Did the New Deal prolong the Great Depression?

by on January 6, 2007 at 6:43 am in History | Permalink

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.

Bill Stepp January 6, 2007 at 9:49 am

What’s good about federal deposit “insurance” and the moral hazard it
created?

spencer January 6, 2007 at 10:26 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.

John Thacker January 6, 2007 at 11:39 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.

John Thacker January 6, 2007 at 11:51 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.

John Thacker January 6, 2007 at 11:55 am

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

Bill Stepp January 6, 2007 at 1:20 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.

wcw January 6, 2007 at 2:26 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.

TGGP January 6, 2007 at 2:48 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.

alphie January 6, 2007 at 3:51 pm

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

Maybe the lefties know something about economics?

Ricardo January 6, 2007 at 5:32 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.

Joseph Steinberg January 6, 2007 at 6:55 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.

Chuck January 7, 2007 at 12:45 am

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

pjgoober January 7, 2007 at 8:15 am

Brad Delong writes: “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.”

Whether or not a non-US nation used Classical or “New Deal” policies, how hard would it be for any other nation to emerge from the Great Depression more rapidly than the US when the US is the largest economic power on earth? Don’t world markets generally follow Americas? It’s not *impossible*, but my point is that Brad Delong is asking for something pretty extraordinary.

pjgoober January 7, 2007 at 8:29 am

Brad Delong writes:
“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 that opinion is mocked mercilessly in Brad Delongs 2005 post: The New Deal and the Problem of Idiocy (not Brad’s words, but Lance Manion’s approvingly cited words)
http://delong.typepad.com/sdj/2005/10/the_new_deal_an.html#comments

TGGP January 7, 2007 at 3:40 pm

spencer, thanks for not even bothering to read the abstract. I don’t ask you to to accept the argument, but when the whole point of the piece is that GDP is a misleading measurement of the period, bringing up GDP to say Higgs is wrong is rather back-asswards.

indiana jim January 7, 2007 at 4:41 pm

Newdealonomics hypothesized that the problem was simply that prices were too low. So, for example, the new dealers killed off some of the stock of pigs for the sole purpose of driving the price of pigs. Wasting pigs was, by newdealonomics, good for the economy because, again, the main problem was that prices were too low. Does anyone seriously believe that newdealonomics didn’t prolong the great recession?

Rafe Champion January 8, 2007 at 5:59 am

Peter Shaeffer advised that Sweden performed well in the 1930s. Perhaps there is something to be said for low or zero tariff barriers. How many nations have had low or zero tariff protection since the 1920s?

Whatever the agricultural policies of the New Deal did for the US, they had a dramatic impact on progressive opinion in Europe, as described by Arthur Koestler.

http://catallaxyfiles.com/?p=2056

“The event that aroused my indignation to a fever pitch never reached before was the American policy of destroying food stocks to keep agricultural prices up during the depression years – at a time when millions of unemployed lived in misery and near starvation. In retrospect, the economic policy which led to these measures is a matter of academic controversy; but in 1931 and ’32, its effect on Europeans was that of a crude and indeed terrifying shock which destroyed what little faith they still had in the existing social order.”

“By 1932 there were seven million unemployed in Germany – which means that one in every three wage-earners lived on the dole. In Austria, Hungary and the surrounding countries the situation was similar or worse. Meat, coffee, fruit had become unobtainable luxuries for large sections of the population, even the bread on the table was measured out in thin slices; yet the newspapers spoke laconically of millions of tons of coffee being dumped into the sea, of wheat being burned, pigs being cremated, oranges doused with kerosene ‘to ease conditions on the market’.”

Anderson January 8, 2007 at 11:20 am

Apart from the actual effect of the New Deal, there’s the question of blameworthiness.

If the New Deal was a bad idea, could FDR have been expected to know that at the time?

The state of economic science in 1933 or 1936 does not seem to’ve been particularly admirable.

Mike January 8, 2007 at 11:48 am

Spencer,

Above you make two claims. First that employment growth was rapid during the New Deal. Second, that real GDP was lower after WWII than during it.

Employment is easy. Productivity is not. The New Deal created a nation of ditch diggers – not something I’d be inclined to point to as a success.

And, didn’t World War II not only destroy lots of physical capital in Europe (with whom we trade), but also a sickening amount of human capital in the US? And did not all the wartime production shift resources out of their most productive uses? It is not surprising that measured GDP per capita was lower after the war, at least not to me.

Nicolaas J Smith January 10, 2007 at 2:39 am

Non-monetary inflation can be stopped.

“People today use the term `inflation’ to refer to the phenomenon that is an inevitable consequence of inflation, that is the tendency of all prices and wage rates to rise.” Ludwig von Mises – “Inflation: An Unworkable Fiscal Policy”.

All prices do not rise. Only the prices of variable real value non-monetary items while many constant real value non-monetary items are not fully updated and many are not updated at all.

The second inevitable consequence of inflation is the tendency of many constant real value non-monetary items NOT to rise at all – during the Historical Cost era while some constant real value non-monetary items are not fully updated.

Inflation today has and always had a second consequence during the 700 year old Historical Cost era.

Inflation has a monetary consequence, called cash inflation refered to above by Ludwig von Mises and defined as the economic process that results in the destruction of real economic value in depreciating money and depreciating monetary values over time as indicated by the change in the Consumer Price Index.

Inflation´s second consequence is a non-monetary consequence defined as Historical Cost Accounting inflation which is always and everywhere the destruction of real economic value in constant real value non-monetary items not fully or never updated (increased) over time due to the use of the Historical Cost Accounting model or any other accounting model which does not allow the continuous updating (increasing) in constant real value non-monetary items in an economy subject to cash inflation.

Inflation´s second consequence is solely caused by the global stable measuring unit assumption.

The stable measuring unit assumption means that we regard the annual destruction of a portion of the real value of our monetary unit by cash inflation in low inflation economies as of not sufficient importance to update the real values of constant real value non-monetary items in our financial statements.

This results in the destruction of at least $31bn in the real value of Dow companies´ Retained Income balances each and every year. Globally this value probably reaches in excess of $200bn per annum for the real value thus destroyed in all companies´ Retained Income balances.

The International Accounting Standards Board recognizes two economic items:

1) Monetary items: money held and “items to be received or paid in money” – in terms of the IASB definition.

2) Non-monetary items: All items that are not monetary items.

Non-monetary items include variable real value non-monetary items valued, for example, at fair value, market value, present value, net realizable value or recoverable value.

Historical Cost items valued at cost in terms of the stable measuring unit assumption are also included in non-monetary items. This makes these HC items, unfortunately, equal to monetary items in the case of companies´ Retained Income balances and the issued share capital values of companies without well located and well maintained land and/or buildings or without other variable real value non-monetary items able to be revalued at least equal to the original real value of each contribution of issued share capital.

The stable measuring unit assumption thus allows the IASB and the Financial Accounting Standards Board to conveniently side-step the split between variable and constant real value non-monetary items. This is a very costly mistake in low cash inflation economies – or 99.9% of the world economy.

Retained Income is a constant real value non-monetary item, but, it has been in the past and is, for now, valued at Historical Cost which makes it, very logically, subject to the destruction of its real value by cash inflation in low inflation economies – just like in cash.

It is an undeniable fact that the functional currency’s internal real value is constantly being destroyed by cash inflation in the case of low inflation economies, but this is considered as of not sufficient importance to adjust the real values of constant real value non-monetary items in the financial statements – the universal stable measuring unit assumption which is the cornerstone of the Historical Cost Accounting model.

The combination of the implementation of the stable measuring unit assumption and low inflation is thus indirectly responsible for the destruction of the real value of Retained Income equal to the annual average value of Retained Income times the average annual rate of inflation. This value is easy to calculate in the case of each and very company in the world with Retained Income for any given period.

Everybody agrees that the destruction of the internal real value of the monetary unit of account is a very important matter and that cash inflation thus destroys the real value of all variable real value non-monetary items when they are not valued at fair value, market value, present value, net realizable value or recoverable value.

But, everybody suddenly agrees, in the same breath, that for the purpose of valuing Retained Income – a constant real value non-monetary item – the change in the real value of money is regarded as of not sufficient importance to update the real value of Retained Income in the financial statements. Everybody suddenly then agrees to destroy hundreds of billions of Dollars in real value in all companies´ Retained Income balances all around the world.

Yes, inflation is very important! All central banks and thousands of economists and commentators spend huge amounts of time on the matter. Thousands of books are available on the matter. Financial newspapers and economics journals devote thousands of columns to the discussion of the fight against inflation.

But, when it comes to constant real value non-monetary items:

No sir, inflation is not important! We happily destroy hundreds of billions of Dollars in Retained Income real value year after year after year.

However, when you are operating in an economy with hyperinflation, then we all agree that, yes sir, you have to update everything in terms of International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies: Variable and constant real value non-monetary items.

But ONLY as long as your annual inflation rate has been 26% for three years in a row adding up to 100% – the rate required for the implementation of IAS 29. Once you are not in hyperinflation anymore (for example, Turkey from 2005 onwards), then, with an annual inflation rate anywhere from 2% to 20% for as many years as you want, you are prohibited from updating constant real value non-monetary items. Then you are forced by the FASB´s US GAAP and the IASB´s International Accounting Standards and International Financial Reporting Standards to destroy their value again – at 2% to 20% per annum – as applicable!

For example:

Shareholder value permanently destroyed by the implementation of the Historical Cost Accounting model in Exxon Mobil’s accounting of their Retained Income during 2005 exceeded $4.7bn for the first time. This compares to the $4.5bn shareholder real value permanently destroyed in 2004 in this manner. (Dec 2005 values).

The application by BP, the global energy and petrochemical company, of the stable measuring unit assumption in the accounting of their Retained Income resulted in the destruction of at least $1.3bn of shareholder value during 2005. (Dec 2005 values).

Royal Dutch Shell Plc, a global group of energy and petrochemical companies, permanently destroyed $2.974 billion of shareholder value during 2005 as a result of their implementation of the stable measuring unit assumption in the valuation of their Retained Income. (Dec 2005 values).

Revoking the stable measuring unit assumption is actually allowed this very moment by IAS 29 but ONLY for companies in hyperinflationary economies. At 26% per annum for three years in a row, yes! At any lower rate, no!

It is prohibited by US GAAP and IASB International Standards for companies that are operating in a low inflation economy.

That means the following at this very moment in time: Today all companies in, most probably, only Zimbabwe (1000% inflation) are allowed to update all their variable real value non-monetary items as well as all their constant real value non-monetary items.

But not the rest of the world.

The rest of the world is forced by current US GAAP and IASB International Standards to destroy their/our Retained Income balances each and every year at the rate of inflation because of the implementation of the stable measuring unit assumption whereby we are all forced to regard the change in the value of the unit of account – our low inflation currencies – as of not sufficient importance to update the real values of constant real value non-monetary items in our financial statements.

We are forced to destroy them year after year at the rate of inflation till they will reach zero real value as in the case of Retained Income and the issued share capital values of all companies with no well located and well maintained land and/or buildings at least equal to the original real value of each contribution of issued share capital.

The 30 Dow companies destroy at least $31bn annually in the real value of their Retained Income balances as a result of the implementation of the stable measuring unit assumption. Every single year.

Retained Income can be paid out to shareholders as dividens. Poor Dow company shareholders. They will never see that $31bn of dividens destroyed each and every year.

We have all been doing this for the last 700 years: from around the year 1300 when the double entry accounting model was perfected in Venice.

When we do this at the rate of 2% inflation (“price stability” as per the European Central Bank and as per Mr Trichet, the president of the ECB) we are forced to destroy 51% of the real value of the Retained Income balances in all companies operating in the European Monetary Union over the next 35 years – when that Retained Income remains in the companies for the 35 years – all else except cash inflation being equal.

Each and every one of those 35 years will be classified as a year of “price stability” by the ECB and Mr Trichet. Mr Trichet will not be the president of the ECB in 35 years time.

I think we will do ourselves a great favour by revoking the stable measuring unit assumption as soon as possible.

FREE DOWNLOAD : You can download the book “RealValueAccounting.Com – The next step in our fundamental model of accounting.” on the Social Science Research Network (SSRN) at http://ssrn.com/abstract=946775

——————–

Nicolaas J Smith
http://www.realvalueaccounting.com/

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batteries October 16, 2007 at 11:37 am
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