Download Recovery from the Great Depression

 Did the US recover from the Great Depression because of WWII? Ilian Mihov February 2009 There is a popular misconception that the US economy recovered from the Great Depression as a result of the military spending associated with World War II. A more extreme version of this statement is that Roosevelt’s policies had nothing to do with the recovery. These statements are inconsistent with the data. Franklin D. Roosevelt became president of the United States in March 1933. Promptly he introduced four key policy initiatives: (1) suspend the Gold Standard, which allowed the Fed to expand money supply; (2) restore confidence in the financial sector through a process of restructuring and sanitizing commercial banks; (3) implement a fiscal stimulus package; (4) introduce new regulation. As a result of these measures, the growth rate of the economy was 10.8% in 1934, 8.9% in 1935, 13% in 1936, and 5% in 1937! Overall the US economy expanded by 44% during his first term. The US economy is supposed to grow at about 3% per year and not 3 or 4 times this rate. During the first term of Roosevelt, the US real GDP had returned to its pre‐Depression level. US Real GDP (1929 =100)
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There is also a claim that Roosevelt’s term was associated with the highest unemployment rate and therefore his policies were unsuccessful. The high unemployment rate was a legacy of the Great Depression. During his first term, however, unemployment declined from 25.2% in 1933 to 14.3% in 1937. The economy had another recession in 1938, which was a result of a policy mistake again, but the mistake was quickly reversed with a fiscal injection of $5 billion. And the economy continued its recovery. Because of the severity of the depression and its depth, it took many years for the economy to return back to its trend. But to say that there was no recovery until WWII is a clear misinterpretation of the data. Reply to a comment on the role of monetary policy: I fully agree with the statement that monetary policy played a crucial role in the recovery. As important as monetary policy were reforms affecting the financial sector (banking holiday, RFC, deposit insurance, etc.). Fiscal policy played a minor role. At the time conventional wisdom was that budgets have to be balanced and Roosevelt made permanent a very steep tax schedule introduced by Hoover with the Tax Revenue Act of 1932. At that time the top marginal tax rate exceeded 70%! As CBlackburn mentions in the comment the policy mistake was the attempt to balance the budget by a sharp reduction in government spending. In fact this is yet another piece of evidence that fiscal policy matters. So, Roosevelt was not as expansionary in terms of fiscal policy as more recent US administrations, but compared to Hoover, he was clearly more aggressive. After all, during the last two years of Hoover's administration, real government spending declined. There is a nice article by Christina Romer on the lessons from the Great Depression. You can download it from Greg Mankiw's blog: http://gregmankiw.blogspot.com/2009/03/from‐cea‐chair.html