Marginal Revolution: Did the New Deal prolong the Great Depression?

リンク: Marginal Revolution: Did the New Deal prolong the Great Depression?.

Brad DeLong is overreaching when he argues "A normal person would not argue that the New Deal [TC: parts of, or "on net"] prolonged the Great Depression."  HedgeFundGuy, who may or may not be normal, responds:

A 2004 paper at the SSRN by Chari, Kehoe and McGratten argues that increased labor rigidity from the New Deal was primarily responsible for prolonging the Great Depression. Cole and Ohanian wrote a similar piece for the Minneapolis Fed in 1999.

Further, the 1937 recession was most probably due to a tax over-reach by anti-business Democrats.  Unemployment rose from 5 million to almost 12 million in early 1938.  Manufacturing output fell off by 40% from the 1937 peak; it was back to 1934 levels.  What caused the plunge in taxes was the tax on retained earnings...

I had thought that bad monetary policy in 1937-8 (arguably not "the New Deal", though we tread close to semantics) was at fault more than fiscal policy; I have never studied that question in depth.  The earlier attempted cartelization of the economy through NIRA and NRA didn't help either.  Deposit insurance, and a move toward automatic stabilizers for aggregate demand, stand on the more positive side of the ledger.

I disagree with much of Gene Smiley's book on the Great Depression, but he has many more reasonable arguments about the negative economic consequences of the New Deal and their connection to the magnitude and length of the Great Depression.  I do not know if he is normal.

Posted by Tyler Cowen on January 6, 2007 at 06:43 AM in History | Permalink

Comments

What's good about federal deposit "insurance" and the moral hazard it
created?

Posted by: Bill Stepp at Jan 6, 2007 9:49:55 AM

That it eliminated the possibility of panic runs and the resulting collapses in the money stock that Milton Friedman always blamed for the Great Depression.

Ads I've understood it, the argument is that the New Deal made the Depression (a) shallower--1934 with a continuation of Hoover-like gold-standard policies is terrifying to contemplate--but (b) longer in that it added to nominal rigidities.

I would like to see an example of a country that followed classical policies and yet emerged from the Great Depression more rapidly before I credit this argument. As best as I can see everybody except Nazi Germany was left with a large, stubborn legacy of structural unemployment in the late 1930s that was only cured by the enormous surges of demand of World War II.

Posted by: Brad DeLong at Jan 6, 2007 10:14:27 AM

But if you go back to the long depression of the 1880 you find an aftermath of very high structural unemployment that closely paralleled that of the late 1930s.

Much of both can be explained by an earlier investment boom being followed by exceptional productivity growth much like what we saw in the early 2000s.

So if you are going to blame the New Deal for high unemployment you also have to blame the high unemployment of the 1890s on the New Deal.

Posted by: spencer at Jan 6, 2007 10:26:19 AM

Britain's non-industrial economy was not mired in a depression for most of the 30's, probably due to sensible monetary policy. The British economy generally was out of the deep depression by the mid-30's due to rearmament.

Which leaves the question why does re-arming work when picks, shovels, and rakes do not? The most obvious is that when you re-arm, the people who actually know how to produce things and make jobs (ie., the hated businessmen) are running the economy rather than bureaucrats. It was FDR's anti-business, WPA-like approach that prolonged the depression. Had he taken an aggressively pro-business stand, the depression would undoubtedly have been much less severe and shorter as well.

Hoover was equally clueless as to what to do. But doesn't it seem obvious now that a flexible-monetary and pro-business policy (like we have today) would have gotten us out of the slump pretty early on?

Posted by: ziel at Jan 6, 2007 11:09:25 AM

Well, it's indisputable that the USA had both a larger decrease in per capita GDP and a larger growth in unemployment during the Great Depression than essentially all other countries. (Canadian statistics were, unsurprisingly, similar to the US.) How much of that was due to policy and how much to other factors is quite difficult to determine.

As best as I can see everybody except Nazi Germany was left with a large, stubborn legacy of structural unemployment in the late 1930s that was only cured by the enormous surges of demand of World War II.

But isn't that untrue of Switzerland? Also, I do recall many of the Nordic countries recovering relatively quickly and having a mild depression. The Nordic countries had gotten off the gold standard quickly and so there's a natural monetary explanation; they also had social democratic governments at the time, allowing one to argue that at least properly executed Keynesianism would not be a problem.

However, Switzerland, famously, had not gotten off the gold standard and still did quite well, relatively, in the Great Depression. I don't know enough about the rest of their economic policy during the time period.

Posted by: John Thacker at Jan 6, 2007 11:39:35 AM

But if you go back to the long depression of the 1880 you find an aftermath of very high structural unemployment that closely paralleled that of the late 1930s.

..

So if you are going to blame the New Deal for high unemployment you also have to blame the high unemployment of the 1890s on the New Deal.

Wait, aftermath? Everything I've ever read says that the US had an actual recession during 1893-1897, possibly with two years of growth in the middle surrounded by recession. And, of course, we could go round and round by noting that the unemployment in that period, while bad, did not reach the levels of the Great Depression. Most things have more than one cause, though, so I'm not sure that any of that is helpful or if your "you also have to" statement follows.

It would be as ridiculous as taking your paragraph:
Much of both can be explained by an earlier investment boom being followed by exceptional productivity growth much like what we saw in the early 2000s.

And arguing that "if you say that, then you also have to admit that something was remarkably wonderful about fiscal and/or monetary policy in the last few years to avoid another depression like the Great Depression or that of the 1890s."

Posted by: John Thacker at Jan 6, 2007 11:44:38 AM

My recollection is that there was a recession in much of Western Europe which started in 1889 or so, but the recession did not really hit the US until 1893, around the time when Western Europe had largely recovered. There had been an earlier recession that had hit the US.

It depends on how you want to characterize the period 1873-1897. There was generally a recession going on somewhere in the world during that time, but there wasn't a 25 year long depression constantly in any country (well, possibly outside the UK, which certainly in relative terms lost its edge over the Continent.) There were periods in the middle of that time in the US with low employment and strong growth.

So was it a long depression or a series of somewhat unconnected recessions interrupted by growth? One thing is certain, it was a time of productivity increases and economic transformation.

Posted by: John Thacker at Jan 6, 2007 11:51:59 AM

Hmm, a little amount of research seems to confirm that the Swiss devalued the franc while keeping it on the gold standard. They also certainly adopted some social democratic/New Deal type policies during the period.

I think it's impossible to find any country that didn't have such reforms during the time period, making a comparison nearly impossible. Some countries did recover faster than others, of course.

Posted by: John Thacker at Jan 6, 2007 11:54:13 AM

Only the US and Canada had the big sudden jump in unemployment from 1937 to 1938, though.

Posted by: John Thacker at Jan 6, 2007 11:55:33 AM

Is "not normal" the new "shrill"?

Posted by: Jason Briggeman at Jan 6, 2007 12:04:09 PM

To Brad DeLong:

Deposit "insurance" didn't do anything to improve banks' balance sheets,
their capital to loan ratios, or their lending policies,
but repealing laws against interstate branch banking certainly did.
This is what lowered the probablity of bank runs.

Deposit insurance and the moral hazard it causes actually makes the banking
system less stable.

Free banks in Scotland had already solved the problem of bank panics, and they
did it with private means (such as option clauses). There were no deposit-like
institutions either before, during, or after
the Scottish free banking episode.

Posted by: Bill Stepp at Jan 6, 2007 1:20:21 PM

John Thacker -- You are completely right that I was being a wise guy about blaming the high unemployment of the long depression on the new deal.

But that does not negate the point that if you compare employment - unemployment -- in the 1930s great depression to the same data in the long depression then the 1930s does not look unusual or weak.

What we have seen in recent years is the emergence of a meme that employment growth was weak in the depression. But from 1934 to 1937 nonfarm employment growth averaged 6.6% --actually greater then the 1941-44 or WW II average employment growth of 4.6%, and the greatest employment growth of any four year period in US history.

So please tell me why the high unemployment rate in 1939-40 was a product of the new deal and not the 25% unemployment rate FDR inherited before the new deal began. I can argue that the new deal reduced the unemployment rate from 25% in 1933 to 10% in 1940-pre WW II era -- and claim that is a fantastic achievement of extremely strong growth.
So what are you comparing it to when you claim it was weak growth?

I suspect the best was to describe the long depression is that it looked a lot like what Japan just went through -- an era of weak recessions and weak recoveries

Posted by: spencer at Jan 6, 2007 1:35:33 PM

Pointed here by what I assume is a McArdle polemic over at the Economist blog, I'd like to drop a link to the revised version of that NBER paper, which I enjoyed. Cf http://minneapolisfed.org/research/SR/SR328_print.pdf

NB: said paper nowhere concludes that "increased labor rigidity from the New Deal was primarily responsible for prolonging the Great Depression," nor does the 1999 Fed paper (its conjecture is about cartelization).

A normal person would miscast research when it suits him, so HFG is quite normal. He's simply not to be trusted, the polemical equivalent of a manager who talks up his book loudly just as he is preparing to sell it out.

Posted by: wcw at Jan 6, 2007 2:26:34 PM

"Not normal" is "reality-based" people's code for "stupid." Hyper-partisan Brad DeLong seems to give the impression that anyone who doesn't think like him isn't "normal."

Posted by: Joe Schmidt at Jan 6, 2007 2:32:00 PM

There was a more severe recession when Wilson was leaving office and Harding was coming in. Although Harding is usually considered to be the worst President in history, he had the recession whipped within a year with a long boom following. The Great Depression was remarkable for it's great length and for another recession occurring within it.

Regarding armament and war causing recover, Wartime Prosperity? A Reassessment of the U.S. Economy in the 1940s from Robert Higgs argues it is largely illusory and that real recovery started after the war was over. Bryan Caplan here discusses Soviet industrialization, which he states was really militarization as production dropped.

Posted by: TGGP at Jan 6, 2007 2:48:33 PM

In 1944 US real GDP was $1,802 and in 1950 it was only $1,777 (real 2000 $). So we actually experienced negative growth. Moreover, under Ike in the 1950s we experienced three recessions and growth was decidely subpar as the fed worked to wring out the post-WW II -- Korean War inflation.

Given this it is hard to accept the Robert Higgs argument about the post war era.

Posted by: spencer at Jan 6, 2007 3:27:21 PM

Under Roosevelt, America's GDP grew at a China-like 8.9 annual rate%

Maybe the lefties know something about economics?

Posted by: alphie at Jan 6, 2007 3:51:22 PM

I keep hearing the argument that the new deal caused the post 1933 recovery to be weak. But I never hear anyone making that claim saying what it was weak compared to.

My little baby girl is six foot tall. Most people think she is tall. But she is the shortest member of out family -- I'm taller, her mother is taller and all of her siblings are taller. Her husband is 6' 6". The normal reaction is that he is tall. But he is shorter then the average NBA Basketball player. Taller like weaker is a comparison.

You have to say that the new deal caused the recovery to be weak compared to something. Weak is a relative not an absolute standard.

Interestingly, if you look at nonfarm payroll data. It peaked in 1929 and fell for 3 years. Then it took 3 years until 1936 to surpass the 1929 peak. Three years down and three years to regain the prior peak.

Ok, if you look at nine post WW-II recssions -- excluding the aborted 1980 recovery --you find that it is almost exactly the norm for nonfarm payroll employment to fall for the same number of quarters that it takes to regain the prior peak. In 6 recessions nonfarm payrolls fell for four quarters and took four quarter to regain the previous peak. In two recessions the recovery to the prior peak was shorter and in one it was longer. but the norm is amazingly symmetrical. That is exactly what happened this cycle -- nonfarm payrolls fell for 8 quarter and took 8 quarter to regain the prior peak.

By this standard the 1934-1936 employment record was amazingly average or normal.

So again, I keep being told the new deal made the post-1933 recovery weak. So all I ask is that anyone making this claim to tell me what it was weak compared to.

Posted by: spencer at Jan 6, 2007 5:10:51 PM

The point of the Robert Higgs argument is that the macro data obscure what was really going on during World War II: much of the increase in production was unsustainable manufacture of military equipment and living standards for many Americans stagnated due to strict rationing and price and wage controls. The labor force also shrunk as young men were drafted into the military.

Posted by: Ricardo at Jan 6, 2007 5:32:34 PM

In FDR: Champion of Freedom, Conrad Black (and, let's put Black's alleged felonies to one side---he's working with FDR archives he bought himself), the'37 recession was not the result of FDR's political maneuvering. Black argues that none of the New Deal made coherent economic sense. FDR played advisers off one another, so this reasoning goes, and some became concerned about the budget deficit, as did industrialists and FDR's peers. FDR tacked to the right so as not to alienate them, but when the numbers went south he tacked back to the left. Black argues that from 1933 onwards FDR's goal was to lift the US from the Depression to prepare it for war against Germany. His goal was to cobble together a political coalition to draw a majority out of isolationism, both in the electorate and in Congress and SCOTUS. But from his first run for VP to his gubernatorial contests and presidential polls, FDR's speechwriters made economic policy by committee, not principle.

Posted by: Joseph Steinberg at Jan 6, 2007 6:51:05 PM

"...the'37 recession was not the result of FDR's political maneuvering."

I meant it was the result of political maneuvering. Unlike Hoover, FDR made policy to win elections, not to make one group happy, or satisfy a theory.

Posted by: Joseph Steinberg at Jan 6, 2007 6:55:21 PM

WPA, aka: wealth pissed away

Posted by: indiana jim at Jan 6, 2007 10:23:50 PM

I studied Economics at UVa 1967-70. We didn't talk about the depression in depth so I've tried to study it some. The best book I've found is Economics and the Public Welfare, Benjamine M. Anderson. He considers the New Deal to start with
Hoover because it was the same bad thinking , Hawley-Smoot, jawboning industry
to keep wages up. lack of cooperation in supporting threatened banks( banks failing in Austria and Germany brought Hitler into power) wasted subsidies on agriculture, leading to going off gold and interfering with industry. He quotes
Rehoboam son of Solomon, a big taxer when asked to lighten the load on the people "My father made yor yoke heavy and I will add to your yoke: my father chastised you with whips, but I will chastise you with scorpions.1Kings 12:11

Posted by: Chuck at Jan 7, 2007 12:45:53 AM

Hitler solved employment in Germany by full military and civilian conscription. There's a tried-and-true method for solving economic problems. On the other hand, business groups and academics advocated maintaining the orthodox methods that had caused the depression. The economic winds might be better charted now, but it still takes political piloting t weather storms.

Posted by: Joseph Steinberg at Jan 7, 2007 2:59:50 AM