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The new deal and modern memory.

It seems odd, fifty years after the event, that economists still do not understand, or at least agree on, the world depression of the 1930s. (Kindleberger 1986, p. 1)

For history does in fact repeat.

--Franklin Delano Roosevelt (1)

1. Introduction

It is now more than 80 years since the onset of the Great Depression, a crisis that, in lay person's discourse at least, was triggered by the stock market crash of October 1929. (2) Although most professional economists rightly discount the popular story [indeed, there are reasons for believing that equities actually were in general undervalued in 1929 (Fisher 1930; McGrattan and Prescott 2004)], (3) the causes and consequences of the global economic collapse of 1929-1933 continue to be topics of considerable scholarly interest and of yet unresolved academic debate.

The macroeconomic events of the past three years have, not surprisingly, redirected the attention of students of economic history, policymakers, and the public to those of the earlier period. How could they not? The similarities between now and then are in some respects so compelling that the economic downturn underway since the bursting of the real estate "bubble" became evident in December 2007 is often referred to as the "Great Recession." The comparisons are valid insofar as both slumps were preceded by extraordinary expansions of bank credit, which fueled run-ups in stock prices and real estate values. Those asset prices subsequently declined precipitously when the Federal Reserve, belatedly recognizing that it had gone too far, reversed course and began pursuing tight-money policies. Many homeowners were plunged under water as the market values of their principal investment fell below the debt they owed. Purchases of durable consumer goods thereafter predictably went south, and mounting defaults on home loans were transmitted to the balance sheets of mortgage lenders, triggering bank failures, declines in production, and increases in unemployment. The two economic crises also elicited similar (and equally counterproductive) fiscal policy responses, combining substantial increases in federal spending, financed primarily by borrowing, with higher taxes and more regulatory controls on the private sector. (4)

But the similarities end there. During the Great Recession, which according to the National Bureau of Economic Research ended in June 2009, GDP fell by at most 3.8% (Smith and Gjerstad 2010) and was growing by (an anemic) 1.6% by the second quarter of 2010; the rate of unemployment peaked at just below 10% and has remained stuck there ever since. Those numbers pale in comparison with those of 80 years ago. Industrial production in the United States fell by 21% in the first year of the Great Depression and declined from its 1929 peak by more than 60% when that indicator hit bottom in 1932 (Romer 1993, pp. 21-2). (5) All other customary measures of macroeconomic performance moved sharply downward once the slump was underway: "Net national product in current prices fell by more than one-half from 1929 to

(3) Irving Fisher (1930) attributed the market's undervaluation of equities ahead of October 1929 to its failure correctly to price the intangible capital of publicly traded companies. But whether undervalued or overvalued, stock ownership was not nearly as widespread then as it is now (IRAs and 401ks had not been invented in 1929), there was a lesser propensity to finance consumption out of wealth, and, while the stock market's crash indeed was dramatic, share prices initially remained above the level they had reached in early 1928 (Temin 1976).

Two weeks before the "Great Crash," Professor Fisher famously said that, "Stock prices have reached what looks like a permanently high plateau." Apparently willing to put his money where his mouth was, "his considerable fortune, invested in the market, followed the Dow Jones Industrial Average into a death spiral" (Okrent 2010, p. 330). 1933 and net national product in constant prices by more than one-third": "money income fell 53 percent and real income 36 percent" (Friedman and Schwartz 1963, pp. 299, 301); real output per capita decreased by 31 percent over the same period (Vedder and Gallaway 1993, p. 75). By March 1933, one in four Americans was unemployed--many had been out of work for a year or more (Vedder and Gallaway 1993, p. 75) (6)--and well over one third of the commercial banks in the United States had suspended operations, had been liquidated, or had disappeared through consolidation or merger (Friedman and Schwartz 1963, p. 299). (7)

Those remarkable declines in economic activity produced profound and sweeping human hardship, documented in grainy, black-and-white photographs of beaten men standing on soup-kitchen lines and of pinched-faced children selling apples on street corners, images that even today are graven on the national conscience (see, e.g., Watkins 1993). Perceived as being callously indifferent to the suffering of his fellow citizens--an indifference epitomized by Douglas MacArthur's brutal routing at saber's point of the "Bonus Army" camped on the mudflats of Anacostia--the economic debacle of 1929-1932 wrecked the presidency of Herbert Hoover and propelled Franklin Roosevelt into the White House pledging "a new deal for the American people" (Williams 1994, p. 167). The unprecedented depth and breadth of the collapse, along with the federal government's policy responses to it, supply ample justification for the era's continued fascination: the Great Depression is to economics what the "Big Bang" is to physics (Margo 1993)--or perhaps it is the profession's "Holy Grail" (Bernanke 2000, p. 5).

In his two valuable collections of interviews with economists who either lived through the Great Depression, have devoted their academic careers to studying it, or both, Randall Parker (2002, 2007) poses five important questions: "What started it? Why was it so deep? Why did it last so long? Why did it spread so completely? Why did recovery come when it did?" (e.g., Parker 2007, p. 54).

In this article, I offer admittedly incomplete answers to all of those questions based upon my own, perhaps idiosyncratic reading of--and modest contributions to--the vast literature on that era (Anderson, Shughart, and Tollison 1988, 1990; Couch and Shughart 1998, 2000, 2008; Shughart 2004, 2009). In so doing, I pay particular attention to two of Parker's queries, namely, what precipitated the Great Depression, and why did it persist in the United States longer than in any other developed country? The answer to those questions is public policy failure. In my judgment, as well as that of many other economists whose work I shall cite, the Great Depression likely originated in the monetary policy errors of the 1920s. The slump was then magnified by the Federal Reserve System's deliberate unwillingness to supply liquidity to a banking system in crisis--to perform the function of lender of last resort, the primary purpose for which it was created in the first place (Parker 2007, p. 13)--and was ultimately prolonged both by the policy experimentation of President Franklin Roosevelt's New Deal, many of his administration's initiatives plainly working at cross purposes, and by a second round of monetary policy blunders later in the decade, which interrupted incipient economic recovery and produced the so-called Roosevelt recession.

2. What Caused the Great Depression?

Numerous explanations have been offered for why the events that began in the mid- to late 1920s produced the worst economic crisis of the Twentieth Century--indeed, in the whole of U.S. history. After all, while much sharper at its onset, the recession of 1920-1921 quickly was followed by brisk growth for the remainder of the decade (Parker 2007, p. 3). The explanatory theories can be divided into the following categories: post-First World War resumption of the international gold standard, underconsumption (reinforced by so-called debt deflation), productivity shocks, and monetary policy.

These theories, I hasten to add, should be treated as complementary rather than as mutually exclusive. Complex events rarely have a single cause. As such, all may play greater or lesser roles in answering the question why the Great Depression happened when it did. But, with the exception of models based on yet unidentified productivity shocks, a fairly broad consensus currently exists pointing to the conclusion that the last of them--monetary policy, especially when embellished by the Austrian perspective--supplies an overarching framework that helps make sense of the economic events of the 1930s.

The Gold Standard

In the aftermath of World War I's bloodbath, which saw most of the belligerents abandon the gold standard temporarily, "resumption" was the order of the day. Britain, in 1925, was the first mover, but did so at an exchange rate that, set as it was at prewar parity, overvalued the pound relative to gold internationally. France also resumed its domestic currency's convertibility into gold but at an exchange rate that undervalued the franc. The resulting international gold flows--into France and out of the United Kingdom--required, under the operation of the prewar standard, French inflation and British deflation. (8)

The latter nation did in fact pay the piper by contracting its domestic money supply and, hence, experienced falling prices, rising interest rates, and sharp reductions in economic activity. (9) France, for internal policy reasons, failed to adhere to the prewar standard's principles. Steadfastly refusing to accept a rehearsal of the run up in the domestic price level it had undergone in the recent past (1921-1926)--and with its central bank prohibited from engaging in open-market operations--France opted to pursue a deflationary monetary policy in response to accumulating gold reserves. (10) The United States, which also attracted gold during the Roaring Twenties and likewise could have been expected to inflate, instead deliberately adopted the same deflationary policy both to defend the gold exchange value of the dollar and to dampen the stock market boom that Federal Reserve policymakers viewed as being fueled artificially by speculators.

Among other respected economists, Peter Temin (1976, 1989), Charles Kindleberger (1986), and, more recently, Barry Eichengreen (1992), see the seeds of the Great Depression as being sown by the resumption of the international gold standard in the mid-1920s. As James Hamilton (1987) has observed, "Returning to the gold standard could not have come at a worse time or for poorer reasons" (Parker 2007, p. 18). That conclusion is reinforced by evidence suggesting that the global pattern of reversals of domestic economic collapse coincided with the date on which individual nations left gold: "The sooner a country abandoned the gold standard, the quicker recovery commenced" (Parker 2007, p. 20):
   Britain left the gold standard in September 1931, and started to
   recover. Sweden left the gold standard at the same time as Britain,
   and started to recover. The United States left in [March] 1933, and
   recovery commenced. France, Holland, and Poland continued to [see]
   their economies struggle after the United States' recovery began as
   they continued to adhere to the gold standard until 1936. Only
   after they left did recovery start; departure from the gold
   standard freed a country from the ravages of deflation. (11)

Insofar as it was insulated from the most damaging effects of the global depression and had not joined in resumption, Spain frequently is offered as yet another example of the counterproductive constraints imposed by the international monetary regime's "golden fetters" (Eichengreen 1992; Parker 2007). (12)

Other scholars have argued, though, that it was not the operation of the interwar gold (exchange) standard per se that was the proximate cause of the Great Depression. Economic Armageddon began in the United States (Romer 1993). And because policymakers here (and in France), "who at the time together held close to 60 percent of the world's monetary gold" chose to take "deflationary paths in 1928-1929" (Bernanke and James [1991] 2000; quoted in Parker 2007, p. 19), those same contractionary forces were in short order transmitted to every country that had resumed its currency's links to the same international monetary standard. The failure of two of its pillars to adhere to the orthodox principles of gold therefore may explain why the Great Depression eventually was global in scope. But except insofar as a gold standard mentalite (Temin 1976, 1989), supposedly focused on the exchange value of the dollar and bent on staving off possible speculative attacks on it, led U.S. policymakers to ignore the predictable downward pressures on domestic prices flowing from a sharply deflationary policy stance, gold supplies an incomplete account of the events of the 1930s. Nor does the operation of international gold standard fully explain why the Great Depression started in the United States or why it persisted there for more than a decade after gold had been abandoned.

Debt Deflation

Irving Fisher (1933) sees all "great depressions," including the one that began in 1929-1930, as being driven by a vicious cycle generated by deflation's effects on business and consumer debt. As prices and nominal incomes begin fairing at the onset of a slump, the real burden of (nominally contracted for) debt rises because borrowers are obligated to repay loans in money whose purchasing power is greater than it was at the time it was lent to them. Default rates therefore predictably increase, debtor insolvency leads to reductions in aggregate demand, the price level declines even more, and the downward spiral continues as the debt burdens of yet other borrowers rise.

The effects of debt deflation were especially acute for American farmers in the late 1920s. Owing to the devastation visited on Western Europe by the war President Woodrow Wilson hoped would end all wars, export markets for U.S. agriculture products boomed after the armistice ending hostilities was signed at the eleventh hour of the eleventh day of the eleventh month of 1918. Indeed, never before and never since have the farm prices of American foodstuffs been as high as they were in 1919-1920. In response, America's farmers borrowed heavily to finance expansions in output intended to satisfy Europe's postwar demands for their produce. But when European agriculture's recovery from the Great War largely was complete in 1929, U.S. export markets shrank and earlier expansions in production capacity no longer could be justified. But payments on the debt incurred to finance that expansion were in many cases still owed. As farm prices fell, that debt became increasingly burdensome and ultimately forced many farmers over the financial precipice into economic ruin, with predictable consequences for agricultural lenders. (13)

Bernanke ([1983] 2000) updates and extends Fisher's (1933) hypothesis by looking at the effects of debt deflation on bank balance sheets. In what is now called the "credit view" (Parker 2007, p. 16), Bernanke argues that debtor default on bank loans caused the values of lenders' asset portfolios to deteriorate, threatened their own solvencies, and forced them to shift toward Treasury securities and other relatively "safe" investments. Foreshadowing a feature of today's financial crisis, that reallocation of potentially loanable funds toward treasuries and other government-guaranteed debt made it more difficult for private borrowers to obtain the credit they needed to finance spending that otherwise would have boosted aggregate demand.

Financial intermediation consequently was short-circuited during the Great Depression, according to Bernanke's theory. Avoidance of credit risk--the unwillingness or inability of lenders to parse the credit worthiness of prospective borrowers--resulted in a situation in which households, small businesses, and farmers were unable to obtain loans at terms that would have justified their spending plans. Pessimistic expectations of persistently falling prices and nominal incomes may have contributed to the widening credit crunch (Parker 2007, p. 17). So, too, did the behavior of the banking system's customers: as greater pressure was placed on the financial conditions of those institutions, depositors rationally began withdrawing their funds. The shift away from deposits and toward currency reduced bank reserves and, by reducing both the money multiplier and the velocity of money, lessened the potential effectiveness of an offsetting policy of monetary expansion, had it been tried (Romer 1993, p. 32).

At bottom, however, debt deflation would not have been an issue in 1929-1932 but for the "Great Contraction" in the U.S. money supply that began when the Federal Reserve raised the discount rate in three steps from 3.5% in February 1928 to 5% in July, and at the same time sold more than $480 million worth of government securities (Friedman and Schwartz 1963; Couch and Shughart 1998). Indeed, Bernanke ([1983] 2000, p. 42) considers the credit view to be a hypothesis that complements the work of Friedman and Schwartz (1963) rather than being one that offers "a complete explanation of the Great Depression." Productivity "Shocks" Resumption of the international gold standard, debt deflation, and monetary policy play limited roles in recent work by economists loosely associated with the University of Minnesota that explores the origins of the Great Depression. These scholars (e.g., Chari, Kehoe, and McGrattan 2002; Cole and Ohanian 2002, 2004) conclude, based on estimates of dynamic, stochastic general equilibrium (DSGE) models of the U.S. economy during the period running from 1929 to 1933, years which saw real gross domestic product per adult decline by as much as 39% below trend and hours worked by 27% (Cole and Ohanian 2004, p. 781), that the slump was caused by exogenous factors that "look like" taxes on labor, taxes on investment, and productivity (Chari, Kehoe and McGrattan 2002, p. 22). (14) The upshot is that these researchers "suspect [that] some negative shock to productivity contributed to the initial downturn" (Parker 2007, p. 23).

The sources of such potential negative productivity shocks have yet to be identified precisely. As a result, the DSGE methodology has not escaped criticism; some of the critics object in principle to applying general equilibrium models to a period when the global economy obviously was in a state of disequilibrium (Parker 2007, p. 24). (15) In an additional contribution to the DSGE literature, however, Christiano, Motto, and Rostagno (2003, p. 1119) examine the explanatory powers of eight possible shocks, including one that represents an indirect effect (a la Bernanke [1983] 2000) of monetary contraction, namely "the shift away from privately intermediated liabilities, such as demand deposits ..., and toward currency." Such a money-demand shock is the only candidate that survives empirical testing. Moreover, after conducting a counterfactual exercise in which the Federal Reserve is assumed to have responded to the initial shock by supplying liquidity to the banking system, the authors conclude that the Great Depression would have been milder (Christiano, Motto, and Rostagno 2003, p. 1169). (16)

Monetary Policy

A recession already was underway in the United States by late summer of 1929, a slowdown that in their chapter titled "The Great Contraction" Friedman and Schwartz (1963) attribute to the Fed's reversal, in February 1928, of the easy-money policy it had adopted in the wake of Britain's return to the gold standard in 1925. Apparently concerned that money supply expansion had contributed to the stock market's boom by furnishing banks with reserves that often were used to underwrite "call loans" (or "brokers' loans") to "speculators" who took advantage of them to finance new equity purchases collateralized by the values of the securities they bought (Williams 1994, pp. 125-6), (17) the Fed began tightening.

As mentioned earlier, it did so by raising the discount rate in three steps from 3.5% to 5% between February and July 1928, its highest level since the previous recession (Parker 2007, p. 5) and, over the same period, sold nearly $500 million worth of government securities on the open market. According to Friedman and Schwartz (1963, p. 290), the Fed's policy initiatives of 1928 were doubly lamentable: "they clearly failed to stop the stock market boom," at least initially. "But they did exert steadily deflationary pressure on the economy." As the supply of money fell by 35%, the general level of prices declined by about one-third (Parker 2007, p. 13). The bulls thus eventually were castrated. After peaking on September 3, 1929, at 381.17 and then gyrating up and down until October 10, when the Dow Jones Industrial Average stood at 352.86, the market began a continuous slide downward. It broke on "Black Thursday," October 24, when 13 million shares were traded (the daily volume historically had averaged four million shares). The Dow fell by 28 points that day, but much worse was to come. On "Black Tuesday" (October 29), the market declined so precipitously that all of the previous year's gains were wiped out in a single day (Hughes and Cain 1994, p. 439). It eventually reached bottom in July 1932, when the Dow settled at 41.22 (Williams 1994, p. 134), more than 96% off the previous high.

In addition to eventually bursting what it considered to be a speculative stock market bubble, the Fed's contractionary initiatives of 1928 had predictable effects on interest rates. Nominal rates fell--market evidence that policy makers erroneously interpreted as demanding further tightening--but real interest rates spiked. Romer (1993, p. 27) calculates that real rates on commercial paper "rose ... from 5.6 percent in the fourth quarter of 1927 to 9.5 percent in the fourth quarter of 1928." She, in fact, credits the U.S. economy's moribund state in the summer of 1929 to those dramatic increases in real interest rates, which chilled private business's incentives to invest in plant and equipment and prompted consumers to defer purchases of durable goods.

Contractionary monetary policy thus explains, as no other theory by itself is capable of doing, the stock market's crash in October 1929, the collapse in private business investment, the corresponding rise in unemployment rates, the decline in personal consumption expenditures, and the atmosphere of panic that gripped depositors and which thereby contributed to the failures of thousands of banks and the disruption of their role as intermediators of financial transactions between borrowers and lenders. (18)

What accounts for the Fed's evident monetary policy failures? One answer is the central bank's aforementioned adherence to a gold standard mentalite, and its attempts to defend the U.S. dollar's parity with gold, to avert speculative attacks on it, or both. Another explanation is found in the Fed's inability to distinguish between reductions in nominal interest rates and increases in real rates. Yet another explanation attributes the Fed's inaction in the face of economic collapse to the untimely death of Benjamin Strong, the Governor of the New York Fed and until then its dominant figure, whose passing in October 1928 created a power vacuum that shifted proximate responsibility for monetary policy from New York to the Board of Governors in Washington, D.C., among whom no one apparently was prepared to take charge (Friedman and Schwartz 1963, pp. 413-9). But such a "devil's theory" of history ignores important institutional and political details. (19)

Another explanation focuses on the Fed's adherence to the so-called real bills doctrine, which at the time supposedly riveted it to the principle that, because bank loans should be made only for the purpose of accommodating the needs of business and should be self-liquidating (i.e., to support investment in plant and equipment justified by expected returns); any other extensions of credit would merely be inflationary and thus ought actively to be discouraged (Meltzer 2003, p. 22). But the Friedman-Schwartz (1963) hypothesis, which suggests that the Great Depression was triggered by monetary contraction, still remains unbowed by more recent attempts to undermine it.

The Austrian Perspective

Virtually all students of the Great Depression agree that the rapid expansion of bank credit overseen by the Federal Reserve System during the 1920s was both unprecedented and ultimately unsustainable. (20) Economists associated with the Austrian School (e.g., Hayek [1933] 1966, [1935] 1967; Mises [1934] 1981; Robbins [1934] 2009; Phillips, McManus, and Nelson 1937; Anderson [1949] 1979; Rothbard 1975), (21) adopt the same inflationary period as their point of departure for analyzing the events that precipitated the U.S. economy's near total collapse in 1929-1933. But unlike their Anglo-American monetarist brethren, the Austrians do not accept the quantity theory of money, at least in its simplest form; they instead emphasize that the Fed's easy money policy had real effects, causing "maladjustment," a serious misallocation of resources away from the production of lower-ordered goods toward that of higher-ordered goods, specifically from consumption goods to capital (or producers') goods.

The key link in the chain of reasoning here is that the expansion of available credit led banks to enlarge their purchases of bonds floated by private businesses to finance purchases of plant and equipment, thereby raising bond prices and forcing down their long-term yields. As long-term interest rates fell, new bond issues became even more attractive for borrowers. This, according to Phillips, McManus, and Nelson (1937, p. 7), "result[ed] in an investment boom which effect[ed] a change in the structure of production in favor of a more rapid growth of capital goods relative to the production of consumption goods." And, just as importantly, that credit-supported investment snowball was not counterbalanced by a reduction in consumption spending (greater personal saving). The consequence was "overcapitalization." The capital market effects of the Fed's easy money policy spilled over into other sectors of the economy. As rates of return on corporate paper fell, investors sought higher returns elsewhere--mainly in the stock market and in real estate: "[A] constructional boom of previously unheard-of dimensions ... developed, first in Florida, but soon was transferred to the urban real estate market on a nation-wide scale; the stock market [also] became the recipient of the excessive credit expansion" (Phillips, McManus, and Nelson 1937, p. 81). Investments in plant and equipment and real estate largely are irreversible in the face of falling prices. And so, when the marginal efficiency of capital eventually declined and investment actually began decreasing, "depression ensued" (Phillips, McManus, and Nelson 1937). In the colorful words of Lionel Robbins ([1934] 2009, p. 43), the Great Depression resulted from "the wreckage of false expectations." Liquidation was the proper response, a point of view expressed trenchantly by Treasury Secretary Andrew Mellon, who advised President Hoover to "liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate." Such actions would, according to Secretary Mellon, "purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people" (quoted in Parker 2007, p. 10). (22)

But the possibility of such salutary market-based adjustments was short-circuited by Hooverian and Rooseveltian policies that sought to ameliorate the effects of economic calamity by propping up wages and prices artificially. Those actions were bound to fail in the face of the Fed's reversion to tight money.

Other Theories of the Origins of the Great Depression

Building on the work of Temin (1976, 1989), Romer (1993) documents the spectacular decline in consumption expenditures that followed the stock market's crash in the fall of 1929. Spending fell much more sharply than it had during either of the interwar period's two other slumps. Based on that evidence, Temin and Romer both argue that the collapse in share prices was instrumental in turning what otherwise would have been a garden-variety recession into something far worse. The sag in consumption, so severe as to be labeled "under-consumption," that represented Main Street's reaction to events on Wall Street was not in this view necessarily caused by the effects of falling share prices on wealth (see footnote 3), but was instead the result of greater uncertainty and the proliferation of pessimistic expectations--a destruction of consumer confidence--provoked by the stock market's freefall and by significant increases in its volatility (Romer 1992). According to Romer (1993, p. 31):
   The effect of this uncertainty was that consumers and producers
   immediately cut their spending on irreversible durable goods as
   they waited for additional information about the future. This
   effect is seen most clearly in the fact that department store sales
   and automobile registrations declined precipitously in November and
   December 1929, while grocery store sales and ten-cent store sales
   actually rose; this is exactly what one would expect if consumers
   were shying away from irreversible goods but had not [yet]
   substantially changed their point estimates of future income.

Other observers of the period see the Great Depression as being almost biblically ordained. (23) In that perspective, the collapse was an inevitable sequel to the economy's robust expansion during the Roaring Twenties. The theory goes that prosperity, stoked perhaps by Keynesian "animal spirits" or Greenspanian "irrational exuberance," had run its natural course and the cyclical nature of market economies therefore demanded a downturn.

Additional explanations blame President Hoover's signing of the protectionist Hawley-Smoot Tariff Act of 1930, which increased import duties above and beyond the "forbiddingly high levels" established by the Fordney-McCumber Act of 1922 (Kennedy 1999, p. 49), (24) as well as his administration's substantial hikes in income taxes in June 1932, intended to help balance the federal budget (Parker 2007, p. 8), with being important contributors to the economic collapse that already had begun.


Economists and other social scientists may never be able to explain fully why the Great Depression happened when it did or why it initially was so severe. Numerous hypotheses have been advanced, as we have seen, and each of them contributes important insights into the causes of the macroeconomic calamity in which most of the world was mired in 1929-1933. If, however, one is forced to adopt a monocausal theory, it must center on the actions of America's central bank, which presided over an extraordinary expansion in bank credit in the mid- to late 1920s and then took the punch bowl off the table.

For the purposes of this article, though, the key question is, why did the Great Depression last longer in the United States than it did in any other nation? The answer, as laid out in the next section, is presidential politics.

3. The Political Economy of the New Deal

The United States was the first nation to suffer the dire effects of the Great Depression but was among the last of the globe's major economies to recover from it. While upturns from the slump's bottom began at about the same time worldwide (1933), industrial production in America was still below its 1929 trend in 1937. Indeed, as we shall explain below, the United States did not recover from the Great Depression until after the Second World War.

Christina Romer (1993, p. 24), who dates national recovery on the basis of "the year in which industrial production reached its pre-Depression peak," writes that
   it occurred in 1932 for New Zealand; 1933 for Japan, Greece, and
   Romania; 1934 for Chile, Denmark, Finland, and Sweden; 1935 for
   Estonia, Hungary, Norway, and the United Kingdom; 1936 for Germany;
   and 1937 for Canada, Austria, and Italy. The United States,
   Belgium, Czechoslovakia, France, the Netherlands, and Poland did
   not recover before the end of the sample in 1937. (25)

The important question is why the United States lagged so far behind, especially when viewed in light of the massive economic "stimulus" spending Franklin Delano Roosevelt (FDR) and his "Brains Trust" oversaw, anticipating that it would ensure attainment of at least the first two of the New Deal's three stated goals of "relief, recovery and reform." Federal government spending grew by 136% between 1932 and 1940 (Wallis 1984, p. 142). (26) All told, about $45 billion eventually was spent by the New Dealers, a figure just $11 billion short of total U.S. Gross National Product (GNP) in 1933 ($56 billion) and nearly half of its 1928 GNP of $97 billion (Hosen 1992, p. 268). (27)

Why Did the Great Depression Last so Long in the United States?

The U.S. economy did in fact begin to revive in 1932-1933 and continued to do so quite robustly until May 1937, when it entered into a 13-month-long recession following the Federal Reserve's ill-timed decision to raise commercial banks' ratios of required reserves to deposits. (The Fed committed that spectacular blunder in order to soak up the "excess" reserves it thought banks were husbanding rather than lending them to consumers and businesses, thus hampering the forces of recovery then evidently well underway.) (28) Except for the "Roosevelt recession" of 1937-1938, (29) U.S. GNP rose, in the four years between 1933 and 1937 in real terms at an average annual rate of 10%, and it did so again "between the recession of 1938 and the outbreak of World War II in the United States in December 1941" (Romer 1993, p. 35), at which time "Dr. Win-the-War" replaced "Dr. New Deal" as the prescribed medicine for returning the U.S. economy to the growth path it had been on prior to the Great Depression's onset (Biles 1994, p. 148).

Romer (1993) credits the U.S. economy's recovery after 1933 to the Fed's resumption of an easy money policy following FDR's abandonment of gold in March of that year: She (Romer 1993) reports that the stock of high-powered money increased by 12% between April 1933 and April 1934 and by another 40% from then until April 1937. Nominal interest rates fell modestly in response to monetary expansion, but because "actual and expected inflation rose substantially," real interest rates plummeted and "interest-sensitive spending, such as construction spending and consumer purchases of durable goods," recovered quickly thereafter (Romer 1993, p. 36; also see Romer 1992). (Steindl 2007 presents evidence, however, that the return to easy money failed to produce anything like a large increase in interest-sensitive spending, especially so in the construction industry.)

According to Friedman and Schwartz (1963), "the most notable feature of the revival after 1933 was not its rapidity but its incompleteness" (quoted in Parker 2007, p. 27). U.S. "output remained substantially below normal until about 1942" (Romer 1992, p. 760), when the nation again was in the midst of global war. Unemployment rates, which had stood at 25% in 1933, still hovered around 10% "as late as 1941" (Romer 1992). (30) The New Deal obviously had not achieved its objectives. (31)

Why not? One answer focuses attention on the counterproductive policies of President Roosevelt's "First New Deal" (1933-1935), which proposed "to cure the depression, itself a catastrophic decline of real output and employment, by cutting back on production" even further (Higgs 1987, p. 174). Exhibits A and B in support of this explanation are the Agricultural Adjustment Act and the National Industrial Recovery Act (NIRA), both of which were passed by Congress during FDR's (in)famous "First Hundred Days" in office. The former statute was intended to prop up agricultural prices and the incomes of farmers by supplying incentives for reducing the outputs of agricultural commodities, including payments for destroying existing crops and livestock herds, as well as for limiting acreages that could be devoted to future productive agricultural use. The latter law created the National Recovery Administration (NRA) and authorized that agency to, among other things, certify industry "codes of fair competition," written by industry members themselves, binding them to cartel-like agreements restricting outputs, allowing privately owned business firms to avoid engaging in "cutthroat" price competition and, given protection from competitive market forces, inducing them, it was hoped, to share with workers the larger profits they could anticipate either by raising wages or by at least not cutting them. That last objective was reinforced under the NRA by provisions that established minimum prices and minimum wages (Cole and Ohanian 2004, p. 784) and afforded new organizational and bargaining rights to labor unions, which increased their memberships dramatically. (32)

Although both laws eventually were for different reasons later declared unconstitutional by the U.S. Supreme Court, (33) the high-industrial-wage and high-farm-price policies of the First New Deal carried over to the Second New Deal, announced during FDR's State of the Union address to Congress on January 4, 1935, which signaled a dramatic leftward shift in administration policies (Couch and Shughart 1998, p. 97). The legislative fruits of the Second New Deal included the Works Progress Administration (WPA), which replaced the Federal Emergency Relief Administration with a new agency that would provide taxpayer-financed jobs for some 3.5 million able-bodied Americans; the Social Security Act, creating a system of pay-as-you-go pensions for older citizens, thereby inducing them to exit the labor force and thus to "create" jobs for still unemployed younger workers; and the National Labor Rights ("Wagner") Act, which conferred even greater bargaining power on employees than they had enjoyed under the defunct NIRA.

The leftward shift in administration policy was symbolized by FDR's reaction to what he called a "strike of capital" (Moley 1939, p. 372)--the apparent unwillingness of business owners to invest in new plant and equipment that was in his view impeding economic recovery. In a speech delivered to Congress on June 19, 1935, the president included tax reform on his "must" list for the legislative program of the Second New Deal. He asked for "very high taxes" on large personal incomes, for "stiffer inheritance taxes," for "a graduated corporate income tax and taxes on intercorporate dividends" (Kennedy 1999, p. 275). The tax bill that eventually emerged from Congress imposed a top marginal federal personal income tax rate of 79% on incomes over $5 million, a rate that applied to just one taxpayer, John D. Rockefeller, Jr. (Kennedy 1999, p. 276). Thus did the patrician Franklin Roosevelt earn the label "traitor to his class" (Kennedy 1999; Brands 2008). (34)

The so-called capital strike coincided, perhaps not by happenstance, with a strike by a second essential factor of production. Passage of the Wagner Act energized the organizers of labor unions, who demonstrated their new-found bargaining power by launching a series of sit-down strikes, a tactic of occupying factories and other production facilities and refusing to work unless their demands were met. In contrast to earlier periods of labor unrest, "President Roosevelt refused to use [federal] force to eject the sit-down strikers," and his temerity was echoed by state and local officials, who likewise held their hands in enforcing the laws of trespass (Higgs 2006, p. 14). Although initially sympathetic to the labor cause, "property-minded citizens were scared by the seizure of factories, incensed when strikers interfered with the mails, vexed by the intimidation of nonunionists, and alarmed by flying squadrons of workers who marched, or threatened to march, from city to city" (Leuchtenburg [1963] 2009, p. 242) waving a revolutionary bloody shirt.

Cole and Ohanian (2002, 2004) and Chari, Kehoe, and McGrattan (2002), among others, see the Great Depression's staying power as being largely explained by the labor policies of the New Deal, exemplified by the NRA and the Wagner Act, which resulted in persistently high real wages and, hence, an inability of markets to absorb the legions of workers who remained trapped in the ranks of the unemployed until America's entry into the Second World War. (35) Robert Higgs (1997) offers a broader account of the events of the 1930s based on the uncertainty FDR's policies fostered amongst the owners and managers of private business enterprises, whose incentives to invest in job-creating ventures were chilled by the administration's increasingly strident anticapitalist rhetoric and its decidedly unmarket-friendly policy initiatives. (36)

Those explanations offer important insights into the persistence of the Great Depression. However, I want to suggest that the answer to the question at the head of this subsection can be found in the political imperatives of the New Deal. FDR was elected to the White House in popular and Electoral College vote landslides in November 1932. But in order to be assured of reelection in 1936, he had to assemble a new and hopefully permanent Democratic Party majority comprised of urbanites, labor union members, the downtrodden and voters in electorally critical "swing" states. His success in doing so is described in what follows.

The Vote Motive

Scholarly work on the political economy of the New Deal begins with Leonard Arrington's (1969) discovery of until then ignored public documents, produced by an obscure agency known as the Office of Government Reports. Those documents were "prepared in late 1939 ... for use ... during the presidential campaign of 1940" to showcase the accomplishments of the multifarious programs FDR had launched to counteract the economic and social effects of the Great Depression (Arrington 1969, p. 311). This invaluable set of reports, one for each of the then-48 U.S. states, supplies information on the federal government's expenditures under all major New Deal programs from 1933 to 1939. It is a treasure trove that economists and historians have been plundering ever since.

Arrington (1969) himself conducted a preliminary analysis of the data he had unearthed, comparing on a per capita basis the cross-state distribution of New Deal emergency relief spending. He found, somewhat to his own surprise, that such spending varied greatly across the states and, moreover, that New Deal money appeared to have flowed disproportionately to the western United States. That pattern of allocations seemingly was at odds with President Roosevelt's repeated characterization of the South as the nation's number one economic problem (Couch and Shughart 1998, p. 155). In a subsequent paper, Arrington (1970) reached the same conclusion. He calculated that "the average loans and expenditures of all New Deal economic agencies during the period 1933 to 1939 were $291 per capita, but they varied from a high of $1,130 per capita for Nevada to a low of $143 per capita for North Carolina" (Arrington 1970, p. 344).

Examining more closely the cross-state allocation of New Deal spending targeting the agricultural sector, Arrington found that the smallest benefits were paid to farmers in the four states where average farm incomes were lowest in 1932 (Alabama, Mississippi, Georgia, and South Carolina), while those in the four states with the highest average farm incomes the same year (California, Connecticut, Massachusetts, and New Jersey) received the most generous payments.

The task of explaining the observed disparity in the cross-state distribution of New Deal spending in a more systematic way than Arrington (1969, 1970) has occupied the attention of scholars for the past 50 years. Don Reading (1973) was the first economist to take up the challenge. Estimating an econometric model with per capita federal spending aggregated across all New Deal programs and pooled over the years from 1933 to 1939 as the dependent variable, Reading reports evidence that, other things being the same, more money flowed to states where a greater percentage of the land was owned by the federal government, where there were more miles of highways per person in 1930, (37) and where declines in per capita personal incomes between 1929 and 1933 had been the largest, a control variable that obviously speaks to the New Deal's stated purposes of providing relief and promoting recovery. On the other hand, the following explanatory variables were not found by Reading to be statistically significant determinants of the allocation of New Deal spending across the U.S. states: per capita income in 1933, the unemployment rate in 1937, the percentage of tenant farmers in 1930, and the fraction of the 1930 population that was black. Along with reporting the results of the first empirical test of the cross-state distribution of New Deal expenditures, perhaps Reading's most important contribution to the literature was to speculate that states which supported FDR in the 1932 election might have been rewarded with federal largesse while states that failed to jump on the president's bandwagon were punished by having relief withheld (Reading 2973, p. 804).

Observing that "the New Deal years offer a laboratory for testing the hypothesis that political behavior in a democracy can be understood as a rational effort to maximize the prospects of electoral success," Gavin Wright (1974, p. 30) added presidential politics to the equation. In addition to entering independent variables consistent with those suggested by the work of Reading--the percentage of a state's population living on farms, the change in per capita state income between 1929 and 1932, the number of people in a state on general relief rolls, the state unemployment rate in 1937, and the fraction of state land owned by the federal government, Wright constructed two measures of a state's importance to FDR's strategy for reelection to the presidency in November 1936. One of these variables was a "political productivity index" based on state presidential voting patterns from 1888 to 1928. That index, calculated as the average difference between the popular vote shares of the Democratic Party's presidential candidates and 0.5, provided Wright with a way of gauging the competitiveness of races for the White House over time. He hypothesized that New Deal spending would be more productive politically--would generate more votes for the incumbent--in states where presidential races tended to be "close" than in states where the Democratic Party's share of the popular vote historically had been either large or small. As a further test of that hypothesis, Wright also computed and entered as a separate explanatory variable the standard deviation of the Democratic Party's presidential vote share over the election cycles from 1888 to 1928. (38) Like Reading before him, Wright estimated the marginal effects of his independent variables on per capita New Deal spending aggregated across all of its emergency relief programs and also pooled over the full 1933-1939 period. In a baseline regression, he finds that a state's farm population, the drop in per capita personal income experienced between 1929 and 1932, and the number of cases on state relief rolls in 1932 collectively explain only 17% of the variation across states in New Deal spending per capita and, moreover, only the estimated coefficient on relief cases is significantly different from zero. His two political variables, when entered along with farming populations (not statistically significant), explained nearly 59% of the cross-state variation in expenditures. Estimates of a fuller model that includes all of Wright's variables explain more than 74% of the variation in the dependent variable, with the marginal effects of farm populations (entering with a negative and significant sign), and federal land ownership plus the two political variables entering positively and significantly.

Wright's seminal contribution to the literature documenting political influences on New Deal spending across the U.S. states was followed by a large number of studies that extended and refined his analysis. As summarized by Price Fishback (2007, p. 407), himself an important contributor to the modern literature, "nearly every [follow-on] study finds that political considerations were important to the Roosevelt administration." John Joseph Wallis (1984) built on the prior work of Reading and Wright by asking whether policy rules requiring that states "match" contributions from the federal government in order to benefit from many of the New Deal's spending programs could explain the otherwise anomalous cross-state distribution of federal funds. His answer is a qualified "yes": other things being the same, state spending per capita aggregated over the years 1937 to 1939 is negatively, but not statistically significantly, related to federal New Deal spending per capita. Among other things, Wallis's (1984) evidence does, however, confirm the statistical significance of Wright's (1974) presidential political productivity index in explaining FDR's spending priorities.

Wallis (1987) later extended his empirical analysis in important ways by estimating employment rates and real incomes per capita for each of the 48 U.S. states during each year of the Great Depression and then including those new variables in regression equations designed to explain the economic and political determinants of the geographic distribution of New Deal spending. The construction of annual state-specific estimates of employment and income allowed Wallis and later researchers to take account of both cross-sectional and time-wise variations in the data. His expanded dataset, comprising 336 observations (48 states times seven years), reproduced some of the results reported in prior work: federal emergency relief spending per capita was more generous for states where larger fractions of the population were living on farms, where more of the land was owned by the federal government, and where, on Wright's measures, those dollars were more productive politically, i.e., where presidential vote shares historically had been closer and more volatile. Holding those variables (plus the drop in per capita income from 1929 to 1933) constant, Wallis also found that less federal aid was distributed to states where employment fell further and recovered less quickly to precrash levels, a result inconsistent with a "need-based" explanation of New Deal spending.

The employment variable did, however, enter with a positive (but insignificant) coefficient except when Wallis included the lagged value of the dependent variable on his regression equation's right-hand side. Also contradicting explanations based on need, the distribution of emergency relief funds turned out to be positively and significantly correlated with state per capita income. Wallis (1987, p. 518) again sees matching as the culprit: "The positive coefficient on income, and perhaps employment, reflects the fact that high income states spent more on the types of programs for which they could receive national matching grants." Ideological opposition to the New Deal, which was most vitriolic in the South, could, in Wallis's view, also have played a role in explaining why some states received more federal aid per capita than others: "an individual state could effectively block a relief program within its boundaries simply by refusing to participate financially" (Wallis 1987, p. 514). In short, states that were for political reasons unwilling, or for financial reasons unable, to raise the necessary matching funds simply lost out in the allocation of New Deal spending.

But in later work, Couch and Shughart (1998, 2000) demonstrate fairly conclusively that Wallis's matching hypothesis lacks explanatory power. They uncovered in the Congressional Record information showing the actual percentages of total project costs state governments had to contribute in order to sponsor projects funded by the WPA. They find, contra Wallis, that in order to qualify for federal dollars the cost shares demanded of states that had experienced the Great Depression's most severe effects actually were larger, on the average, than were those where economic "need" was less urgent.

In any case, the empirical salience of presidential politics, alternatively measured as state-specific popular vote shares for FDR in 1932, the number of electoral votes per capita in play in a state and voter turnout rates in national elections, is quite robust. It has been confirmed in studies that examine the distribution of relief funds under specific programs of the New Deal (for evidence on agriculture and public works, see, e.g., Couch and Shughart 1998, 2008), and in those which analyze spending and voting data disaggregated at the county level (Fleck 1999a, b, c; Fishback, Kantor, and Wallis 2003). Some complementary evidence has been reported (Anderson and Tollison 1991) that members of key congressional committees and party leaders in Congress "were effective at helping their constituents obtain more New Deal funds" (Fishback 2007, p. 407). Nevertheless, the jury is still out on the question whether the Roosevelt administration targeted voters in "swing" states who might be decisive in 1936 or instead rewarded those in states that had been reliably loyal to the Democratic Party. (39)

Virtually all studies of New Deal spending across the states find that various measures of economic "need" also are statistically significant determinants of FDR's spending priorities. As Couch and Shughart (1998) report, however, the "need" variables by themselves explain much less of the cross-state allocation of emergency relief spending than do the political variables. If that evidence subsequently is confirmed, the inevitable conclusion to be drawn from it is that the Great Depression lasted longer in the United States than it did in any other nation because President Roosevelt exploited the extraordinary powers granted to him by the electoral mandate he won in November 1932, less with an eye on saving capitalism from itself than on guaranteeing his own reelection in November 1936.

A Short Digression on the Politics of the WPA

In an editorial titled "Not the New Deal," published in the New York Times on September 16, 2005, Paul Krugman, 2008's Nobel laureate in economic science, charged that the federal government's response to the economic devastation visited on America's Gulf Coast by Hurricane Katrina had, in addition to its obvious slowness and ineffectiveness, been plagued by corruption and abuse at the local, state, and national levels. (40) He argued that in contrast to Democrat politicians, Republicans, who then controlled the White House, lacked the capacity to disburse public resources effectively in response to economic emergencies. That conclusion, he asserted, is made evident when compared to the high principles that guided the Roosevelt administration's response to the disaster of the Great Depression: "The New Deal made almost a fetish out of policing its own programs against potential corruption. This commitment to honest government ... reflected a political imperative. F.D.R.'s mission in office was to show that governmental activism works. To maintain that mission's credibility, he needed to keep his administration's record clean." Krugman asserts that President Roosevelt established a governmental oversight process that effectively monitored and controlled one of the New Deal's brightest ornaments, the WPA.

For many people the WPA is synonymous with the entire New Deal and, hence, should serve as an exemplar of it. If so, the historical record shows that the agency's operations were influenced heavily by politics and that it was plagued by corruption. (41) That conclusion is supported by the findings of the Senate Special Committee to Investigate Unemployment and Relief (Byrnes Committee). The committee was formed in response to complaints that had "arisen as to the lack of uniformity in the treatment of the different States by the Federal Government in the matter of sponsors' contributions to the cost of work-relief projects. Discretion has been left to the Chief Executive to decide how much of the cost of any project should be contributed by the sponsor." The formula by which such distributions were made continued to be an administration secret. Subsequent contributions to the literature suggest, among other things, that funding for public works projects was timed to coincide with the election cycle: "WPA employment reached peaks in the fall of election years" (Wright 1974, p. 35); in states where primary elections were more important than general elections to electoral success, such as Florida and Kentucky, "the rise of WPA employment was hurried along in order to synchronize with" them (High 1939, p. 62). (42)

More damaging to Krugman's conjecture is evidence that the WPA was a hotbed of political corruption. Michigan's governor, for example, was forced to resign as chief of his state's organization for that very reason. His replacement later was accused of encouraging social workers to channel aid to certain individuals for partisan purposes. Governor William Langer of North Dakota was accused of misusing WPA funds, found guilty, and later served time in prison. Ohio governor Daley utilized the same work-relief program to build a personal political machine so disregardful of democratic principles that the federal government eventually seized control of the WPA's programs there. In the state of Washington, "the WPA administrator became involved in politics so deeply that he allowed WPA workers on the job to be assessed for contributions to local Democratic organizations" (Charles 1963, p. 184). A local WPA administrator in Pennsylvania was advised in a letter sent to her by Indiana County's Democratic County Party Committee that she must contribute $27 to the party's coffers or jeopardize her reappointment. Also in Pennsylvania, evidence exists that "eighteen relief workers on a [WPA] project in Laverne County were transferred to a project some forty miles from their homes because they wore Republican party buttons and registered as Republicans" (MacMahon, Millet, and Ogden 1941, p. 285).

The Barkley-Chandler primary race for the Kentucky Democratic Party's nomination to a seat in the U.S. Senate supplies a particularly egregious example of raw politicking. Incumbent U.S. Senator Alben Barkley, who eventually won both the nomination and the 1938 general election, was pro-New Deal and thus was the Roosevelt administration's favored candidate. The (mis)use of WPA funds for partisan political purposes during the primary campaign became so obvious that Judge Brady M. Stewart, state campaign manager for Barkley's challenger, Governor Chandler, fired off an angry letter to President Roosevelt, charging that

the WPA in Kentucky had been converted into an out-and-out political machine, dedicated over and above all other considerations to reelecting Senator Barkley. Those with starving mouths to feed were forced to surrender their one remaining privilege of choosing for whom they shall vote; otherwise, their dependants must go hungry and naked.

Persons are being employed who do no definite work, but are instructed to spend their entire time in political activity. Practically every Federal project is top heavy with foremen, part of whom confine their time and attention to keeping certain men definitely in line for Senator Barkley.... (U.S. House of Representatives 1939, p. 7239)

As indicated by the source for this extract from Judge Stewart's letter to FDR, the irregularities in Kentucky led to the appointment of a special congressional committee to investigate the charges, on the basis of which it was concluded that "WPA officials and employees ... had been active in the solicitation of contributions to a campaign fund for Senator Barkley and that a systematic canvas of WPA employees had been made to determine their preference in the senatorial campaign" (MacMahon, Millet, and Ogden 1941, p. 284). Charles (1963) supplies many other examples of improprieties.

When Congress enacted the Emergency Relief Appropriation Act of 1935, thereby authorizing the creation of the WPA, it approved $4 billion in new federal spending to fund public projects that would employ some 3.5 million unemployed Americans. Additional funding for the WPA was authorized in Emergency Relief Appropriation bills passed in each of the next four years: $1.881 billion in 1936, $1.525 billion in 1937, $2.33 billion in 1938, and $1.477 billion in 1939 (Office of Government Reports 1939, p. 77). Such substantial sums of money, spent hurriedly, as the crisis conditions seem to have demanded, created opportunities for waste, employee shirking (one indelible image from a critic of the WPA shows a worker leaning on a shovel), and other forms of abuse, such as financing projects of questionable merit (the proverbial boondoggle). That was to be expected. But it is evidence pointing to the conclusion that the WPA was, at least in some states, exploited for partisan political gain which leads one to doubt assertions that FDR and the New Dealers were committed to "honest government." 4. What Ended the Great Depression?

When asked what ended the Great Depression in the United States, the economists interviewed by Randall Parker (2002, 2007) are unanimous in answering that the nation finally returned to its precrash growth path soon after Pearl Harbor, when America declared war on Japan, and Adolph Hitler responded by declaring war on the United States. Recovery, as we have seen, got underway soon after the United States abandoned gold in March 1933, and the Federal Reserve System, no longer shackled by "golden fetters," reverted to an easy money policy that it followed until 1937, when it reversed course and plunged the nation into recession once again. Economic recovery then resumed, but, according to most observers, it took global war and wartime emergency expenditures to at long last restore GNP and employment to levels not seen since 1928-1929.

Such is the conventional wisdom, even among professional economists. But in a series of books and papers, Robert Higgs (1987, 1992, 1997, 2006, 2007) and Gene Smiley (2002) argue that it is not supported by the evidence. (43) America's entry into World War II assuredly "solved" the nation's unemployment problem: between mid-1940 and mid-1945, the "uniformed, active-duty ranks of the U.S. armed forces increased by 11.6 million persons.... " And "that increase alone was more than sufficient to account for the simultaneous reduction of [civilian] unemployment by 7.9 million persons." At the same time, the number of civilians employed by the armed forces rose by 2.3 million, and private employment in war-related supply industries, including the iconic "Rosie the Riveter," increased by 10.7 million (Higgs 2007, p. 442). All together, America's total (civilian plus military) labor force grew from 55.9 million persons in 1940 to 65.7 in 1945; only 900,000 persons remained unemployed in that last year (Higgs 2007, p. 443), yielding a national unemployment rate of roughly 1.4%.

While millions of men and women were being outfitted with uniforms or shifted into jobs supporting the war effort, "total nonmilitary employment actually fell by 7 million" (Higgs 2007; emphasis in original). And most of those who ended up on active duty in the U.S. Army, Navy, or Marine Corps did so involuntarily: "Of the sixteen million who served in the armed forces at some time during the war, more than 10 million, or about 63 percent, were drafted outright" (Higgs 2007, p. 442).

Wartime spending by the federal government was, to the economists interviewed by Parker and to many other commentators, decisive in bringing the Great Depression to an end. Starting in 1940 at $9.5 billion, federal outlays eventually grew to $92.7 billion in 1945, by then comprising almost 44% of officially measured GNP (Higgs 2007, p. 443). But looking only at the levels of public spending and U.S. GNP commits the error of ignoring their changing compositions toward military goods and away from civilian goods. The civilian economy shrank drastically as the federal government mobilized scarce resources to defeat the Axis powers. And in order to draw those resources away from alternative uses without generating inflationary pressures in the economy, wage and price controls were imposed, at first selectively in 1941, and then more extensively in 1942, after passage of the Emergency Price Control Act (January) and the Emergency Stabilization Act (October). Because price controls inevitably create shortages, the Office of Price Administration (OPA) was established in 1942 to manage the controls and a system of strict rationing designed to enforce them (Higgs 2007, p. 445).

Many ordinary consumer goods, "including gasoline, tires, canned foods, meat, fats, sugar, clothing, and shoes" (Higgs 2007) were rationed. Beginning in early 1942, new automobiles stopped rolling off the assembly lines as the War Production Board commandeered Detroit's production facilities in order to equip the armed forces with tanks, trucks, jeeps, and other vehicles. In consequence of the massive quantities of steel required to support the war effort, household appliances and other durable consumer goods were soon in very short supply (Higgs 2007, pp. 445-6).

In addition to price controls and rationing, individuals and businesses faced steeply higher tax rates to help finance the war effort (Higgs 2007, p. 444). The war years were in short lean years on the home front as well as being a time of mortal peril for husbands, brothers, and sons shipped overseas. It is therefore misleading to compare the GNPs of 1941 to 1945 with those of any peacetime year before or since. World War II may have reduced the unemployment rate and raised the level of production, but it did not bring economic prosperity in any meaningful sense. (The only benefit of war rationing, of which I am aware, is that an alert entrepreneur invented the bikini so as to conserve on the textiles that were then hard to come by for civilian use.)

America became prosperous again only after war's end. Victory achieved, Washington cut spending sharply, lowered personal and corporate income tax rates, albeit not all the way to prewar levels, and reduced its wartime budget deficits. Anticipating the drastic reductions in federal spending that demobilization would bring, at least some economists--James Tobin being one of them (Parker 2002, p. 133)--predicted a return to the depressed economy of the 1930s. That never happened, of course. The economy instead boomed, perhaps owing to the pent-up demands for consumer goods war's privations had created (Paul Samuelson, quoted in Parker 2002, p. 36), to which the private sector quickly responded once freed from wartime controls. (44) More plausibly, however, America's post-World War II expansion was driven by reductions in federal tax rates, significant cut-backs in federal government spending, and the reconversion of private industry to the production of civilian goods.

5. The Lessons of the Great Depression and of the New Deal

What lessons can be learned from the Great Depression and the public policy responses to it? First and foremost, in my judgment, is that the economic crisis of the 1930s largely was manmade. Although the slump undoubtedly had more than one father, the various explanations are tied together by the inept monetary policies adopted by the Federal Reserve System, which, first overheated the economy during the Roaring Twenties, and then, by reversing course in 1927, brought it to its knees. Most economists, especially public choice economists, will be uncomfortable with that explanation, however. It is essentially a theory of public policy "mistakes" traceable to the untimely death of Benjamin Strong (and to the ensuing struggle between New York and Washington for money market hegemony) or to the Fed's inability to distinguish nominal from real interest rates. (45)

Second, and more important than its cause, the Great Depression was deepened and prolonged by the policies of the New Deal, not because Washington spent too little in an attempt to prime the economic pump, but because what it did spend was influenced more by FDR's strategy for reelection to the White House in 1936 than by the economic misery into which the nation had been plunged.

Much has been written about the Great Depression, the New Deal, and Franklin Delano Roosevelt as a person. (46) Whether sympathetic to the president's policy prescriptions or not, the literature highlights a third important lesson, namely that inconsistent and incoherent responses to economic crises can make things worse by creating uncertainty and undermining business and consumer confidence. FDR once said famously that

"the country needs--and, unless I mistake its temper, the country demands--bold, persistent experimentation. It is common sense to take a method and try it. If it fails, admit it frankly and try another. But above all, try something" (quoted in Brands 2008, p. 241).

The political imperative to be perceived as taking action, as doing "something," may have been irresistible in the economic atmosphere of 1933, as it also apparently was to presidents George W. Bush and Barack Obama in the wake of the financial crisis that began at the end of 2007. A third and final lesson to be drawn from the Great Depression as well as the New Deal's responses to it is that it may be better to do nothing than to rush into the adoption of policies, many of which are irreversible, that do much more harm than good.


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(1) With his experience as Assistant Secretary of the Navy during the First World War in mind, President Roosevelt was, at a press conference in the Oval Office on September 1, 1940, commenting on events in Europe that threatened to draw America into a second global conflict (Smith 2007, p. 435).

(2) John Kenneth Galbraith's ([1954] 1988) well-written, but seriously flawed, analysis is largely responsible for the widespread misconception that the Great Depression was caused by the precipitous decline in share prices that began in the fall of 1929.

(4) See, for example, Higgs (2006), Rowley and Smith (2009), and Shughart (2009). Wheelock (2008) compares housing market conditions then and now and analyzes the public policy responses to the distress faced by many mortgagees, focusing on the Home Owners' Loan Corporation, which was the primary conduit through which the federal government refinanced delinquent mortgages during the New Deal. For an analysis of the contribution to the current financial crisis of public policies designed to promote home ownership, see Congleton (2009).

(5) After peaking in June 1929 at 125, the index of industrial production declined to 118 within four months and continued to fall thereafter, registering at 88 in October 1930 (Williams 1994, pp. 138-9), with further reductions to come. (Observations on industrial production have been relied on widely by students of the Great Depression to measure economic activity largely because of the availability of such data. But as Robert Higgs emphasized in transmitting his comments on an earlier version of this article, during the decade of the 1930s, the United States still was predominately an agricultural economy and, hence, changes in industrial production do not necessarily track events in other sectors.) For a detailed analysis of the Great Depression's effects on one American manufacturing industry, see Bresnahan and Raff (1991).

(6) By way of contrast, the U.S. unemployment rate was just 3% in August 1929 (Parker 2007, p. 3). The economic impact of the decline in employment during the Great Depression arguably was more serious than it has been during the Great Recession because in that earlier time unemployment was concentrated among heads of households who were their families' sole breadwinners.

(7) Owing to the fact that the banking industry was more highly concentrated at the beginning of the current financial crisis than it was on the eve of the Great Depression, it is likely that the carnage visited on financial markets by the Great Recession exceeds that of 1929-1933, if gauged in terms of the total assets involved rather than on the sheer numbers of institutions affected.

(8) The world, strictly speaking, did not return to a pure gold standard in the interwar period but instead adopted a gold exchange standard under which reserves could be held in the form of convertible currencies--the U.S. dollar, Britain's pound sterling, and the French franc, primarily--only 40% of which currency reserves had to be backed by gold. Although the fractional gold-reserve requirement generated a multiplier effect on the domestic money supplies of countries losing gold equal to 2.5 times the gold outflow, it did not necessarily demand inflation in countries gaining gold (Parker 2002, p. 18). Under the gold exchange standard, the gold-gaining nations had the option of reducing their holdings of convertible foreign currencies by using them to settle their international debts.

(9) At a time when more than one million Britons already were unemployed, British exports, "notably cotton, shipbuilding, steel, and coal," as the opponents of resumption had predicted, were especially hard hit (Johnson 2009, p. 76). The upshot was a general strike instigated by coal miners who refused either to accept lower wages or to boost their productivities. Joined in solidarity by railway men, other transport workers, and the employees of many of the nation's print and radio media outlets, the back of the strike ultimately was broken in a settlement negotiated by then-Chancellor of the Exchequer Winston Churchill (Johnson 2009, pp. 78-80).

(10) According to Beaudry and Portier (2002, p. 83), monetary policy did not become tightly contractionary in France until 1935. Evidence adduced by Bernanke and James ([1991] 2000, p. 77; emphasis in original) suggests, however, that owing to an increase in domestic demand for francs stimulated by economic growth, "the country actually experienced a wholesale price deflation of almost 11% between January 1929 and January 1930." (11) Also see Choudri and Kochin (1980), Eichengreen and Sachs (1985), Temin (1976, 1989), and Bernanke and James ([1991] 2000). More recent evidence (Cover and Pecorino 2005) suggests that, after leaving the gold standard, the U.S. economy became more stable; for instance, economic expansions were of longer duration than before. Young and Du (2009) report contradictory empirical findings, however, indicating that the "structural break" occurred much later, perhaps as late as the 1950s, and, moreover, that FDR's abandonment of gold in 1933 may have increased the U.S economy's volatility, as measured by deviations from GNP trend.

(12) That nation was of course later (beginning in 1936) ravaged by civil war (Beevor [1982] 2006; Thomas [1961] 1989). The experiences of Canada, then and now, also are apt. Perhaps because it had adopted rules allowing branch-banking nationwide early on and never had anything like a New Deal, Canada weathered the two global financial crises at issue here with much less economic disruption than most other developed nations.

(13) According to Romer (1993, p. 34), "when deflation started in 1930, farmers were the first to default," and that rise in defaults helped precipitate the nation's banking crisis by "sending undiversified rural banks into failure." (14) Cole and Ohanian (2004) draw similar conclusions with respect to the United Kingdom, the economy of which followed a trajectory from 1929 to 1933 very similar to that of the United States.

(15) For a concise summary of the criticisms, along with a valiant attempt to detect empirically one exogenous shock to the real U.S. economy, see Young and Shughart (2010).

(16) A more recent contribution to the literature utilizing a DSGE modeling approach (Eggertsson 2008) suggests that America's recovery from the Great Depression was, as result of FDR's election to the presidency in November 1932, a change in expectations on the part of consumers and business owners from deflationary (monetary and fiscal) to inflationary policies. He argues that, but for the Fed's "Mistake of 1937" (see below), by abandoning the "dogmas" of a "small" federal government and a balanced federal budget, the New Deal produced the "sharpest" recovery in U.S. economic history. That conclusion has not gone unchallenged; see Horowitz (2009) and Eggertsson's (2010) reply.

(17) From the point of view of New York's financial institutions, Galbraith ([1954] 1988, p. 21) characterizes such loans as the "most profitable arbitrage operation of all time": they "could borrow from the Federal Reserve Bank at 5 percent and re-lend it in the call market for 12 percent." (18) Fuel was added to the fire of the panic-inspired bank runs that led to the collapse of a third of the U.S. commercial banking system by regulatory rules that prohibited branch banking and limited each financial institution's operations to a single physical location. America's "unit banks" thus were prevented from diversifying loan default risks geographically (Temin, quoted in Parker 2007, p. 44). Canada, where nationwide branching had a long history, experienced almost no bank failures during the 1930s.

(19) Anderson, Shughart, and Tollison (1988, 1990) dispute Friedman and Schwartz's explanation and in so doing supply evidence that the Fed's policy inaction provided it with important bureaucratic benefits: 80% of the banks that failed between 1929 and 1933 were small, state-chartered institutions that were not then members of the Federal Reserve System. After the dust had settled, the profits of surviving national banks consequently were larger, and the Fed thereafter exercised wider regulatory control over the U.S. commercial banking system as a whole.

(20) From June i921 through December 1929, deposits in all U.S. banks grew by $19 billion. The expansionary period thus added more to the total than had been on deposit in June 1914 ($18.6 billion) (Phillips, McManus, and Nelson 1937, p. 82).

(21) Hayek's two important contributions to the literature cited herein, but long out of print are, thanks to the Ludwig von Mises Institute, newly accessible in Hayek (2008).

(22) Or, as Joseph Schumpeter expressed it, "Recovery 'is sound only if it [comes] of itself. For any revival which is merely due to artificial stimulus leaves part of the work of depressions undone and adds, to an undigested remnant of maladjustment, new maladjustment of its own which has to be liquidated in turn, thus threatening business with another [worse] crisis ahead'" (quoted in Krugman [1999] 2009, p. 21).

(23) "There will come seven years of great plenty throughout all the land of Egypt, but after them will arise seven years of famine, and all the plenty will be forgotten in the land of Egypt; the famine will consume the land...." (Genesis 41:29-30, NKJV).

(24) According to Robbins ([1934] 1999, pp. 65-6), international trade policy during the Great Depression "witnessed the odd spectacle of the nations of the world zealously endeavoring to bring about a further contraction by excluding each other's products." Although most scholars downplay the adverse effects of Smoot-Hawley, arguing that international trade accounted for only 7% of U.S. GNP at the time, Rustici (2005) places that law at center stage, finding it to have been decisive in the distress suffered by America's agriculture sector and the consequent failures of many rural (unit) banks.

(25) Romer's (1993) pinpointing of dates of national recovery from the Great Depression fails to distinguish between increases in domestic industrial production associated with war or mobilization for war and production intended to satisfy civilian demands for goods and services. That error turns out to be critical in assessing the effects of FDR's New Deal policies. Although, as conventionally measured, industrial production (and GDP) includes governmental expenditures on both military and other, so-called public goods, such as bridges, highways, and dams, the consequences of the two budget categories for social welfare are quite distinct.

(26) Wallis (1984) adopts 1932 as the starting point for his calculation because the Reconstruction Finance Corporation (RFC), a Hoover administration precursor to the New Deal, was created on January 22 of that year. The RFC initially was authorized to extend loans to financial institutions and railroads; by the end of the following year, it had lent more than $1.3 billion to 5817 banks. Some $300 million in credit was made available to state and local governments by the RFC after President Hoover signed the Emergency Relief and Construction Act in July 1932. With some modifications, and although "designed to be a temporary emergency agency" (Fishback 2007, p. 395), it continued to operate under FDR and, indeed, survived into the 1950s (Couch and Shughart 1998, pp. 70-4). One of the RFC's defects was that the federal government was "given first priority over depositors and other lenders when the borrowing banks failed" (Fishback 2007, p. 294). Its operations may have been fatally compromised soon after its founding by revelations of the identities of the institutions to which it had extended loans, thereby fostering the belief that the recipients were in dire financial straits.

(27) Such substantial increases in federal spending until then unprecedented in a peacetime economy--tend to undercut arguments that the New Deal failed to return output and employment to their predepression levels because it was too timid. According to E. Cary Brown, for instance, "fiscal policy ... seems to have been an unsuccessful recovery device in the 'thirties--not because it did not work, but because it was not tried" (Romer 1992, p. 758). On the other hand, federal "budget deficits during the 1930s never reached more than 3.9 percent of GNP in any one year" (Fishback 2007, p. 392). The inadequacy of the New Deal's fiscal responses to the Great Depression has been echoed lately by Nobel laureate Paul Krugman ([1999] 2009).

(28) Coincidentally or not, 1937 also was the first year social security taxes were due, taking a bite of some $2 billion out of national income, without yet returning any benefits (Kennedy 1999, p. 355).

(29) Real U.S. GNP fell by 5% during that 13-month period (Romer 1992, p. 760).

(30) Official employment statistics did not at the time include people on work relief. They, along with individuals who were unemployed but not actively seeking jobs, were not considered to be in the labor force. Owing to the way in which the unemployment rate was then defined, "for every relief job created the private sector shed half of a ... job" (Fishback 2007, p. 400). Evidence supporting the conclusion of private labor-market "crowding out" can be found in Fleck (1999b).

(31) Raymond Moley, who in the interregnum prior to Inauguration Day in March 1933 organized what soon became known as FDR's "brains trust," an unofficial advisory group that included himself, Adolf Berle, Jr., and Rexford Tugwell, wrote in 1939, in a chapter titled "Summer without Increase," that "immense treasure has been spent for economic rehabilitation that has not materialized, ... after seven years, investment remains dormant, enterprise is chilled, the farmers' problem has not yet been solved, unemployment is colossal" (Moley 1939, p. 399).

(32) Moley's (1939, pp. 369-70) later assessment of the programs of the First New Deal is among the most colorful ever put to paper: "To look upon these policies as the result of a unified plan was to believe that the accumulation of stuffed snakes, baseball pictures, school flags, old tennis shoes, carpenter's tools, geometry books, and chemistry sets in a boy's bedroom could have been put there by an interior decorator." (33) The NRA was abolished following the Court's ruling in A. L. A. Schechter Poultry Corp. et al. v. United States, 295 U.S. 495 (1935); a subsequent decision, United States v. Butler, 297 U.S. 1 (1936), struck down the Agricultural Adjustment Act. For details, see Shughart (2004).

(34) Including Herbert Hoover's Revenue Act of 1932, "federal tax collections ... more than doubled between 1930 and 1939 from $4.7 billion to $11.8 billion" (Fishback 2007, p. 390).

(35) Wallis (1989) examines the labor-market effects of the Social Security Act and finds that it too contributed to the economy's sluggish recovery from the Great Depression. He reports empirical evidence supporting the hypothesis that "states with higher proportions of their labor force in covered employment ... experienced larger declines in employment" after 1935. Two other, more recent contributions by Wallis (1991, 1998) are apt. The latter reports evidence that the influence of presidential politics on New Deal spending loses statistical significance if the State of Nevada is excluded from the dataset. However, Nevada does not appear to be an "outlier" if one focuses on the distribution of federal spending across states in specific programmatic categories, such as agriculture and public works (Couch and Shughart 2000, 2008).

(36) "In December, 1939, and January, 1938," writes Moley (1939, p. 374), "the President acquiesced in a campaign launched by [Tommy] Corcoran, [Benjamin] Cohen, [Harold] Ickes, [Harry] Hopkins, and Robert H. Jackson for the purpose of blaming the depression upon business." FDR spoke, "On January 3, 1938, ... of great corporations created 'for the sake of securities profits, financial control, the suppression of competition and the ambition of power over others.'" And, "On January 8th the President denounced 'the autocratic controls over the industry and finances of the country.'" Such rhetoric was followed in "April, with all business indices plummeting," by a presidential message to Congress asking "for an investigation of monopolies," a request that ultimately led to the creation of the Temporary National Economic Committee (Moley 1939, pp. 375-6). FDR, according to his chief brain-truster, failed "to understand what is called, for lack of a better term, business confidence" (Moley 1939, p. 370).

Moley went on to write that "maintenance of confidence presupposes both a general understanding of the direction in which legislative and administrative changes tend and a general belief in government's sympathetic desire to encourage the development of those investment opportunities whose successful exploitation is a sine qua non for a rising standard of living. This, Roosevelt refused to recognize" (Moley 1939, p. 371). He then cited chapter and verse: (1) "the confusion of the administration's utility, shipping, railroad, and housing policies had discouraged the small individual investor"; (2) "the administration's taxes on corporate surpluses and capital gains, suggesting as they did, the belief that a recovery based upon capital investment is unsound, discouraged the expansion of producers' capital equipment"; (3) "the administration's occasional suggestions that perhaps there was no hope for the reemployment of people except by a share-the-work program struck at a basic assumption in the enterpriser's philosophy"; (4) "the administration's failure to see the narrow margin of profit on which business success rests--a failure expressed in an emphasis upon prices while the effects of increases in operating costs were overlooked--laid a heavy hand upon business prospects"; and, finally, (5) "the calling of names in political speeches and the vague, veiled threats of punitive action all tore the fragile texture of credit and confidence upon which the very existence of business depends" (Moley 1930, pp. 371-2).

(37) Reading included the first variable because of Washington's responsibility for maintaining and improving such lands. He also conjectured that federal land ownership is correlated with the existence of public agencies that already were in place through which relief spending could be channeled quickly. But the pattern of federal land ownership then and now also suggests that that variable may simply serve as a proxy for a state being located in the West. As to the second variable, Reading thought that states characterized by fewer highway miles per capita would face greater difficulties in financing federal programs aimed at building and maintaining roads.

(38) U.S. presidents are of course not elected on the basis of popular votes, but popular vote shares matter insofar as the candidate who receives a plurality of the votes cast in a state claims all of that state's electoral votes, which are apportioned on the basis of the sizes of states' congressional delegations, comprising two U.S. senators plus the population-determined number of members of the House of Representatives. Given a "first-past-the-post" methodology for selecting the winner of a state's electoral votes, a majority of all such ballots being required for election to the White House, Wright's decision to compute the difference between the Democratic Party's popular vote share and 0.5 is, strictly speaking, a precise measure of electoral "closeness" only in presidential races contested by just two candidates.

(39) The hypothesis of party loyalty is undercut by the New Deal's documented propensity to shortchange the South (Couch and Shughart 1998, 2008). On the other hand, as Fleck (1999a, c) observes, voter turnout rates there were much lower than they were in other regions of the United States owing to the disenfranchisement of African-Americans, thereby making the southern states doubly unimportant to FDR's strategy for reelection to a second term in office. Fleck (2001) reports evidence supporting the decisiveness of "swing voters" in states with closer competition between parties in general elections.

(40) The following discussion is based in part on a letter to the editor of the New York Times, written by Jim Couch and me in response to Krugman's column, which, to neither of our surprises, was not accepted for publication.

(41) The WPA, it should be remembered, was known widely at the time as "We Piddle Around." Although that New Deal agency undoubtedly financed many worthwhile public projects, it also was responsible for the adding the word "boondoggle" to the dictionary of American English. In that regard, the WPA followed closely in the linguistic tracks of the NRA, which until its demise in 1935 often was referred to as the "National Run Around" (see, among others, Couch and Shughart 1998).

(42) Evidence from an investigation conducted in the state of Illinois suggests, "that some 450 men were added to the WPA rolls in one district in Cook County solely for the period of the primary campaign and that some 70 of these did no WPA work but canvassed their precincts" on behalf of the Democratic Party's candidate (MacMahon, Millet, and Ogden 1941, p. 285).

(43) Higgs's earlier work on the Great Depression is expanded and updated in Higgs (2006), which supplies the most accessible summary of his relevant scholarship (also see Higgs 2009).

(44) Higgs (1997) sees the immediate postwar period as a crucial test of Keynesian principles: If fiscal stimulus had played a significant role in the U.S. economy's recovery from the Great Depression, drastic cuts in that spending should have operated in the reverse, as James Tobin and others predicted. Because it did not, according to Higgs, Professor Keynes failed his test.

(45) A related lesson, emphasized by nearly every economist interviewed by Parker (2002, 2007), is that the Fed should not be an arbiter of stock prices or of interest rates but should instead focus its attention exclusively on using its monetary tools to maintain a stable price level.

(46) In addition to the literature cited earlier, see, in particular, Badger (1989), Black (2003) and, of course, Schlesinger ([1957] 2002, [1958] 2003, [1960] 2003). Much of the historical literature treats Franklin Roosevelt as a demigod who single-handedly rescued capitalism from its own excesses. For more critical assessments, see Flynn (1949), who referred to the New Deal as "the greatest vote-buying operation in history"; Powell (2003); Shlaes (2007); and Folsom (2008).

Department of Economics, University of Mississippi, P.O. Box 1848, University, MS 38677, USA; E-mail:

* Presidential Address, 80th Meeting of the Southern Economic Association, Atlanta, Georgia, November 21, 2010.

I benefitted considerably from comments on an earlier draft by Jim Couch, Robert Higgs, Michael Reksulak, Charles Rowley, Robert Tollison, and Andrew Young. Any remaining errors are solely my responsibility.
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Title Annotation:2010 Presidential Address
Comment:The new deal and modern memory.(2010 Presidential Address)
Author:Shughart, William F., II
Publication:Southern Economic Journal
Geographic Code:1USA
Date:Jan 1, 2011
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