Believe those who are seeking the truth. Doubt those who find it. Andre Gide

Tuesday, October 6, 2009

Averting the Worst

According to Paul Krugman, we recently avoided a Great Depression because of Big Government; see here.

By any "reasonable" estimate, he says that the current stimulus program has saved up to 1 million jobs. Let's imagine that this is true. According to the government's own figures (see here), roughly 100 billion of the stimulus plan has been spent to date (the vast majority in the form of transfers; rather than purchases). So, if my arithmetic is correct, this translates into only $100,000 per job. Well done, government.

The thing that caught my eye in Krugman's piece was this statement:
All of this [Big Government not slashing spending the way the private sector does during recession] has helped support the economy in its time of need, in a way that didn't happen back in 1930, when federal spending was a much smaller percentage of GDP.

He is, of course correct in stating that the U.S. federal government was much smaller in 1930. And while he does not say so explicitly, I think he may leave the reader with the additional impression that, in addition to being small, the Hoover government actually chose to become smaller (mimicking the private sector in tightening its belt through hard times). The facts, as far as I can gather, seem to suggest something quite different.

According to this data, government outlays from 1930-33 increased by 9.0%, 19.4% and 46.5%, respectively. The latter two years in particular constituted classic deficit-financed expansionary policy (a policy, one might add, came under scathing criticism for recklessness by the Democratics in Congress, led by Roosevelt himself).

I'm not sure what to make of such data; but it does seem to dispell the myth of Hoover as a "do nothing" president.

It is of some interest, I think, to record how the economy recovered from recession prior to the era of Big Government. I seem to recall a fairly significant recession occurring in the early 1920s. Here is the data.
According to this data, the economy contracted by 3.3% and 4.3% in 1920 and 1921, respectively. The economy expanded by 4.5% and 11.4% in 1922 and 1923, respectively.

How did it manage this recovery after 2 years in the absence of Big Government? Why did a Great Depression not occur?

In fact, fiscal policy throughout this entire episode was significantly contractionary. How are we to make sense of this? Or, more precisely, I wonder how Krugman would make sense of this?

[Thanks to Doug Smith, for gathering this data]


  1. Why You've Never Heard of the Great Depression of 1920

    The second half is a bit more interesting than the first.

  2. David:

    The video pointbite links to is a good one (I'm pretty sure it's the same one he posted the link to on WCI).

    It made me think, and made me realise I don't understand the self-equilibrating properties
    of the economy at the macroeconomic level as well as I need to. (I did a post on "Pre-Darwinian macro" expressing my discomfort.)

    But let me turn your question back to you (non-rhetorically): how does the economy recover by itself, without the aid of fiscal or monetary policy? Why does the AD curve slope down, in other words? (I know the textbook answers of course, but find them less than convincing.)

  3. Hi Nick,

    Please send me a link to your post.

    The short answer to your question is that I do not know. My current view is that recessions are largely the product of investments that turn out bad, relative to (more or less rational) expectations. The mechanism described by Joseph Zeira "Informational Overshooting, Booms and Crashes, JME 2001) may also play a role. The recovery takes place when resources are rediverted to activities with more promising returns. I have sympathy with Fisher Black, who argued that monetary and fiscal policy plays little role (indeed, they could not have played any major role in recoveries that occurred prior to big government or the founding of the Fed). On top of this, you can add sectoral adjustment no individual "shock" is likely to impinge on all sectors of the economy in precisely the same way.

    As for money supply and banking, the National Banking Era in the US (1863-1913) is enlightening. Back then, coalitions of banks would form clearinghouses that would suspend redemptions in specie and issue clearinghouse certificates. Gary Gorton estimates that the maximum average depositor loss over the 6 or 7 crises that occurred over this period was about 2 cents on the dollar. Of course, this institution did not prevent severe recessions from occurring, but none, as far as I know, ever generated a decade long period of high unemployment.

  4. Hi David:

    And my short answer to my question is that I don't know either! My post does little more than express my ignorance, and my frustration at being ignorant. But it might be up your street:

  5. Currently employment is about 145 million according to BEA in October 2009. GDP is 14.2 trillion, which means the economy is paying almost 100,000 per job! How could that be?

    You forgot that some of the stimulus will go towards capital income. Naturally the stimulus could be oriented to make-work projects that are more labor intensive than corresponding market activities, but the stimulus having the same capital intensity as the rest of the economy is hardly problematic. Or do you want to build roads with shovels instead of Caterpillar machinery?

    I see this 100,000 dollars per job number being made over and over again by right wing economists. It's meaningless.

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