Some tidbits about stimulus, recovery, and the Great Depression

Paul Kasriel of Northern Trust is one of the few economists to have warned about the present economic malaise. So his analysis of present events carries weight. In making recommendations about the future economic path in the United States, Kasriel leans heavily on historic precedent regarding periods of deleveraging, one such period being the Great Depression. He draws some interesting conclusions.

In a post yesterday, he said the following about the Great Depression:

Contrary to what you might believe, the Great Depression of the 1930s was not a decade-long era of economic decline. Rather, the Great Depression was made up of two distinct economic slumps – August 1929 through March 1933 and May 1937 through June 1938. As Chart 1 shows, the first recessionary period of the Great Depression was not only longer in duration, but more severe in magnitude. Notice, however, that a quite robust economic recovery/expansion occurred between the two recessions. In the four years ended 1937, real GDP grew at a compound annual rate of 9.4%. Lest you think that all of the increase in real GDP growth in the four years ended 1937 was accounted for by federal government spending, Chart 2 should dissuade you of this notion. In the four years ended 1937, real GDP excluding real federal government expenditures grew at a compound annual rate of growth of 9.0%. In the four years ended 1937, industrial production grew at a compound annual rate of 12.9%. Although this vigorous real economic recovery did not bring the unemployment rate back down to anywhere near where it was before the 1929 recession commenced, the unemployment rate did fall from a cycle high of 25.6% in May 1933 to a cycle low of 11.0% in July 1937.

Chart 1


Now, I am actually not a fan of Franklin Roosevelt. However, the line that Amity Shlaes and others take on New Deal stimulus causing the Depression is false.  Roosevelt was not in office until March 1933 — the same month the economy bottomed.  Actually, stimulus may have been a net benefit for the United States during the Great Depression and hastened recovery post-1933. This is why, despite my Austrian Economics roots, I do see a role for stimulus in the present crisis.

Despite protective tariffs, Fed discount rate increases, personal income tax rate increases and massive bank failures, the first recession of the Great Depression ended in March 1933, the same month in which Franklin D. Roosevelt was inaugurated as president. That is, the business cycle trough occurred before the “New Deal” policies were implemented.

In 1936, marginal personal income tax rates were increased again. For incomes between $100,000 and 150,000, the tax rate went from 56% to 62%, a 10.7% increase in the tax rate; for incomes between $1,000,000 and $2,000,000, the tax rate went from 63% to 77%, a 22.2% increase; and for incomes in excess of $5,000,000, the marginal tax rate became 79%, an increase of 25.4% from the previous top marginal tax rate of 63%. Between August 1936 and May 1937, the Federal Reserve doubled the percentage of reserves commercial banks were required to hold relative to their deposits. The economic expansion that commenced in April 1933 then peaked in May 1937. The economy entered the second recession of the Great Depression, which lasted through June 1938.

There is much discussion in the media of late that FDR’s “New Deal” policies were detrimental to economic growth during the 1930s. But we need to make a distinction between New Deal policies that dealt with increased federal government spending and those that dealt with the direct interference in markets. Perhaps the New Deal policies that directly interfered with markets were responsible for keeping the unemployment rate from falling as much as it otherwise would have. But as was discussed at the outset of this commentary, real GDP grew at a compound annual rate of growth of 9.4% in the four years ended 1937. …. Perhaps it is coincidental that real GDP contracted by significantly less in 1933 and grew in 1934 through 1937 as the rate of growth in real federal government expenditures increased significantly in 1933, 1934 and 1936. Perhaps, had it not been for the stepped up increases in real federal government expenditures, the compound annual rate of growth in real GDP in the four years ended 1937 would have been even higher than 9.4%. Perhaps.

Edward here. At a minimum, the preceding analysis should cause you to question those who claim that stimulus categorically will not work to cushion a hard landing and speed recovery. However, what is key is that this stimulus be felt in terms of an increase in bank reserves. Otherwise, as when you fund the stimulus through tax increases, you are robbing Peter to pay Paul. Back to Kasriel.

I have argued that increased government spending without the monetization of the increased federal debt has little impact on aggregate demand – real or nominal. That is, if increased federal government spending is funded by increased taxes or increased sales of Treasury securities to the nonbank public that are not monetized by the Fed and the banking system, then spending “power” is merely transferred from the private sector to the government sector, the net result of which is little if any increase in total spending in the economy. In this regard, it is interesting to observe the behavior of commercial bank reserves, which are, in effect, credit created by the Fed figuratively “out of thin air,” during the 1930s. This is shown in Chart 6. The change in bank reserves was negative from 1929 through 1932. Then rapid growth in reserves commenced in 1933. In the four years ended 1936, bank reserves grew at a compound annual rate of 25.9%. Then, in 1937, reserves contracted by 18.9% along with a contraction in nominal federal government expenditures.


Kasriel’s conclusion should give those expecting a recovery some cheer:

It is not my role to endorse government policies. It is my role to forecast the impact of government policies on the economy. I believe that large increases in federal government spending that are monetized by the Fed and the banking system will result in a recovery in real economic activity. When that recovery sets in depends on how quickly the federal government increases its spending and by the magnitude of that increase. We can debate whether tax rates should be cut or federal spending should be increased. We can debate what kinds of spending should be increased. We can debate whether the federal government should increase any of its spending. But the facts of the 1930s appear to be pretty clear – monetized increased federal government spending does result in increased real economic activity in the short run.

The economic data are likely to be abysmal through the first half of this year. The popular media will reinforce the gloom of the data. The same pundits who did not see this downturn coming will not see the recovery coming either. My advice to you is to keep your eye on the index of Leading Economic Indicators. If history is any guide, the LEI will signal a recovery well ahead of the pundits.

I like this analysis. Where things are different today is that Barack Obama enters the picture at a point much earlier in the bottoming cycle than Roosevelt. We still have a lot of downside to course through both in the financial sector and the real economy. Nevertheless, this is another important piece of analysis from Kasriel.

The Great Depression — Just the Facts, Ma’am – Paul Kasriel, Northern Trust

  1. hbl says

    This provides some useful data on the Great Depression, however I think Kasriel may be missing the key point (at least in this exerpt, perhaps he elaborates in the full piece) with respect to how soon our recovery might start. The growth starting in 1933/1934 took place AFTER massive deleveraging had occurred and GDP had already fallen dramatically.

    Steve Keen (who I personally believes understands this crisis better than any other public-facing economist) has suggested informally that US GDP likely must contract in the rough order of 20% (hope I’m not misremembering!) to reach a sustainable level, given the amount of ponzi debt growth that our recent GDP has been predicated on.

    But as you say, the key of stimulus spending should be to “cushion a hard landing and speed recovery” (i.e., prevent too much overshoot on the downside), so it doesn’t mean we shouldn’t try.

  2. Edward Harrison says

    hbl, we agree 100% -although 20% is a huge number that I can’t say agree with. But, along the lines of your thinking, I added this paragraph at the end after I first posted:

    I like this analysis. Where things are different today is that Barack Obama enters the picture at a point much earlier in the bottoming cycle than Roosevelt. We still have a lot of downside to course through both in the financial sector and the real economy. Nevertheless, this is another important piece of analysis from Kasriel.

  3. VicktorCapitalist says

    I can’t help but suspect that the sharp rebound/recovery for the 4 years ended 1937 was due to the devaluation of USD against gold – I believe it happened right after FDR assumed president’s role (with the confiscation of gold…). If so, I think the analysis missed this point big way.

    In fact, given the huge debt deflation now, non-stop money printing may still not be able to solve the problem easily. I am seeing “hyper gold inflation” as the way out, followed by “hyper gold standard” to axe the self-fulfilling fear of hyperinflation. For further info, see the below 3 links

    1. hyper gold inflation

    2. hyper gold standard

    3. From deflation to hyperinflation

  4. melpol says

    The loss of jobs has a tremendous economic and social impact. Those laid off lose their ability to support families and pay their mortgages. Without income, many can no longer afford health care coverage. Sharing available work would increase the employee base. If employees agree to a cut in salaries and tighten their belts less would lose their jobs. An agreement to work at reduced pay, would also increase feelings of job security. Another way to share the work would be by sharing the work week. Working one week and staying home the next one is better than being unemployed. Sharing the pain and sharing the gain is the American way. Workers are entitled to a piece of the pie not all of it.

  5. hbl says

    Ed – Yeah I hadn’t read your added paragraph or I wouldn’t have felt the need to comment.

    As for the 20% of GDP figure, I probably had it wrong… I’ll be more careful about waiting until I have time to check for actual references in the future. The closest I can find to where I would have read it is on pages 10-11 of this Keen PDF, which frames a conservative example of $2.7 trillion one year drop in combined spending PLUS asset purchases (not the same as drop in GDP).

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