Christina Romer on Learning from the Great Depression

This from a (much longer) Five Books interview with Christina Romer:

Let’s talk about the role of fiscal policy, from the perspective of Lester Chandler’s America’s Greatest Depression. Please tell us about the book.

This book gives a great description of what went on during the Great Depression. It is especially strong in describing the policy response. It was published in 1970, but is still the book I go to when I want to know about the actions that were taken in the New Deal [economic programs]. It gives you a sense of all the things that were done in the 1930s.

One of the things you learn from Chandler is that President Roosevelt was trying everything. Back in the 1930s policymakers didn't know as much about what monetary and fiscal policy could do. So they tried all sorts of things – housing policy, agricultural policy, various credit policies, even allowing industries to collude to raise prices. Now, many of these policies were not very successful. And the ones that were successful often were not pushed far enough.

This is especially the case with fiscal policy. Chandler’s book reminds us of something that is often forgotten, that the fiscal response to the Great Depression just wasn’t very big. In fact, under President Hoover it actually went the wrong direction. When the deficit rose because tax revenues fell due to high unemployment, Hoover’s answer was a big tax increase – that was the Revenue Act of 1932. This misguided deliberate fiscal contraction was another reason why the economy kept going down and the Depression was as terrible as it was.

Even under Roosevelt the fiscal expansion was modest. When we think about the New Deal, we tend to remember things like the WPA [Works Progress Administration relief program], which built dams and bridges, and the Civilian Conservation Corps, which constructed so many buildings in our national parks. These programs left enduring legacies, and so we often think of the fiscal policy response of the New Deal as being big and aggressive. But what Chandler points out, building on a classic paper by E Cary Brown, is that the fiscal response to the Great Depression was actually quite small – not nearly as large as the American Recovery and Reinvestment Act of 2009. Even when Roosevelt increased the Federal deficit in the mid-1930s, a move to budget surpluses by state and local governments meant that the net fiscal stimulus was much smaller.

Brown’s famous conclusion, repeated in Chandler’s book, is: “Fiscal policy, then, seems to have been an unsuccessful recovery device in the ’thirties – not because it did not work, but because it was not tried.”

The same is true this time around. When declines at the state and local level are factored in, the net stimulus was near the breakeven point. That doesn't mean the stimulus did nothing -- the state and local declines would have happened in any case so offsetting the state and local declines with federal spending was important and preserved many job -- but maintaining rather than gaining ground is harder to sell as a policy success. [Update: I should have also noted Paul Krugman's Reversing Local Austerity.]