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Wednesday, January 10, 2007

The New Deal and the Great Depression

When Brad DeLong said:

A normal person would not argue that the New Deal prolonged the Great Depression.

It got quite a reaction. Arnold Kling says:

...In case you have not been following it, Daniel Gross and Brad DeLong have been hurling insults at people who fail to genuflect to the proposition that the New Deal helped to cure the Great Depression. A reasonable view is that some New Deal policies helped, and some hurt. ...

Knowing what I know now, if I could go back to 1933 and tell President Roosevelt what to do, I would say "yes" to deposit insurance, "yes" to going off the gold standard, and "no" to pretty much every other New Deal policy, including Social Security. I would also encourage two things that were not tried--a monetary expansion and a fiscal expansion (which in those days, with taxes relatively low, would have meant more government spending). Although I do not believe in Keynesian "fine tuning," I think that in the 1930's I would have tried Keynesian policies as a way of getting to the right channel.

Whether Roosevelt's actual policies were, on balance, helpful or harmful, is something that I think reasonable people can debate. Hurling insults at one side or the other is not appropriate.

Here's the piece by Daniel Gross he mentions. This is likely the statement Arnold took offense at:

The argument that the New Deal's efforts "perhaps had prolonged, the Depression," is likewise a canard. One would be very hard-pressed to find a serious professional historian--I mean a serious historian, not a think-tank wanker, not an economist, not a journalist--who believes that the New Deal prolonged the Depression.

Jim Hamilton is also taken aback by Brad DeLong's statement:

The New Deal and the Great Depression, by James Hamilton: Like the folks writing at Mahalanobis, Marginal Revolution and Free Exchange, I was rather surprised to see Berkeley Professor Brad DeLong claim, "A normal person would not argue that the New Deal prolonged the Great Depression." Since Brad is a smart guy, I think it might be time for me to acknowledge my freakiness.

Jim goes on to discuss three phases of the great Depression and then focuses on the third phase where:

What really distinguished this episode from a typical downturn was not the severity of the initial decline, but the fact that, unlike a typical business cycle, things began to deteriorate quite dramatically after 1930. In my opinion, one of the reasons for that is the collapse of the money supply, which led the economy into a ferocious deflation. I've argued that the gold standard contributed to that... I also believe that the bank panics played an important role in propagating that second phase, and am quite happy to grant Daniel Gross that New Deal financial innovations such as the FDIC and FSLIC were unambiguously helpful in correcting some of those problems.

After 1933 [the third phase], the economy began to grow again... However, although growth over this period was strong, the unemployment rate stayed high, and there surely remained substantial excess production capabilities. So, in my mind, the third part of the question of "What caused the Great Depression?" is to explain why did the recovery take as long as it did after the contractionary monetary forces were removed?

What is supposed to help the economy recover is that a substantial pool of unemployed workers should result in a fall in wages and prices that would restore equilibrium in the labor market... And yet, in the midst of quite significant unemployment, between 1933 and 1934, average hourly earnings increased by over 25% in sectors such as iron and steel, furniture, and cement, and over 50% at lumber mills. How could that be? ...

[A paper by] Cole and Ohanian noted that many in the Roosevelt Administration believed that the severity of the Depression was due to excessive business competition that led to wages and prices that were too low. ... The purpose of the NIRA and NLRA was to promote labor and trade practice provisions so as to limit the extent of competition between firms and competition between workers. Among the NIRA codes that Cole and Ohanian highlight include minimum prices below which firms were not allowed to sell their products, restrictions on productive capacity and the amount that could be produced, and limitations on the workweek. Cole and Ohanian concluded on the basis of model simulations that these kinds of New Deal policies might have accounted for 60% of the persistence in the output gap.

Outside of manufacturing, the Agricultural Adjustment Act of 1933 and Soil Conservation and Domestic Allotment Act of 1936 -- paying farmers not to grow wheat-- were designed with the specific goal of reducing agricultural production in order to raise agricultural prices. State regulatory commissions like the Texas Railroad Commission ordered oil producers to cut back production in an effort to increase oil prices.

The notion that if we can just create more monopoly power for every single sector of the economy, encouraging every sector to produce less so they can raise their wages and prices, that we will then somehow make everybody richer, is so spectacularly wrong-headed that I would be just as dumbfounded to find that Brad De Long believes it as he seems to be by those of us who maintain that some aspects of New Deal policy surely did make the recovery from the Great Depression slower.

I openly confess to believing that government policies that were explicitly designed to limit manufacturing, agricultural, and mining output may indeed have had the effect of limiting manufacturing, agricultural, and mining output.

This is  bit rushed, but let me come to Brad's defense. If we change his statement from:

A normal person would not argue that the New Deal prolonged the Great Depression.

To:

Most economists would not argue that, on net, the New Deal prolonged the Great Depression.

I don't think it is objectionable. Brad surely would not argue that every single policy was beneficial, only that on balance the policies were helpful, and there does seem to be agreement about that.

Update: No need to speculate about what Brad would argue, he states his view here.

    Posted by on Wednesday, January 10, 2007 at 08:56 AM in Economics, Policy | Permalink  TrackBack (1)  Comments (130)

          

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