The lessons of 1939

“The recovery from the [Great] Depression is often described as slow because America did not return to full employment until after the outbreak of the second world war. But the truth is the recovery in the four years after Franklin Roosevelt took office in 1933 was incredibly rapid. Annual real GDP growth averaged over 9%. Unemployment fell from 25% to 14%. ....

However, that growth was halted by a second severe downturn in 1937-38, when unemployment surged again to 19%. The fundamental cause of this second recession was an unfortunate, and largely inadvertent, switch to contractionary fiscal and monetary policy. ....

The 1937 episode provides a cautionary tale. The urge to declare victory and get back to normal policy after an economic crisis is strong. That urge needs to be resisted until the economy is again approaching full employment. ....

As someone who has written somewhat critically of the short-sightedness of policymakers in the late 1930s, I feel new humility. I can see that the pressures they were under were probably enormous.”

Christina Romer, "The lessons of 1937", The Economist (20 June 2009).

www.economist.com/businessfinance/displaystory.cfm?story_id=13856176

Berkeley economist Christina Romer (née Duckworth, 1958-) is Class of 1957 Garff B. Wilson Professor of Economics at the University of California Berkeley and, currently, Chair of the Council of Economic Advisers in the Obama administration. Her area of research is macroeconomics, and she has studied in depth the causes of the Great Depression.


The above excerpt is taken from an important article by one of the President’s key economic advisors. It points to one of the elements in the policy approach of the Administration. Leading economists, including Allan Meltzer, Brad DeLong, Barry Eichengreen, Tyler Cowen, Michael Bordo and Carmen Reinhart, discuss her essay at www.economist.com/blogs/freeexchange/romer_roundtable/.

Professor Romer is correct in saying that the premature removal of policies intended to deal with a downturn in the economy, as in 1937, can be a major threat to the recovery. Her argument may be extended to the present where signs of a recovery can be seen but it is by no means clear that small progress made to date represents anything more than a temporary respite. For this reason, any fiscal or monetary tightening at the present time could well reverse that progress. On this, Professor Romer is no doubt right.

But if she is right that one might ask “Why is the Obama Administration advocating the end of the Bush tax cuts, which would be a large tax increase at a time when the economy is struggling to recover from the financial crisis?” And “Why is the Obama Administration trying to radically restructure one-sixth of the nation’s economy in untried ways, with its inevitable increase in unemployment, at a time when unemployment is already high and projected to go even higher?” And, further, “Why is the Obama Administration pushing a ‘cap and trade’ energy proposal that will markedly raise costs and lead to a tremendous redeployment of resources across the entire economy, with its attendant unemployment and loss of incomes, when the economy is already reeling under the disruptions of a prolonged recession?” One could go on asking questions.

The U.S. economy today is suffering from its most severe recession in many decades. It has been battered not just by the excesses of the past decades that left it with huge financial bubbles and extreme macroeconomic imbalances but by a host of erratic measures introduced by the government to deal with these problems. Now, even before the recovery is safely underway, before the economy has had a chance to adjust and adapt to what we all hope would be a more sustainable and stable future, before the nation has had a chance to reduce the enormous debts and unsustainable entitlement obligations it has incurred in the past and greatly increased recently, the Obama Administration proposes to introduce mammoth new taxes and an extensive restructuring of major parts of the economy, from the auto industry through financial services to the health care sector. I for one doubt the economy can ever recover and prosper under the burdens of the Administration’s policies and reckless attitude promoting constant economic turmoil.

The lessons of 1937 are not only that the government should not prematurely remove needed policy support but more significantly that it should not raise taxes and impose huge costs on the private sector that it cannot carry. Surely Christy Romer understands that.

A tip of the hat to Larry Willmore for the Tdj.