In the field of economics, Christina Romer is one of the acknowledged leading experts on the Great Depression. It’s worth listening to her insights on the relevance of the Great Depression for today. Here she is in The Economist, (no left-wing magazine that)!:
“The recovery from the Depression is often described as slow because America did not return to full employment until after the outbreak of the second world war. But the truth is the recovery in the four years after Franklin Roosevelt took office in 1933 was incredibly rapid. Annual real GDP growth averaged over 9%. Unemployment fell from 25% to 14%. The second world war aside, the United States has never experienced such sustained, rapid growth.
However, that growth was halted by a second severe downturn in 1937-38, when unemployment surged again to 19% (see chart). The fundamental cause of this second recession was an unfortunate, and largely inadvertent, switch to contractionary fiscal and monetary policy. One source of the growth in 1936 was that Congress had overridden Mr Roosevelt’s veto and passed a large bonus for veterans of the first world war. In 1937, this fiscal stimulus disappeared. In addition, social-security taxes were collected for the first time. These factors reduced the deficit by roughly 2.5% of GDP, exerting significant contractionary pressure.
Also important was an accidental switch to contractionary monetary policy. In 1936 the Federal Reserve began to worry about its “exit strategy”.After several years of relatively loose monetary policy, American banks were holding large quantities of reserves in excess of their legislated requirements. Monetary policymakers feared these excess reserves would make it difficult to tighten if inflation developed or if “speculative excess” began again on Wall Street…The Fed then doubled reserve requirements in a series of steps. Unfortunately it turned out that banks, still nervous after the financial panics of the early 1930s, wanted to hold excess reserves as a cushion. When that excess was legislated away, they scrambled to replace it by reducing lending. According to a classic study of the Depression by Milton Friedman and Anna Schwartz, the resulting monetary contraction was a central cause of the 1937-38 recession.”
The lesson is clear — fiscal and monetary stimulus had the effect of cushioning the depression, while a premature withdrawal of this stimulus caused a relapse. Today, memories are short. We forget that, just a few short months ago, the world financial system faced imminent meltdown. We forget that growth rates at the end of last year were the worst since the Great Depression. Now, attention is focused on signs of life, and people want business as usual. The worries have switched to the inflationary impact of excess liquidity sloshing around the system, and the sustainability impact of huge fiscal deficits. In other words, it sounds like 1937.
Of course, there will come a time when it is right to be concerned with these things, but is it premature? I will merely draw your attention to the recent work by Barry Eichengreen and Kevin O’Rourke, showing that we are tracking the Great Depression very well at this stage in the game, and the overwhelming aggressive policy response is all that is saving us.
June 19, 2009 at 1:58 pm
Democratic talking points: straight from the Democratic Party to Brad DeLong’s blog (he’s been called on this before) to Vox Nova. Why not mention that the Romer piece was part of a symposium in the Economist and that others made criticisms of her arguments?
June 19, 2009 at 2:06 pm
Christina Romer is one of the leading experts in economic history, especially the Great Depression. She’s been doing research in the topic for at least two decades now. It says a lot that a mainstream economic analysis from a leading scholar is seen as “Democratic talking point”. Such is the state of the world. Sigh.
June 19, 2009 at 2:23 pm
Nicolas,
Your comments above are just nonsense. What MM says here was standard fare taught in economics classes in the 1950s. To reduce these remarks to talking the points of the Democratic Party is way too cute and just plain silly.
But if you want to discuss Democratic and Republican party talking points, here is one Republican talking point you forgot to mention. When the Republicans turned their talking points into economic policy, the chief results were the Great Depression and the current economic crisis.
Now that record is pretty difficult to beat! No wins, all losses!
June 19, 2009 at 3:44 pm
“Why not mention that the Romer piece was part of a symposium in the Economist and that others made criticisms of her arguments?”
So an idea “criticized” is an idea refuted?
Have we discovered a new fallacy?
June 19, 2009 at 3:57 pm
I agree that caution is called for here. However, both Romer’s own work and the economic consensus suggest that, when the time for tightening does come, you should remove all fiscal stimulus before engaging in any monetary tightening.
June 20, 2009 at 9:26 am
FWIW, I think the Economist can be classified as a liberal (in the American sense) and illiberal (in the European sense) magazine.