Depression

Harold L. Cole and Lee E. Ohanian, two economics professors, relate some employment numbers during the 1930s depression in a Feb. 2nd, 2009 op-ed in the WSJ “How Gov’t Prolonged the Depression.”

“Total hours worked per adult, including government employees, were 18% below their 1929 level between 1930-32, but were 23% lower on average during the New Deal (1933-39). Private hours worked were even lower after FDR took office, averaging 27% below their 1929 level, compared to 18% lower between 1930-32.” They ask why there wasn’t a vigorous recovery, noting that “Productivity grew very rapidly after 1933, the price level was stable, real interest rates were low, and liquidity was plentiful.”

They acknowledge the benefits of a “basic social safety net through Social Security and unemployment benefits, and by stabilizing the financial system through deposit insurance and Securities Exchange Commission.” But those benefits were offset by “suppressing competition, and setting prices and wages in many sectors well above their normal levels.” These latter policies “choked off powerful recovery forces that would have plausibly returned the economy back to trend by the mid-1930s”.

These recovery forces included expansionary [see my note at the end of this blog entry] Federal Reserve policy and productivity growth. They note that the National Industrial Recovery Act (NIRA) voided existing antitrust laws and “permitted industries to collusively raise prices” as long as they paid their workers above average wages, in effect, gaming the system. The NIRA codes detailed conduct for 500 industries that were designed to eliminate “excessive competition”, which Roosevelt believed to be the cause of the depression. “These codes distorted the economy by artificially raising wages and prices, restricting output, and reducing productive capacity by placing quotas on industry investment in new plants and equipment.” NIRA was declared unconstitutional in 1935 but the practices continued.

At the end of 1938, with the reversal of some of these New Deal policies, the economy began to recover. The main lesson to be learned, the writers contend, from the policies of the 1930s and price controls introduced in the 1970s, is that government intervention on a large scale can have unintended consequences. The professors call for reforms including updated bank regulations, tax changes that “broaden rather than narrow the tax base”, as well as savings and investment incentives.

A person reading Milton Friedman’s analysis of Federal Reserve policy during the depression years would hardly call that policy “expansionary”, as these two authors do. Here is a more detailed telling of the Federal Reserve’s role in the depression. There is also a book of essays by the current Fed chairman, Ben Bernanke.

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