Ready for 1937 v.2?

The Great Recession is a replay of the Great Depression in many ways; one of them is fiscal policy. Let’s rewind the tapes:
-1929-1930: President Hoover’s first response is to do as little as possible to let market mechanisms do the job of “correcting imbalances.” The general consensus is that government deficit would lead to crowding out effects and so would worsen the economic situation. As a consequence, those first two years records a fiscal surplus (Figure 1).
-1931-1932: The economic situation worsens and enters into a debt-deflation process. Hoover is forced to increase government involvement through policies like the Reconstruction Finance Corporation. This leads to a fiscal deficit representing about 2.5% of GDP.
-1932-1933: Public opinion is outraged by the “massive” deficit and “waste.” Roosevelt runs a Presidential campaign that promises to bring back the federal government fiscal position into the black; he is elected in a landslide.

-1933-1936: Roosevelt puts in place New Deal programs and experiments a bit more with fiscal deficit. While the scale of ND programs is quite impressive, their actual impact on the deficit-to-GDP ratio is limited with a deficit of 5% relative to GDP. Unemployment rate (Figure 3) goes down from 25% to 9% if one includes WPA, CCC and others New Deal employees into the employed population (official data counts them as unemployed). WPA, CCC, and other work programs bring the US into the 20th century in terms of infrastructures (electrification, irrigation, schools, etc.). However, all this is completely overshadowed by outcries about the “unsustainable” deficit and the supposed “communistic” nature of the New Deal.
-1936: An election year, Roosevelt feels the pressure in terms of discontent regarding the deficit so he proposes to cut New Deal Programs massively (see Figure 2) and to lower other government expenditures.
-1937: Recession year. Roosevelt implements his proposal to “restore fiscal sanity.” The decline in government spending leads to massive layoffs, and so to a decline in wage earnings. Profits of companies also go down because of decline in aggregate demand. Nobody is happy even though the deficit-to-gdp ratio reaches 0%.
-Back to the present:
We are now in 1936 with the government focused on trying to cut deficit because “America cannot be great if we go broke”. The government proposes to cut government spending and to raise taxes.
Get ready for a replay of 1937 if the government goes through with its propositions. The first step in this direction seems to have been taken with Congress failing to extend unemployment benefits.
This constant hysteria about fiscal deficit is counterproductive, dangerous and unnecessary. The deficit to gdp ratio (and debt to gdp ratio) will go down by itself as the economy recovers, no need to cut government spending and to raise tax rates now. On the contrary, one should let government spending and tax levels be whatever they need to be to promote economic stability. As the economy recovers, government spending will go down and tax levels will rise (given tax rates) which will lower government deficit.
Figure1 . Deficit/GDP ratios
Source: BEA.
Figure 2. Federal Work Programs During the New Deal
Figure 3. Unemployment rate.

Sources: BLS, Historical Statistics of the United States by Census Bureau (ed.).
Note:  Data is for persons 16 years old and over, except prior to 1947 when the figures are for persons 14 and over.  Dotted line represents the corrected BLS data to remove emergency relief workers from unemployed.

9 responses to “Ready for 1937 v.2?

  1. The deficit to gdp ratio (and debt to gdp ratio) will go down by itself as the economy recovers…The arithmetic of ratios is apparently too difficult for most people. But I do not think this —… no need to cut government spending and to raise tax rates now.— is at all effective. On the other hand, it might be fairly easy to convince people it is private-sector debt that is holding our economy down.Art

  2. Looks like history will be repeating itself? Unfortunately it was Military Spending which pulled the economy out of the depression. The doctrine of Military Keynsianism i.e, that the economy can reach full employment objectives & permamently sustain economic growth. Nevermind the opportunity costs e.g., trillion dollars worth of nuclear weapons v genuine economic developmentIn the long run Military spending has ruined the economy and polluted the political system. I don't see how the US & the globe will ever recover from the damages. Too many vested interests with Wall Street dependent on the military to keep the dollar as the world reserve currency

  3. Seems like e-cons, dems and repubs, can always agree on Keynsian stimulus in the form of military spending. The weight of such infrastructure does not bode well for the rest of the world.

  4. Vote for the most influential people in financial regulation in 2010 here: http://www.gfsnews.com/vote.php

  5. Dear bloggers,I don't know where to post my question, so, here it is :Central Banks can't really create money ; they allegedly regulate credit aggregate size through reserves they now provide on demand ; excess reserves fail miserably to spur inflation ; reserves can't be legaly used to buy real economy things ; when private banksters needed money the most badly they asked the government, not the central bank to lend to them ; here's my question :Is central banking actually merely a tragic accounting joke to prevent the banksters clan from experiencing bankruptcy when the rest of the economy falls apart due to their very deeds ?Could sensibly a ELR government demand 100% (non-)fractional reserve rate and get rid of central banking, managing the whole economy only tuning the levels of taxes, spendings and treasury bonds issuing ?I've read this blog almost entirely, also Wray's Understanding Modern Money, and you all insist on governments's role, not central bank's. Before you I had a hemiplegic view of money : I thought like many that Central Banks create money and manage it : government was a market-blind powerless player only able to wreck the economy, now, with you, I'm hemiplegic again, but with my very scarce understanding of central banking ;¬/I'm honored to say hello to all the team, especially William Black (I've read The Best Way to Rob a Bank Is to Own One, he's sort of a hero in my eyes, along Gray)Best Regards,Mithradate

  6. Government spending and taxes should remain unchanged, and people should start volunteering more. I think the government should implement additional guidelines for people who receive unemployment that encourages them to give back to the community for what they receive from the government. For example, the government should make it a requirement for individuals- who are capable- to participate in volunteer work for a business or community by providing free labor. This will help businesses operate more efficiently and volunteers will gain job skills, in which the economy will experience the benefits over time.

  7. Thanks for the History. It's all too persuasive.Mithradate, I am no expert but my understanding is that the central bank is the lender of last resort so that a run on banks cannot happen. But you are correct that there is no need for the central bank to be "independent" from the federal government as it said to be right now. The treasury and central bank could operate together just fine. But hopefully one of "the team" will give you a full answer.JPM, I agree fully with your comment as a potentially more politically feasible way of instituting ELR type programs. It's easier for people to argue against bigger government but harder to argue against bigger charities.

  8. JPM & EBW – No, that just won't work. It is a neoliberal ELR workfare program which does not do what the ELR is designed to do, has been tried and failed everywhere – and it offends logic. Required volunteer work is a contradiction in terms. Required working for a business is a prescription for corruption at best, slavery at worst. If people deserve benefits, it is purposeless cruelty to insist on this kind of "work". A real ELR will counteract the business cycle, and create a high growth, high employment, low inflation economy. The private sector cannot create money (net financial assets) and stably boost or diminish demand when needed. Only government spending & programs can do this. The greatest tool in the hands of an oppressor is the control of the mind of the oppressed. The idea that a real ELR Job Guarantee is not "politically feasible" is a very good example. All it needs is a to be preached from a bully pulpit, for people to know the idea exists, makes sense and will very clearly work and has worked, and it will become a permanent reality everywhere.

  9. Having a much higher debt to GDP ratio now than we did going into the Great Depression, and having done nothing to deal with it (whereas in the Depression, they used the Home Owners Loan Corporation), I do not see how we have made it past 1932. The bump from stimulus gives us the illusion of a recovery, but it is not.Our bailout of the banks and trying to engineer demand stimulus to increase employment is parallel to the "market forces will do it" philosophy of Hoover. We have yet to reduce unemployment by hiring people. Until we do ….