All about ideas…

Repeating the Mistakes of History: It’s Looking a Lot Like 1937 Again.

with 2 comments

Bruce Bartlett, senior policy adviser in the Reagan and George H.W. Bush administrations, has an enlightening column this morning on the NY Times Economix.

Given the deficit/debt talks that have completely overshadowed any discussion of how to increase demand (sales) which would create jobs, Mr. Bartlett brings his historical knowledge to the debate.

By 1937, President Roosevelt and the Federal Reserve thought self-sustaining growth had been restored and began worrying about unwinding the fiscal and monetary stimulus, which they thought would become a drag on growth and a source of inflation. There was also a strong desire to return to normality, in both monetary and fiscal policy.

On the fiscal side, Roosevelt was under pressure from his Treasury secretary, Henry Morgenthau, to balance the budget. Like many conservatives today, Mr. Morgenthau worried obsessively about business confidence and was convinced that balancing the budget would be expansionary. In the words of the historian John Morton Blum, Mr. Morgenthau said he believed recovery “depended on the willingness of business to increase investments, and this in turn was a function of business confidence,” adding, “In his view only a balanced budget could sustain that confidence.”

Roosevelt ordered a very big cut in federal spending in early 1937, and it fell to $7.6 billion in 1937 and $6.8 billion in 1938 from $8.2 billion in 1936, a 17 percent reduction over two years.

At the same time, taxes increased sharply because of the introduction of the payroll tax. Federal revenues rose to $5.4 billion in 1937 and $6.7 billion in 1938, from $3.9 billion in 1936, an increase of 72 percent. As a consequence, the federal deficit fell from 5.5 percent of G.D.P. in 1936 to a mere 0.5 percent in 1938. The deficit was just $89 million in 1938.

At the same time, the Federal Reserve was alarmed by inflation rates that were high by historical standards, as well as by the large amount of reserves in the banking system, which could potentially fuel a further rise in inflation. Using powers recently granted by the Banking Act of 1935, the Fed doubled reserve requirements from August 1936 to May 1937. Higher reserve requirements restricted the amount of money banks could lend and caused them to tighten credit.

This combination of fiscal and monetary tightening – which conservatives advocate today – brought on a sharp recession beginning in May 1937 and ending in June 1938, according to the National Bureau of Economic Research. Real G.D.P. fell 3.4 percent in 1938, and the unemployment rate rose to 12.5 percent from 9.2 percent in 1937.

As a side note, the U.S. economy failed to recover from that recession until the vast federal stimulus, caused by our entry in WWII, created massive business demand.

Americans need to learn from our economic history rather than disregard it or remain ignorant of it. If a specific policy failed to work in the past or caused even more harm, why should it work now?


Written by Valerie Curl

July 12, 2011 at 9:38 AM

2 Responses

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  1. The problem with this analysis, and the problem with most historical analysis, is that it points to one thing and then claims it is either the cause of or the answer to a problem.

    Are you sure it was just the “combination of fiscal and monetary tightening” that caused the continuation of the depression? Is it possible that the introduction of a payroll tax that could have led to higher unemployment?

    What where the lending practices of banks? I find that most recessions/depressions, like the one we are in now, are preceded by and include a tightening of lending.

    I would also be careful of calling for WW2 type stimulus. Yes, FDR did find that removing 400k Americans from the work force did wonders for the unemployment numbers.

    There is no one specific policy that failed during the depression. Why not look to the policies that worked during the depression of 1920?


    July 12, 2011 at 11:20 AM

  2. A recession caused by a financial crisis is not like a normal recession. There’s no aggregate change in supply & demand and no change in monetary policy (higher or lower interest rates). The recession we’ve been in and the one creating the Great Depression are the same: too much speculation, too much cheap credit, and too much over leveraging. Until the house of cards fell.

    However, in ’37, as Bartlett and history books state, the government believed the economy had recovered enough to begin belt tightening to reduce the deficit. Regardless of which policy caused the ’37 – ’38 recession, we need to be aware and avoid making the same mistakes now. What if the large cuts to the budget actually was the primary driver of that recession? Are you willing to accept the same consequences now, driving up unemployment further and killing off even more economic activity?

    Valerie Curl

    July 16, 2011 at 3:23 PM

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