What ended the Great Depression?

by on November 11, 2008 at 7:14 am in History | Permalink

There has been recent circulation of the older view that it is World War II, as a kind of giant public works project, which ended the Great Depression.  This claim is not consistent with our best knowledge of the subject.  To survey the cutting edge of the literature briefly:

Christina Romer writes:

This paper examines the role of aggregate demand stimulus in ending the
Great Depression. A simple calculation indicates that nearly all of the
observed recovery of the U.S. economy prior to 1942 was due to monetary
expansion. Huge gold inflows in the mid- and late-1930s swelled the
U.S. money stock and appear to have stimulated the economy by lowering
real interest rates and encouraging investment spending and purchases
of durable goods. The finding that monetary developments were crucial
to the recovery implies that self-correction played little role in the
growth of real output between 1933 and 1942.

Here is another interesting paper on the topic; it focuses on productivity issues and mean reversion.  Here is from a paper by Cullen and Fishback:

We examine whether local economies that were the centers of federal
spending on military mobilization experienced more rapid growth in
consumer economic activity than other areas.  We have combined
information from a wide variety of sources into a data set that allows
us to estimate a reduced-form relationship between retail sales per
capita growth (1939-1948, 1939-1954, 1939-1958) and federal war
spending per capita from 1940 through 1945.  The results show that the
World War II spending had virtually no effect on the growth rates in
consumption that we examined.

Further debunking of the WWII idea can be found in this paper by Robert Higgs, who stresses the difference between standard gdp measures and actual economic welfare.

I also find the experience of the Latin American economies convincing.  The economic recovery of Argentina, for instance, clearly was due to monetary policy, not fiscal policy, which remained tight throughout the period of recovery.  Mexico recovered from the Great Depression relatively quickly and this history also does not fit the fiscal policy view.  Later on, most of the Latin economies experienced commodity booms because of wartime demands and again this was not fiscal policy and of course they were not fighting the war themselves.  The two countries where fiscal policy played a significant role in recovery are, not surprisingly, Germany and Japan and here I am referring to their prewar spending.

Tim November 11, 2008 at 7:36 am

How did gold inflows impact the money supply. Didn’t the U.S. disconnect the dollar from gold in the mid-
1930s? Or do I have my dates wrong?

whosonfirst November 11, 2008 at 7:50 am

Here’s a related question. I’ve read that as the war was winding down the government was scared to death that when all the soldiers came home we would go right back into Depression.

Why didn’t this happen?

Dave Richardson November 11, 2008 at 8:52 am

I need to read Romer’s paper; huge inflows of gold caused by political instability in Western Europe and the East?

I remember a little ditty my late father used to say they repeated in the summer of 1945 while on occupation duty in Germany, awaiting orders to the Pacific, “the Golden Gate in ’48, the Bread Line in ’49.”

kurt November 11, 2008 at 8:59 am

I think when people say that World War II ended the Great Depression, they mean it ended the unemployment problem. Or am I wrong here?

Dave Richardson November 11, 2008 at 9:01 am

More thoughts I should have had before posting the above: Selective Service Act in 1940 removed significant portion of young males from work force, bringing down unemployment and increasing personal income/consumption. Anecdotally I know from family stories this helped tremendously.

Also, effects of increasing war production; remember the war in Europe began in September, 1939, although Western Europe wasn’t overrun until the Spring of 1940. How much did British purchases stimulate production, jobs, etc.?

datadave November 11, 2008 at 9:21 am

It’s kind of funny seeing the libertarians and Republicans tying themselves up in knots over rewriting history.

Interestingly, Hoover and the Balanced Budget boys (Andrew Mellon at the top) had three years to get us out of the Depression. Instead the economy went into a tailspin unlike anything before or until now(?) Why aren’t you looking at their ‘success’. They tightened monetary policy, they nearly balanced the books…and then demand and employment fell off the cliff. Then after 1932, when another conservative , FDR, took office a bit of innovation occured, job growth was steady upwards, even though bumps along the road furnished by an very conservative Supreme Ct. Over at Yglesias’ there’s a chart showing job growth going up and up after ’32 while the famous cliff of late ’29 thru ’32 is obviously being reinacted now (if we don’t get crackin’).

Following Conservative, Libertarian Ideology would be a Disaster for Our Country. (capitals only used for emphasis, not every letter!)

And final question: What got us into the Depression in the first place? Leverage, fraud, duplicity are all factors. And tariffs only came later, not before when the bubble was being formed.

Luckily, we at least had Banks relatively protected due to New Deal reforms. FDIC has so far saved most of the smaller banks that hadn’t engaged in ‘financial innovation’.

“Financialization” got us into this mess….so let’s examine how we got into this mess.

Selfreferencing November 11, 2008 at 9:31 am

Link to your awesome paper on the Marshall Plan!

Anderson November 11, 2008 at 10:01 am

From the lay point of view, all this “what caused/prolonged/ended the Depression” talk sounds a lot like the blind men examining the elephant.

What “caused” the French Revolution? the Reformation? etc.

Something about the academic mind appears to recoil from the notion that “it was a lot of stuff happening together.”

Ironman November 11, 2008 at 10:45 am

If it helps, here is a timeline of the Great Depression, as the stock market saw it.

Economatheek November 11, 2008 at 12:22 pm

This is interesting, but I’m always a bit cautious when evaluating accounts of what started/ended a specific event, in order to not become yet another victim of the narrative fallacy.

AndrewG November 11, 2008 at 1:12 pm

Great, great post. I think it’s incredibly important for us to take C. Romer’s analysis to heart: That the abandonment of the gold standard was the primary catalyst that ended the Great Depression. This is yet another reason to be extremely bearish medium-term, as the Fed will almost certainly have to adhere to a de facto oil standard over the next few years. Indeed, the Fed pretty much did that up until September or so, when they finally stopped sterilizing the liquidity facilities.

Of course, the ‘oil standard’ is far more difficult to abandon since oil plays a much more important role than gold in the real economy. Hence, I don’t see how we can avoid another Great Depression (and perhaps a more enduring one).

Trumpit November 11, 2008 at 2:01 pm

“Many of the above commenters should read Higgs’ paper that was linked to.”

Maybe I should, but I can’t bring myself to read stuff by Higgs. I looked him up on Youtube and the first thing I hear out of his mouth is that environmentalism is the new communism. Apparently a clean and sustainable environment does jibe with his radical world view. He’s not my cup of tea, so I’ll pass on stuff written by or referenced to him. I don’t think he is intellectually honest, or particularly informative.

Max November 11, 2008 at 2:06 pm

Does the broken window fallacy apply? As a popular American philosopher once said, “War, what is it good for? Absolutely nothing.”

Do you know what a 1945 Ford (or Chevy, or Packard) looked like? It looked exactly like a 1941 Ford (Chevy, etc.) because that’s what it was. The economy was on hold for the duration.

The death of FDR during the war meant he wasn’t around to connect the pre war depression to the post war depression.

The GI Bill and the Marshall plan where two good things that came with the end of war. Education is the great value added factor for human beings. Breaking open the class bound universities was a good thing. The new lawyers, doctors, engineers, accountants, teachers and so many others are the ones who built the new post war economy and ended the depression.

Both Truman and Marshall were veterans of WWI. They had seen that left on their own, Europeans would be back at each others’ throats in a generation in an unending civil war. WWI had cost America 116,000 dead. WWII had cost America 405,000 dead. Let’s not do that again. So, after WWII the Americans stayed and for all practical purposes occupied former enemies and former allies. Pax Americana.

Europe has enjoyed a peace since WWII that is longer than any they organized on their own. They have prospered. Somehow they have avoided the need for another war to boost their economy. Just lucky, I guess.

djg November 11, 2008 at 2:23 pm

“The results show that the World War II spending had virtually no effect on the growth rates in consumption that we examined.”

How is this “consumption” being measured, pray tell? Did the war not consume a full 60% of the GNP in war production?

sammy November 11, 2008 at 3:21 pm

How about monetary policy in respect to Japan recently? Assholes.

Michael Smith November 11, 2008 at 3:25 pm

datadave claimed:

“Interestingly, Hoover and the Balanced Budget boys (Andrew Mellon at the top) had three years to get us out of the Depression. Instead the economy went into a tailspin unlike anything before or until now(?) Why aren’t you looking at their ‘success’. They tightened monetary policy, they nearly balanced the books…and then demand and employment fell off the cliff. Then after 1932, when another conservative , FDR, took office a bit of innovation occured, job growth was steady upwards, even though bumps along the road furnished by an very conservative Supreme Ct. Over at Yglesias’ there’s a chart showing job growth going up and up after ’32 while the famous cliff of late ’29 thru ’32 is obviously being reinacted now (if we don’t get crackin’)”

In 1939, after seven years of New Deal, the unemployment rate still stood at 20%. Henry Morgenthau, Secretary of the Treasury and personal confidant and friend of Roosevelt, testified before the House Ways and Means Committee to explain why unemployment was still so high. Here is what he said:

“We have tried spending money. We are spending more than we have ever spent before and it does not work. And I have just one interest, and if I am wrong†¦..somebody else can have my job. I want to see this country prosperous. I want to see people get a job. I want to see people get enough to eat. We have never made good on our promises†¦. I say after 8 years of this Administration we have just as much unemployment as when we started†¦. And an enormous debt to boot!†

So there is a New Dealer telling you that the New Deal didn’t work.

Larry November 11, 2008 at 9:27 pm

Professor Cowen: I’m interested in your interpretation of Krugman’s counterargument here, where he tries to show that only after the war began did the explosively increasing spending levels fail to be matched by explosively increasing tax collections, i.e., that only then did the spending become stimulus in a Keynesian sense.

liberty November 11, 2008 at 10:26 pm

ironman:

may be a stupid question, but that timeline says “nominal values” — why would nominal values be used? Wasn’t there first a deflation and then an inflation that would highly distort the graph? Could you please explain?

Andrew November 12, 2008 at 5:20 am

Ahh, war and deficits. Bush was simply ahead of his time.

Check out the new apostles
http://www.infowars.net/articles/november2008/071108CFR.htm

I know, I know, why on earth would there be an organization that wanted to control the planet with less than altruistic intentions.

amity shlaes November 12, 2008 at 9:58 am

Tyler’s montary point is really germane this week.
Another question about the Depression is not how or even whether World War II ended it.
It is why the Depression lasted all the way clear through to the War, or even farther, as some say.
I’m just flipping through some old posters from THE WIZARD OF OZ, which premiered in the late 1930s.
We all know that Baum’s book was a monetary fable but so in its way is the movie.
People were beginning to think that Kansas would always be gray and assaulted by twisters.
Anyhow,when it comes to the GD, the puzzle is the duration, given the natural impulse of the economy to recover.

dave November 12, 2008 at 1:23 pm

Current: I’ve read about the keynesian theory, and I agree it’s BS. They consider savings to be ‘money witheld from the economy’ as in ‘locked in a vault.’ When in reality, savings is the best kind of spending in the world, capital creation. (Money in a bank or fund is money lent to someone else.) Look, even our modern keynesians are using two conflicting concepts here, ‘stimulate demand’ and ‘injecting capital directly into banks.’ Of course that’s not all that’s going on, but I think someone’s wires are crossed somewhere.

ralph November 13, 2008 at 1:36 pm

I absolutely LOVE these posts on the GD and on the **real problems** in the economy currently from day to day. But there is SO much of the posting that essentially rides on the distinction of what a “depression” is. The economically minded stress productivity, GDP, the trends of various numerical factors, including some that have to do with either “unemployment” or “real wages” and so on.

This is critical and I love the information I’m getting. But many people don’t think those numbers are a “depression” — the GD was something for many people because of the relative deprivation that people experienced as a human (and sometimes brutally animal) concern. There are data that address this concern, at an angle, of course, and I strongly encourage doing that and getting more. I feel, nonetheless, that it’s important to keep clear that what FDR did was primarily a “confidence” thing for a political-economic community, most specifically in the US but also abroad. Viewed this way, many little things — things that had little macro-impact and appear merely as blips in data trends and might easily be seen as data irregularities — had a profound impact across a broad swath of people. The political value of FDR was profound.

But I digress, I think. IMHO, when people say that the war ended the GD, they almost certainly mean NOT that we had more food daily, or that more money was being made, or whatever, but that more people had daily purpose — more people were working (and huge numbers were forced one way or the other into working by killing people in europe/asia, too) and there was a daily sense that the world had purpose going forward, even if there was fear about the ultimate outcome of the war.

There is something of the “crisis of confidence” in our current situation that the Paulson Effect — gee, what are we going to try today? Which are we going to let fail; which save? — merely contributes to. Cripes am I falling to pieces now. Nevermind; continue with our regularly scheduled data argument….

Greg December 29, 2008 at 5:14 pm

I think its clear WW2 only suspended the depression if the vets had returned to a country run by Hoover who said thank you now go sell apples on the street corner at the same time there were massive layoffs in the defense industry we would’ve gone right back into a depression. Post war programs among them the G.I. bill making education and housing attainable, programs that put a safety net under farmers to end the boom and bust cycles in rural areas and the investment in infrastructure all helped the returning vets contribute to the economy. What I believe was another factor that has been over looked is the unionizing of factories and transportation that gave people good wages so they could afford to buy thus creating the rising tide that lifted all boats. Polices that regulated banks, mortgage companies, and the stock market to avoid the bubble and bust of the ‘20s also played a role. The Republicans have taken us away from the policies of activist government and regulation and we can all see were that’s gotten us. In short I believe what ended the great depression and had kept the US a stable economy was the shift from a do nothing government to an activist government.

Keith E. Taylor January 7, 2009 at 2:46 pm

Common sense tells me that WWII had a very large impact, but not for the reasons usualy given. WWII forced the Government to rely more upon contracts with the “evil” capitalists where the incentive is for “evil” profits which demand efficient operation, rather than direct government employment where the incentive always is to work less and demand more. I know this from personal experience working for both government and private enterprise.

james77777 January 25, 2009 at 10:59 pm

The war ended umemployment. Soldiers learning their lesson came back and bought what they could pay for and did not borrow as much. Standards for making loans was higher. The demand to rebuild Europe required materials that created jobs. This recession/depression will not end with a war but will take 30 years and 2 generations to put behind us. Assume all the problems were solved today. Will people continue to buy expensive homes? Will people invest in the stock market? Will people continue to buy SUVs? I think not. Even with all our problems solved today, the gross national product will be a slow go for a long time.

green May 15, 2009 at 4:02 am

It is enlightening!

ashleigh November 12, 2009 at 4:04 pm

fanklen delano roosevelt had something to do with it. he made the New Deal law witch made 42 new agencies desinged to creat jobs. and ww2 created defense related jobs.

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