a look back at the (limited/failed) New Deal

Last month marked the 75th anniversary of the beginning of FDR's "New Deal".

The Great Depression is the most famous event in U.S. macro-economic history. Most or all of my students know that it happened in the first half of the 20th century. They have no sense of what caused it-- except perhaps to lay blame on the 1929 stock market crash. And they have a vague sense that the New Deal policies of FDR were helpful in ending it.

Because their impressions of the New Deal are limited, it is relatively easy to communicate what economists know about the Great Depression and the New Deal.

The Great Depression was noteworthy for its length and depth. A typical recession-- probably what we're dealing with now-- is relatively short (e.g., 6-9 months in length) and features a slowdown in economic activity (negative output growth with reduced income and production). The most notable feature, politically, is a modest increase in unemployment. Even unemployment of 6-7% is enough to induce howls of pain from the unemployed and unlikely promises to make things better by a range of politicians (e.g., the recent macro "stimulus package").

That said, some recessions are (much) more severe than others. For example, in fighting the inflation of the mid-late 1970s, we ended up with double-digit unemployment in the early 1980s. In further contrast, the Great Depression lasted for more than a decade and featured unemployment as high as 25%.

One quick way to note the limits of the New Deal: unemployment was 19% in its 6th year.

Markets may have trouble "adjusting", but they don't have that much trouble. So, it is wise to look at government policy during the 1930s to fill out one's hypothesis of cause/effect about the Great Depression. Economists point to four major policy blunders:

1.) four tax increases, including the initiation of Social Security's payroll tax on income-- a tax on labor, thus making it more painful to hire workers

2.) a shrinking money supply-- not from the Fed actively reducing it, but from passively sitting by while confidence decreased, lending activity dropped, and the amount of money in the system fell (in contrast, note the Fed's activity-- or even hyper-activity in recent days)

3.) the Smoot-Hawley Tariff Protection Act of 1930 is generally considered the primary catalyst for the stock market crash of 1929-- as investors looked forward to the devastating impact this would have on international trade and the significant impact it would have on our economy

4.) the imposition of laws that would prevent wages and prices from adjusting downward (as they need to do in a recession): most notably, price floors (e.g., in farming), wage floors (the minimum wage), and a spate of pro-union legislation.

Bad policy was responsible for the bulk of the Great Depression-- and perhaps is entirely responsible for its length and continued depth.

Finally, the most famous part of the New Deal could not have been all that effective. The government worked hard to create jobs-- most famously, through the Works Progress Administration (WPA). And it was successful in part. But in doing so, it must have destroyed at least as many jobs. To note, where did the money come from to create the jobs? From the private sector-- where economic activity was squashed and jobs were destroyed as a result. Government spending is typically a shell game-- moving resources from one area to another, creating some and destroying other. Moreover, government rarely does things in an efficient manner, so one would expect the net effect to be negative. And again, if one looks at the results, it is clear that government policy was not a cure for a struggling economy.