“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. ... I would start with the following lessons:
Monetary Policy is Key: As Milton Friedman and Anna Jacobson Schwartz argued in a classic book,... 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. ...
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,”... 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.
Get the Small Things Right: ...Roosevelt instituted a disastrous legacy of agricultural subsidies and sought to cartelize industry... Neither policy helped the economy recover.
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.
Today, President-elect Barack Obama faces pressures to make unionization easier, but such policies are likely to worsen the recession for many Americans.
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. Government spending went up considerably, but taxes rose, too. ... When all of these tax increases are taken into account, New Deal fiscal policy didn’t do much to promote recovery.
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. ...
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.
You Can't Turn Bad Into 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. The bad policies made things worse. 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. ...
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.”
Tyler Cowen, “The New Deal Didn’t Always Work, Either”, The New York Times (21 November 2008).
http://www.nytimes.com/2008/11/23/business/23view.html
Tyler Cowen is a professor of economics at George Mason University.
In this Op Ed, Professor Cowen points out that in the view of many economists the Great Depression was caused mainly by a monetary collapse that can be traced to the failure of the Federal Reserve to properly manage the money supply. During the time from August 1929 to the cyclical trough of the depression in March 1933 the money supply fell by a third, and in their view it is this contraction in the stock of money that brought about the collapse of the banking system and accelerated the decline in production and employment. In some sense, the economic and financial catastrophe of the 1930s is seen as a failure of leadership on the part of the Fed, as drift and indecision on the part of members of its governing board paralyzed policy making and needed action to stem the contraction of the economy.
Cowen also points out that the root of today’s crisis is not in a monetary contraction and deflation. In this regard, the Fed has done everything it can (some would say too much) to prop up banks and other financial institutions. In doing so, one of its problems is that a huge shadow banking system has developed where credit derivative instruments not under the control of the Fed are traded. Since monetary policy does not directly affect shadow institutions, the effect of the Fed’s actions are weakened and therefore it will take monetary policy longer to stimulate the economy. Nevertheless, it is fair to say the Fed is doing all it can to implement an expansionary monetary policy and save the banks. If the deteriorating economy is to be turned around, it will have to come from other measures.
This leaves fiscal policy and ad hoc measures. However, some of the proposals under discussion are similar to those made as part of the New Deal, and many of those ideas clearly made a bad situation worse. Any attempt by the government to prop up housing prices, for example, would leave in its wake a tremendous inventory of unsold houses with the potential for another housing crisis down the road. Efforts to make it easier to unionize the work force without the clear agreement of the workforce, as proposed in the “Employee Freedom of Choice Act”, would drive up wages and potentially raise the long-term unemployment rate. As another example, an auto industry bailout that protected the industry from foreign competition and tightened the insane Corporate Average Fuel Economy standards while it failed to address the need to invigorate management with a sense of purpose and the unions with a sense of reality would be disastrous for the entire manufacturing sector. Finally, raising taxes or, just as bad, flirting with protectionism, would set the stage for a prolonged and deep recession.
The U.S. economy is in deep trouble. Two months have passed since Treasury Secretary Paulson announced the financial system was on the verge of collapse. It still has not been stabilized, as reflected in by a very week interbank market and the continuing fall in equity prices, particularly those of banks. It would appear that government regulators are considering a plan to bail out Citigroup and the spreads for the credit default swaps of major banks are rising, indicating that the financial markets believe other banks have the potential to default on their obligations. Add to this the mad scramble by every firm, every state and every city for a bailout and a picture of utter financial chaos emerges.
One can only pray that the President-Elect and his economic team provide the intellectual and policy leadership during a crisis that the Federal Reserve and the Executive Branch failed to show during the Great Depression.
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