Yet Another Reason for the 1937-38 Depression

Tyler Cowen, in a New York Times column, offers yet another explanation for the depression within the depression. (HT to Cafe Hayek)

A study of the 1930s by Christina D. Romer, a professor at the University of California, Berkeley (“What Ended the Great Depression?,” Journal of Economic History, 1992), confirmed that expansionary monetary policy was the key to the partial recovery of the 1930s. The worst years of the New Deal were 1937 and 1938, right after the Fed increased reserve requirements for banks, thereby curbing lending and moving the economy back to dangerous deflationary pressures.

Read more!

Krugman Schools Will?

As my students know, I believe that being an economist is almost a holy calling and earning a Nobel Laureate makes an holy man a prophet.  Paul Krugman, this year's winner disappointed in an a 1 minute 17 second exchange with George Will on an ABC news show.  Dubbed, "Krugman Schools Will" on many blogs the exchange is  downloaded to YouTube.  Will has an excuse, he is a columnist, not an economist.  Krugman has no excuse.  

Krugman did not school Will.  He agreed with Will's initial premise that net investment during the thirties was negative, and with his end point that the economy was not restored to full employment until WWII began.  In between, he offered an alternative hypothesis as to why net investment remained low for so long--that Roosevelt mistakenly tried to balance the budget. 

Will begins by observing that one of the ways that the government turned a depression into the Great Depression was by tinkering with property rights.  Krugman is wrong when he flatly objects and would be judged misinformed by a jury of his economic peers.  For example,  Schumpeter, one of the greatest economists of the last century wrote in Capitalism, Socialism and Democracy, (which I nicked form Robert Higgs, Regime Uncertainty).

The subnormal recovery to 1935, the subnormal prosperity to 1937 and the slump after that are easily accounted for by the difficulties incident to the adaptation to a new fiscal policy, new labor legislation and a general change in the attitude of government to private enterprise all of which can...be distinguished from the working of the productive apparatus as such...[S]o extensive and rapid a change of the social scene naturally affects productive performance for a time, and so much the most ardent New Dealer must and also can admit.  I for one do not see how it would otherwise be possible to account for the fact that this country which had the best chance of recovering quickly was precisely the one to experience the most unsatisfactory recovery.

Krugman dissembles on the government's role in expanding and prolonging the Great Depression.  Certainly markets deteriorated beginning in 1928 into 1929, punctuated by the October stock market crash.  But the government at all federal levels responded with policy that deepened and prolonged a depression, morphing it into the Great Depression.  Friedman evaluated the role of the Federal Reserve, and the Nobel Prize committee noted in the press release announcing his award, that

His major work, A Monetary History of the United States,1867 - 1960, is regarded as one of Friedman's most profound and also most distinguished achievements. Most outstanding is, perhaps, his original and energetically pursued study of the strategic role played by the policy of the Federal Reserve System in sparking off the 1929 crisis, and in deepening and prolonging the depression that followed.

The Smoot-Hawley Tariff Act of 1930 passed by the Congress and signed by President Hoover dealt a body blow to the economy by restricting trade.  The Wikipedia entry in part states,

Although the tariff act was passed after the stock-market crash of 1929, many economic historians consider the political discussion leading up to the passing of the act a factor in causing the crash, the recession that began in late 1929, or both, and its eventual passage a factor in deepening the Great Depression.

Krugman then offers a second hypothesis that an attempt to balance the budget prolonged the Great Depression not the messing with property rights.  Many economists dispute this notion.  Price Fishback on Freakonomics writes,

John Maynard Keynes published an open letter to Franklin Roosevelt in major American newspapers saying more spending was not enough; the government needed to run larger deficits. As Keynes’s arguments were fleshed out after the 1930’s, various scholars ranging from Abba Lerner to E. Cary Brown to Claude Pepper have re-examined the New Deal budgets. They all agree that the New Deal cannot be described as a Keynesian stimulus program. We can only hope that the word will finally spread widely enough now to correct the myth.

Both Will and Krugman claim the Great Depression ended with the Japanese fleet appeared off Hawaii initiating a giant public works program.  In an upcoming post, I will dispute that opinion.  

Read more!

Policy for Inequality?

Arthur Brooks, author of Gross National Happiness, writes,

About half of all American adults think economic inequality is a major problem, and about half of them do not. Do these two groups differ in some way that might explain the contrasting attitudes? As it turns out, their opinions cannot be explained by income, class, race, or education. Instead, what best predicts an individual’s views on income inequality is his or her beliefs about income mobility—that is, about whether Americans have opportunities to get ahead economically. And it is these beliefs about mobility, not beliefs about income inequality, that lie directly behind much happiness and unhappiness. Those who believe that they and other Americans can get ahead with hard work and perseverance—that America offers paths to success—are generally happy and unfazed by economic inequality. Those who think that economic mobility in the United States is an illusion are relatively unhappy and tend to complain about income inequality.

What policy implications does this statement suggest?
Read more!

Budget Cuts for Obama

Ross Colvin and Jeff Mason of Reuters write

President-elect Barak Obama vowed on Tuesday to cut billions of dollars from wasteful government programs as he sought to reassure Americans anxious about a growing mountain of debt and a faltering economy.

Please make suggestions of cuts that you believe the President-elect should make when he assumes office.

Read more!

No Single Person to Blame

As an economist, I am dismayed at the common impression that the president is at the helm of the economy guiding us through stormy economic times. Political cartoons showing President Bush handing over the reins of a broken economy to President Elect Obama illustrate this perspective. Even some very good economists like Alan Blinder seem to accept this portrait. Most economists believe that the President has little to do with the economic outcomes. Without empirical evidence, I would like to assert by opinion. It is easy for elected officials to harm an economy, nearly impossible to help in the short run, and difficult to help in the long run.

What can the government do in the long run to help the economy grow? It can allow the owners of productive resources to profit from utilizing these resources, keep taxes low and the government sector small, enforce, protect and respect private contracts, support education and public research.

Good and bad policy may not manifest its impact until the president and Congress that implemented it are gone. Suppose that the Obama Administration signs legislation passed by the Congress that drastically improves educational achievement and future worker productivity but must be implemented with first graders. It increases the cost of education by 2% but has a 50% return on investment when first graders graduate from college in 16 years. This policy change would be very productive, but will produce a negative return during the Obama Administration and give a future administration an unearned increase in economic growth.

Likewise, the Obama Administration might enact a bad energy policy. For arguments sake, let's say it mandates that power companies increase wind generated electricity by 20% per year beginning in 2016 and that this is an inefficient source of energy production. Power companies know the policy is bad, and do not increase current investment in wind power. Beginning in 2016, they start producing more wind power, it is more expensive than other energy sources and the growth rate in the economy slows.

Is it realistic to see policy from previous administration to affect current economic activity? The current housing crisis may well demonstrate that it does. Our friends on the political right blame the crisis in part on Democrats with the creation of Fannie Mae in 1938 (Roosevelt) which was taken public in 1968 (Johnson) creating a government sponsored entity with privatized profits and nationalized losses, a moral hazard. But Freddie Mac followed a similar path being created in 1970 by the Republican Nixon Administration, and taken public in 1989 by the G. H. W. Bush Administration again creating a GSE with a moral hazard. The Clinton Administration gave the GSE's the mandate to make more loans to underserved areas, but so did the Bush Administration. Fannie and Freddie complied by lowering underwriting standards: home prices collapsed, foreclosures skyrocketed, shaking the financial markets, and the rest is history.

Our friends on the political left often blame deregulation implemented by Republicans. The article from the Daily Kos linked above blames the Garn- St. Germain Depository Institutions Act for deregulating Savings and loans and passed during the Reagan Administration as the beginning of our current mess, ignoring similar legislation, the Depository Institutions Deregulation and Monetary Control Act of 1980, that was passed, signed and implement during Carter Administration. According to the blame deregulation and the Republican crowd, the next shoe dropped with the passage of the Gramm-Leach-Bliley Act in 1999, which repealed earlier banking law allowing banks to compete with insurance companies and investment banks. Note that the bill was signed by President Clinton. The third and final shoe (yes, we have created a strange beast) dropped in 2000 with the passage of the Commodity Futures Modernization Act. The act expanded futures trading and speculation, and was passed with Republicans again leading the charge, but again with President Clinton signing the legislation. Unrestrained markets lead to market excess creating the housing bubble and collapse, and the rest is history.

One party may be better than the other in encouraging growth. One party might be more "fair." One party may have contributed to the current crisis more than the other. I don't know, and I don't know of any article in a referred economics journal that attempts to answer these questions.

As a student of economics, when examining economic legislation, you should apply economic principles to attempt to predict the value of the policy, and if the policy is enacted, measure the outcomes of the policy.

Please comment. You are not required to agree, just to make reasoned, polite responses.

Read more!

Required Service?

John Maynard Keynes, an economist who heavily influenced macroeconomic theory famously stated, “The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”

Not yet defunct, Greg Mankiw (scroll down to Friday, November 7th) singlehandedly changed the policy of the incoming Obama Administration. The Obama Administration was proposing required national service for all middle school, high school and college students. Economists have a long tradition of opposing required or mandated service in part because it force people to work for less than the market wage. Within twenty four hours, the Obama team changed the word “required” to “setting a goal of.” Shortly thereafter, the entire Obama agenda was pulled from the Internet being replaced by a perfunctory promise of change. To be fair, and I don’t like being fair with our elected officials, I believe that the incoming administration was wise to alter policy goals given current economic turmoil. Michele Catalano at PajamasMedia.com disagrees with Dr. Mankiw’s opposition. Please read the postings by following the links in blue and give your opinion on the program. Do you support the idea of required community service, or the less intrusive program of setting a goal and why?

Read more!