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Friday, February 13, 2009

The Deficits Weren't Big Enough

Republicans should listen to Bruce Bartlett instead of covering their ears and kicking him out of the club when he says things they don't want to hear:

The Real Lesson Of The New Deal, by Bruce Bartlett, Commentary. Forbes: One reason why Republicans strenuously oppose the Obama administration's fiscal stimulus plan is because it repeats the errors of Franklin D. Roosevelt. To them, the New Deal was mainly about vastly expanding government spending and deficits, which Republicans believe made the Great Depression worse rather than better. ...

The true New Deal legacy, however, is more complicated. Serious mistakes were ... made. In ... terms of fiscal policy, Roosevelt's error wasn't that he spent too much, but that he didn't spend nearly enough.

As economists Milton Friedman and Anna Schwartz proved..., the core economic problem in the early 1930s was a contraction of the money supply by a third. This caused the general price level to fall by about 25%. ...

Despite a falling price level, there were those who nevertheless viewed any rise in prices as the first step on the road to German-style hyperinflation. Insanely, they argued that the government had no business compensating for any amount of deflation; that somehow it represented the natural workings of the market. The only appropriate response, they said, was for businesses to slash prices and workers to accept massive wage cuts.

It never seems to have dawned on these critics ... that deflation was a decidedly unnatural phenomenon caused by the Federal Reserve's mistakes, not those of workers and businessmen. Yet the critics expected the entire burden of adjustment to be borne by them as if it was their fault that the nation was in an economic depression.

The critics were also totally opposed to deficit spending. As with Republicans today, they said that federal borrowing would simply draw funds out of productive uses in the private sector to be squandered...

Apparently, it didn't occur to these critics that the existence of vast unemployment, closed factories, abandoned farms and extremely low interest rates meant that much of the private sector's resources were simply idle. Borrowing them by running deficits didn't reduce private output because there were no alternative uses available. ...

In the table below, I have done a very simple calculation showing what fiscal policy should have been during the New Deal. ... As one can see, the actual federal budget deficit was much too small in every year of the Great Depression. And of course it was disastrous for the government to run a surplus in 1937. Economists are unanimous in their view that this was one of the greatest economic mistakes in history.

Nevertheless, Republicans claim that today's fiscal stimulus is doomed to fail because the deficits of the 1930s didn't end the Great Depression. "We know for sure the big spending programs of the New Deal did not work," Senate Republican Leader Mitch McConnell asserted on Feb. 6.

The implication seems to be that the economy would have recovered faster from the Great Depression if the budget had been balanced. But as my calculations demonstrate, the true failure of the New Deal was that deficits were much too small, not too large. ...

Republicans conveniently overlook the fact that it was massively larger budget deficits--which averaged close to 20% of GDP from 1941 to 1945--that were the principal contribution of the war to economic recovery.

    Posted by on Friday, February 13, 2009 at 12:24 AM in Economics, Fiscal Policy | Permalink  TrackBack (0)  Comments (61)

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