I’m a bit late to commenting on Christina Romer’s Sunday op-ed on monetary policy and the Great Depression, but it makes a point that bears repeating. The story most of us know about the Great Depression, the one in which Herbert Hoover screws up but then Franklin Delano Roosevelt comes in and hires people to paint murals and repair roads and defeat Hitler and that solves the problem, is wrong, or at least incomplete. Monetary policy — Boring, hard-to-understand, no-one-likes-to-talk-about-it, increases in the money base — was really the key to getting the economy back on track.
To get even more specific, the two policies Romer identifies as being key to the recovery were FDR’s decision to sign Executive Order 6102 and Hitler’s decision to overrun Europe.
Executive Order 6102 sounds pretty bizarre when you explain it. Remember that in the 1930s, dollars were backed by gold. Your dollar was worth what it was worth because the American government was committed to giving you a certain amount of gold in exchange for it. In Executive Order 6102, FDR forced every American to turn in almost all of their gold at a price of about $20 an ounce. Then he said that gold would stop being worth $20 per ounce and begin being worth $33 an ounce. This meant a massive devaluation in the dollar, which sounds bad, but actually meant a huge stimulus: our exports became cheaper and more popular, which in turn meant we created jobs because we needed more people to manufacture stuff that we could export.
As for Hitler, the more he did to threaten Europe, the more Europeans did to safeguard their money in the event of a Nazi invasion. That meant investing in American stocks and bonds, which expanded the amount of money in our economy, which lowered interest rates and increased expectations for future inflation (and eased fears of coming deflation), and gave consumers and businesses reasons to invest. For a bit more on this, the video at the start this post is an interview I conducted with Romer on yesterday’s edition of the Martin Bashir show, which I’m hosting all this week on MSNBC.
It’s worth emphasizing that this interpretation of the Great Depression is also held by economists of other political stripes. Greg Mankiw, George W. Bush’s former top economic adviser, wrote that “of all the things that Roosevelt did to get the economy out of the Depression, jettisoning the gold standard was the most successful.” Milton Friedman, the Nobel laureate and Reagan advisor also argued that the Great Depression and our recovery were substantially about monetary policy.
Obviously, we’re not on the gold standard today. The modern equivalent would be permitting a bit more inflation in the economy, with Romer, Mankiw and others, like financial-crisis expert Ken Rogoff, all favor. Some time ago, Chris Hayes wrote a very good piece on what this would mean, and how we might do it.
But we’re going in the opposite direction. As Dylan Matthews showed yesterday, the Republican Party has turned sharply against expansionary monetary policy. It’s worth noting that this happened during the Great Depression, too. In 1937, the Federal Reserve became worried about inflation, and the political system became worried about all this monetary and fiscal expansion, and we started pulling both back. The result? A fresh — and completely unnecessary — recession. For more on that, see “The Mistake of 1937,” a paper by Gautti Eggerttsson and Benjamin Puglsey, both of the New York Federal Reserve.