Let's Avoid Other New Deal Policy Blunders

In the third and final installment of articles comparing today’s economic situation to the Great Depression, economic historian Price Fishback implores policy makers to avoid the mistakes that were made in the Great Depression. His two prior posts in the series are here and here.

Let’s Avoid Other New Deal Policy Blunders
By Price Fishback
A Guest Post

The slow reaction to the financial crises during the 1930’s was grouped with a series of policy blunders in other areas. The Hawley-Smoot Tariff Act of 1930 in the United States touched off a series of protectionist reactions in other countries and contributed to a downward spiral in world trade. Total imports for a group of 75 countries fell to one-third of the 1929 level by 1933. In the modern crisis, the occasional cries to buy American have not led to any protectionist measures. This is good news because many of our trading partners appear to be experiencing more problems than the United States, a reversal of the situation in the 1930’s. President Obama and the Congress might find it good policy to follow in Roosevelt‘s footsteps. Roosevelt negotiated a series of Reciprocal Trade Agreements with key trading partners that helped stimulate a world-wide recovery. Moves to sign similar agreements with Latin American countries and Korea would likely have a similar effect in improving prospects for all parties to the agreements.

The pundits favoring government intervention have argued that the current crisis calls for the type of government experimentation seen in the New Deal. Yet experimentation leads to uncertainty, which causes consumers to delay purchases of durable goods and companies to delay capital investments.
Luckily, no one, as yet, has proposed a replay of Franklin Roosevelt’s most disastrous experiment, the National Recovery Administration (NRA). The NRA allowed employers and workers in each industry to agree to codes of “fair competition” that would help raise both prices and wages. The hope was that wages would rise more than prices. In actuality, the policy allowed a number of industries to reduce market competition without fear of antitrust prosecution, while the wage rise contributed to a reduction in hours of employment. Thank the Supreme Court of 1935 for striking the program down. There is plenty of evidence that the combination of the NRA and widespread policy experiments served to slow the recovery in the 1930’s.

Fiscal moves during the 1930’s also left much to be desired. President Hoover signed a substantial tax increase on the small share of households subject to income taxes at the time. The tax rise was not too harsh for the lowest tax brackets. Individuals in the $2,000 tax bracket (roughly $24,000 today) and families in the $5,000 bracket ($60,000 today) saw their rates rise from 0.1 percent to 2 percent. But the rates on those earning $1 million per year rose from 23.1 percent to a confiscatory 57 percent. The Roosevelt administration could have opted to lower the rates, but it only made slight adjustments during the rest of the 1930’s, lowering them some for those earning less than $10,000 and raising them some for those earning over $100,000.

Both the Hoover and Roosevelt administrations largely adhered to the idea of small budget deficits. The doubling of federal government spending as a share of G.D.P. is often incorrectly cited as an example of Keynesian stimulus policy. Yet Keynes wrote open letters in U.S. newspapers to Roosevelt telling him that spending more was not enough unless he taxed less and ran large budget deficits. A slew of Keynesian economists since that time have shown that the New Deal expansions in federal spending were largely matched by increases in federal tax collections. The stimulus was weakened further by the introduction of sales taxes and income taxes in a number of states who sought to meet their own constitutional balanced budget requirements.

The Bush and Obama administrations have clearly not followed Roosevelt’s lead. Bush sought large-scale tax rate cuts during the recession in the early stages of his first term and then handed out tax rebates when fears of a recession arose in the winter of 2008. He also supported the financial bailouts negotiated by Paulson and Bernanke. The largest Bush deficit was 3.2 percent of G.D.P. in 2008. In addition to all of the distribution of funds and guarantees in the financial sector, President Obama and the Democratic Congress agreed on a fiscal stimulus package of nearly $800 billion in mid-February. This appears to be a true Keynesian push. The tax reductions are described as lump-sum payments, not the kind of rate reductions expected to stimulate a supply-side response. The Congressional Budget Office projects a budget deficit of nearly 10 percent of G.D.P. for 2009.

These are uncharted waters outside of the command economies of the world wars. Although several generations of students were taught Keynesian economics in college classrooms, the U.S. does not really have much experience with Keynesian stimulus packages. The New Deal budget deficits were too small. The World War II deficits were associated with a command economy that drastically cut production of civilian goods to produce for the military, while putting 15 percent of the workforce into the military. The famous Kennedy Tax Cut in 1964 was associated with a deficit of only 1 percent of G.D.P. Based on budget deficits as a share of G.D.P., Ronald Reagan and George H.W. Bush were the most Keynesian presidents with budget deficits exceeding 4 percent of G.D.P. in seven out of their 12 years in office. Reagan apparently was a closet Keynesian because he emphasized the supply-side reasoning for his tax-rate reductions. Gerald Ford in 1976 is the only other president who faced a deficit greater than 4 percent since 1946.

We all want to know whether all of the government action will work to save us from a major downturn. There are questions about whether the spending and tax cuts in the stimulus package will happen soon enough to offset the recession. A significant part of the spending will not begin until 2010 and 2011 when most economists believe we will be into the next recovery. With unemployment rates only between 8 percent and 9 percent, we might expect the deficit and government hiring to make it more difficult for private firms to obtain investment funds and hire workers. Some recent studies of the New Deal relief programs suggest that additional work-relief jobs were associated with partial reductions in private employment. Meanwhile, the Federal Reserve has flooded the banking system with so much liquidity that we may be facing worries about inflation in the near future. The population can rest assured, however, that we have a very long downward path to follow before we get anywhere near the pain associated with the Great Depression.


I understand that exports were less than 5% of U.S. GDP during the 30's. How, then was the Hawley-Smoot Tariff Act a major factor in the depression?

Some 30%+ unemployment was caused by loss of a portion of 5% of our GDP? Seems improbable.

Milton Friedman's contention that the Fed's clamp down on the money supply was responsible seems more plausible, to this layman at least.


"These are uncharted waters outside of the command economies of the world wars. Although several generations of students were taught Keynesian economics in college classrooms, the U.S. does not really have much experience with Keynesian stimulus packages"

I agree that we have a long way to go before the Great Depression, but at the same time I fear that the inertia generated by new public spending will be to difficult to tame once the recession passes. Will we be able to cut enough expenses and generate enough new tax revenue to close the budget gap? The recent history of government's ability to do this is not good. The 1990's surpluses were largely a result of capital gains and exponential growth in productive due to the IT revolution. Can we count on a confluence of these and the balance that a Democratic fiscal conservative and Republican house brought to the table? Does anyone believe Obama has the same fiscal ideas that Clinton did? I think not. We may not be in as dark a hole economically as the Great Depression, but I do fear that our government lacks the discipline to act properly after we escape this recession. That is an area entirely outside of Keynesian economics. His system deals poorly with the reality that politicians have incentives to continue running deficits, even when the good times are rolling. His theory is just as rationalistic as the efficient market hypothesis that doomed many on Wall Street to fail and regulators to fall asleep at the switch.



I also agree we have a long way to go before another Great Depression. Yet I always find stimulus packages very interesting. In today's case, they are meant to help those who are struggling - but I saw an interesting idea the other other - why not give the money to institutions doing well so they can continue to grow and provide jobs rather than be victims of the collateral damage. Read more on it at http://bearonbusiness.com/antonym-of-a-bailout

Martyn Strong

Capital markets are unstable. In the past there was no way to make them stable. But today we have computer power that can be used to make them stable.

By using the greater computer power of today we can have a much higher turn over of capital in the capital market. This higher turnover will make the market harder to game or control and the market will no longer have the unstable run ups or declines. Who can change or control the market when say 20% of the capital is trading each day?

So now that we have the compute power to provide for all these transactions that will smooth out the market how do we force people to turn over at a rate of 20% a day? Easy, put a cap gains tax of 0% (zero) on all gains of 7 days or less and put a cap gains tax of 90% of all gains of more than 7 days.

The likes of Yahoo, Micosoft and/or Sun Micro Systems will give us the systems that will provide automated software agents to support turning over one's investments every 7 days (based on the specs you give the agent).

A system like this will make the financial markets work as smoothly as the local fruit market.


Adam B.

In remarks prepared for a House subcommittee, Heidi Shierholz, an economist with the Economic Policy Institute stated "The 10 postwar recessions prior to this one have averaged 10.4 months in length, with the longest being 16 months. The current recession is now in its 16th month and the labor market is still shedding over 600,000 jobs a month."

So do you suggest we just sit and wait for the market to fix itself?

I've see a lot of anti-stimulus posts on Freakonomics, but not really any suggestions on what to do differently...


Experimentation is necessary to try and end the recession, normal economic moves are not working and I dont think it creates uncertainty. People will see that things are being done to at least try and recover and they will get confidence. In the great depression the public didn't get confused and uncertain when Roosevelet tried lots of different things, they got confidence because there was something being done


Martyn Strong for President!
If only the stock market ran as smoothly as the local fruit market....
That is beautiful, main


I have yet to see a good quantitative study that demonstrated that anything FDR did had a negative impact on capital spending in the 1930s.

If you make capital spending from 1929 to 1939 a function of the GDP gap, corporate profits and the cost of capital it does an outstanding job of fully explaining the downturn from 1929 to 1933, the 1934-37 rebound, the 1938 downturn and the 1938-39 rebound.

I have tried adding numerous things that different people claim hurt investments in the 1930s, like the NRA and they never play a significant role.

Remember, during the short life of the NRA real GDP growth was the strongest of any peacetime period in US economic history. If this was the product of a disasterous policy maybe we need some more disasters.

Actually, I doubt that the NRA was in place long enough, or enforced strenuously enough to have had a significant impact either way. According to insiders in the FDR administration by the time it was declared unconstitutional the administration had pretty much given up on the NRA and were moving on to other experiments.


Tariq F

Reagan was a closet Keynesian? Keynes was a supply-side economist? I'm puzzled by these suggestions.

To clear up common misperceptions, Keynes did not suggest tax cuts in order to boost supply but rather tax cuts in order to boost demand. In accordance with this he advocated tax cuts be targeted at cash-strapped, lower-income earners, who are more likely to spend additional income.

See http://en.wikipedia.org/wiki/Supply-side_economics for more background.

Now I'm no Reagan expert (nor am I American), but I'm not too sure that Reagan and George W H Bush were cutting taxes to benefit primarily the poorest folks, nor do I think that either they or conservatives like Margaret Thatcher can be described as demand-side Keynesian economists.