought shortages and rationing of
consumer goods.
[right. We knew that: WW II started before the US got in -- as did the
stimulative effects on the US economy. Cowen seems to be eliding the
fact that the shortages and rationing happened only when the war
became a total war.]
While overall economic output was rising, and the military draft
lowered unemployment, the war years were generally not prosperous
ones. As for today, we shouldn't think that fighting a war is the way
to restore economic health.
[War does promote the demand side, which is what the US economy needed
at the time. In the long run, I think that war and military spending
are bad for supply side growth (i.e., for long-term trend of real GDP)
because they are tremendously wasteful. On the other hand, WW II and
the Cold War may be the exceptions. The working class was strong
enough to win the GI Bill (partly because our rulers remembered the
negative effects of soldiers being abandoned after WW I), which helped
supply-side growth. That, plus Cold War related infrastructural
investment and subsidies for housing, helped create the so-called
"golden age" of the US economy.]
YOU CAN'T TURN BAD TO GOOD The good New Deal policies, like
constructing a basic social safety net, made sense on their own terms
and would have been desirable in the boom years of the 1920s as well.
[Now there's an irrelevant point! Was Cowen around back in the 1920s
to convince Coolidge of this point?]
The bad policies made things worse. [well, duh!] Today, that means we
should restrict extraordinary measures to the financial sector as much
as possible and resist the temptation to "do something" for its own
sake.
•
In short, expansionary monetary policy and wartime orders from Europe,
not the well-known policies of the New Deal, did the most to make the
American economy climb out of the Depression. Our current downturn
will end as well someday, and, as in the '30s, the recovery will
probably come for reasons that have little to do with most policy
initiatives. [That's Cowen's faith.]
Tyler Cowen is a professor of economics at George Mason University.
Copyright 2008 The New York Times Company
--
Jim Devine / "Nobody told me there'd be days like these / Strange
days indeed -- most peculiar, mama." -- JL.
_______________________________________________
pen-l mailing list
[email protected]
https://lists.csuchico.edu/mailman/listinfo/pen-l
