In a deep recession, "the usual
rules don’t apply":
1938 in 2010,
by Paul Krugman, Commentary, NY Times: Here’s the situation: The U.S.
economy has been crippled by a financial crisis. The president’s policies have
limited the damage, but they were too cautious, and unemployment remains
disastrously high. More action is clearly needed. Yet the public has soured on
government activism, and seems poised to deal Democrats a severe defeat in the
The president in question is Franklin Delano Roosevelt; the year is 1938. ...
Now,... President Obama’s economists promised not to repeat the mistakes of
1937, when F.D.R. pulled back fiscal stimulus too soon. But by making his
program too small and too short-lived, Mr. Obama did just that: the stimulus
raised growth while it lasted, but it made only a small dent in unemployment —
and now it’s fading out.
And ... the inadequacy of the administration’s initial economic plan has landed
it — and the nation — in a political trap. More stimulus is desperately needed,
but in the public’s eyes the failure of the initial program to deliver a
convincing recovery has discredited government action to create jobs.
In short, welcome to 1938.
The story of 1937, of F.D.R.’s disastrous decision to heed those who said that
it was time to slash the deficit, is well known. What’s less well known is the
extent to which the public drew the wrong conclusions from the recession that
followed..., voters lost faith in fiscal expansion. ... And the 1938 election
was a disaster for the Democrats, who lost 70 seats in the House and seven in
Then came the war. ... Over the course of the war the federal government
borrowed ... the equivalent of roughly $30 trillion today.
Had anyone proposed spending even a fraction that much before the war, people
would have said the same things they’re saying today. They would have warned
about crushing debt and runaway inflation. They would also have said, rightly,
that the Depression was in large part caused by excess debt — and then have
declared that it was impossible to fix this problem by issuing even more debt.
But guess what? Deficit spending created an economic boom — and the boom laid
the foundation for long-run prosperity. ... And after the war, thanks to the
improved financial position of the private sector, the economy was able to
thrive without continuing deficits.
The economic moral is clear: when the economy is deeply depressed, the usual
rules don’t apply. Austerity is self-defeating: when everyone tries to pay down
debt at the same time, the result is depression and deflation, and debt problems
grow even worse. And conversely,... a temporary surge of deficit spending, on a
sufficient scale, can cure problems brought on by past excesses.
But the story of 1938 also shows how hard it is to apply these insights. Even
under F.D.R., there was never the political will to do what was needed to end
the Great Depression; its eventual resolution came essentially by accident.
I had hoped that we would do better this time. But ... politicians and
economists alike have spent decades unlearning the lessons of the 1930s, and are
determined to repeat all the old mistakes. And it’s slightly sickening to
realize that the big winners in the midterm elections are likely to be the very
people who first got us into this mess, then did everything in their power to
block action to get us out.
But always remember: this slump can be cured. All it will take is a little bit
of intellectual clarity, and a lot of political will. Here’s hoping we find
those virtues in the not too distant future.
Posted by Mark Thoma on Monday, September 6, 2010 at 12:33 AM in Economics, Fiscal Policy |