By Price Fishback, Frank and Clara Kramer Professor of Economics
Part three of a three-part series originally posted on here The New York Times Freakonomics Blog.
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.