For Insight on Stimulus Battle, Look to the '30s
For Left and Right, Issue Rekindles New Deal Debate

By Steven Mufson
Washington Post Staff Writer
Thursday, February 12, 2009

Underlying the partisan division over President Obama's stimulus bill is a dispute over history -- a decades-old debate between liberals and conservatives over the impact the New Deal had in bringing the country out of the Great Depression.

Senate Minority Leader Mitch McConnell (R-Ky.) said flatly last week that "the big-spending programs of the New Deal did not work." Sen. Richard Shelby (R-Ala.) said, "If we look back, even to the New Deal, it's not going to help employment." And two economists argued in the Wall Street Journal that "there was even less work on average during the New Deal than before FDR took office."

But most mainstream economists say the lessons of the Depression, which didn't end until World War II spending kicked in, are different. They say New Deal spending programs instituted by President Franklin D. Roosevelt -- combined with moves to bolster the banking system, loosen monetary policy and end the gold standard -- did help put millions of people back to work. At the same time, they say that federal spending increases under Roosevelt before the war were modest compared with the size of the economy, and not a good test of stimulus spending.

"The Depression at its worst moment had 25 percent unemployed," said Alice Rivlin, former Clinton budget director and former director of the Congressional Budget Office. "Many of those people got back to work. Not all of them. We still had very high unemployment for many years. But to say it didn't work is to say we know what would have happened without it."

Like most disputes about the past, the wrestling match over the lessons of the Depression has everything to do with the present. If Roosevelt's New Deal programs -- such as the Civilian Conservation Corps, the Works Progress Administration and Social Security -- didn't revive the economy in the 1930s, Republicans in Congress have a powerful argument justifying their opposition to President Obama's stimulus program. And if the Roosevelt programs worked, Democrats can justify the huge stimulus package as following a successful precedent.

In fact, for most of the New Deal era, the economy grew quickly -- an annual rate of about 13 percent from 1933 to 1937 and more than 10 percent from 1938 to 1941, Commerce Department data show.

Many liberal economists say that shows the virtue of boosting spending. Dean Baker, co-director of the Center for Economic and Policy Research, said that "when Roosevelt came in, he started spending money, and from 1933 to 1937 the economy grew at a double-digit annual rate. It was soaring, and the unemployment rate fell at 4 percentage points a year."

But in 1937, the economy started tumbling backward again. Drawing an analogy to today's fiscally conservative Democrats in Congress, Baker said Roosevelt "listened to the Blue Dogs of his day and cut spending, and the unemployment rate rose again."

Government statistics show that federal spending as a proportion of the economy tripled from 1933 to 1937, but from a small base. In 1937, federal spending tumbled by 10 percent; the year before, the government had paid a one-time bonus to World War I veterans. Spending by all levels of government -- federal, state and local -- fell from almost 16 percent of gross domestic product in 1936 to 13.9 percent, essentially putting the brakes on the still-struggling economy. In addition, Roosevelt introduced Social Security, including a tax on wages that also hindered growth.

Many economists say that fiscal stimulus did not end the Depression because fiscal stimulus was not really tried; the spending increases were too small.

"The fiscal impulse was small relative to what was needed," says Barry Eichengreen, a University of California at Berkeley economics professor and author of a book that argues that getting off the gold standard was a key part of getting out of the Depression. "Did it end the Depression? No. Should we be surprised that it didn't end the Depression given its small size by the standards of the problem? No."

As for the lessons the New Deal has for today's stimulus plan, he said, "To argue that because policy was limp before and didn't work that it should be limp again strikes me as a total non-sequitur."

In 2008, total government spending was 20.2 percent of GDP, and the stimulus plan now under consideration would come to about 5.8 percent, albeit mostly spread over two years. As in the 1930s, it could be partly offset by reductions in state and local government spending.

Among economists, the debate over the Depression -- one result of the stimulus before it even has been enacted -- has followed partisan lines, but not always.

"The standard view among economic historians . . . is that the most important thing FDR did to get us out of the Depression was abandoning the gold standard, which freed the Federal Reserve to follow a more expansionary monetary policy," said N. Gregory Mankiw, a Harvard University economics professor who served as President Bush's chairman of the Council of Economic Advisers.

In an essay for the Encyclopedia Britannica, Christina Romer, now chairman of the Council of Economic Advisers, argued that the 42 percent increase in the money supply from 1933 to 1937 was the main driver of recovery. A tightening of money supply after the Fed ordered an increase in bank reserves in 1936-37, not just the cut in spending, explains the slowdown of the economy at the outset of Roosevelt's second term.

"The actual increases in government spending and the government budget deficit were small relative to the size of the economy," Romer wrote. "This is especially apparent when state government budget deficits are included, because those deficits actually declined at the same time that the federal deficit rose. As a result, the new spending programs initiated by the New Deal had little direct expansionary effect on the economy. Whether they may nevertheless have had positive effects on consumer and business sentiment remains an open question."

Asked how she squares that with her current support for the stimulus bill, Romer yesterday said: "Normally economists like me would say that when faced with recession, let monetary policy be the first tool. It is something you can change quickly." But, she added, "the thing that is striking about this time is that it is not an ordinary recession. Here we had one caused . . . by a financial meltdown. And even when the Fed tried to be fairly aggressive, it wasn't enough. That's why the usual rules would not apply."

Moreover, she said, the current stimulus is much bigger than anything Roosevelt tried. "It's a completely different animal in terms of size," she said.

Mankiw said that because New Deal spending was relatively tepid, "spending as stimulus is really betting on a theory rather than on empirical evidence. That's why economists are so divided on this."

Recently, economists have focused on the impact of regulatory actions during the New Deal. Lee E. Ohanian of the University of California at Los Angeles argues that the National Labor Relations Act and the National Industrial Recovery Act dampened competition and kept prices artificially high, thus reducing demand rather than stimulating it.

"If you're GM and I'm Ford, the government said, 'Keep prices high and don't undercut each other, and we'll let you do that as long as you help workers with higher salaries,' " Ohanian said. "It sounded good, and it was good for the workers who had those jobs, but . . . you're not going to hire many workers. And if you raise the prices of industrial goods above competitive circumstances, people aren't going to be able to buy many of them."

The debate over the New Deal and the Depression is often a matter of massaging numbers. Ohanian has helped fuel the conservative critique of the New Deal, in part by writing in a Wall Street Journal op-ed that "comparing hours worked at the end of the 1930s to those at the beginning of FDR's presidency doesn't paint a picture of recovery. Total hours worked per adult in 1939 remained about 21 percent below their 1929 level, compared to a decline of 27 percent in 1933."

But the same statistics can be used to say something quite different: Despite a growing population, the hours worked per adult rose 8 percent from 1933 to 1939 -- hardly a smashing success but at least a step toward recovery.

McConnell said last week that "in 1940, unemployment was still 15 percent. What got us out of the doldrums that we were in during the Depression was the beginning of World War II."

But is that an argument for or against stimulus? During the war, government spending soared sixfold and federal government debt more than doubled.

It was only in 1936 that John Maynard Keynes published his "The General Theory of Employment, Interest and Money," the book that provided the intellectual underpinning for deficit spending in economic downturns.

Today, the consensus on the role of government in pulling the economy out of recession is so widespread, Rivlin said, that the idea of government stimulus is built into "automatic stabilizers." When the economy slows, the government spends more on unemployment insurance, food stamps and Medicaid while taking in less in taxes. "It's already helping," she said.

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