Monetary and Fiscal Policies during the Great Depression

We have argued that monetary and fiscal policies could have been used to help the economy out of the Great Depression. But what did policymakers actually do at the time? The answer comes in two parts: at the start of the Great Depression, they did not do much; after 1932, they did rather more.

Both presidential candidates campaigned in favor of conservative fiscal policy in 1932. Here are some excerpts from the party platforms. [***See John Woolley and Gerhard Peters, The American Presidency Project, accessed June 30, 2011, http://www.presidency.ucsb.edu.***]

From the Democratic Party platform:

We advocate an immediate and drastic reduction of governmental expenditures by abolishing useless commissions and offices, consolidating departments and bureaus, and eliminating extravagance to accomplish a saving of not less than twenty-five per cent in the cost of the Federal Government. And we call upon the Democratic Party in the states to make a zealous effort to achieve a proportionate result.

We favor maintenance of the national credit by a federal budget annually balanced on the basis of accurate executive estimates within revenues, raised by a system of taxation levied on the principle of ability to pay. [***“Democratic Party Platform of 1932,” The American Presidency Project, accessed June 30, 2011, http://www.presidency.ucsb.edu/ws/index.php?pid=29595#ax zz1N9yDnpSR.***]

From the Republican Party platform:

The President’s program contemplates an attack on a broad front, with far-reaching objectives, but entailing no danger to the budget. […]

Constructive plans for financial stabilization cannot be completely organized until our national, State and municipal governments not only balance their budgets but curtail their current expenses as well to a level which can be steadily and economically maintained for some years to come. [***“Republican Party Platform of 1932,” The American Presidency Project, accessed June 30, 2011, http://www.presidency.ucsb.edu/ws/index.php?pid=29638#axz z1N9yDnpSR.***]

Both parties were arguing for cuts in government expenditures, not the increases that (with the benefit of hindsight and better theory) we have suggested were needed. Monetary policy was likewise not used to stimulate the economy at this time. It seems unlikely that the fiscal and monetary authorities knew what to do but did nothing. Instead, the tools of economic thought needed to guide policy were simply not sufficiently well developed at the time. In keeping with the prevailing view that the economy was self-correcting, the incumbent Republican president, Herbert Hoover, had insisted that “prosperity is just around the corner.”

The election of Franklin Roosevelt in 1932 was a turning point. After his election, President Roosevelt and his advisors created a series of measures—called the New Deal—that were intended to stabilize the economy. In terms of fiscal policy, the US government moved away from budget balance and adopted a much more aggressive spending policy. Government spending increased from 3.2 percent of real GDP in 1932 to 9.3 percent of GDP by 1936. These spending increases were financed by budget deficits.

Roosevelt also took action to stabilize the banking system, most notably by creating a system of deposit insurance. This policy remains with us today: if you have deposits in a US bank, the federal government insures them. According to the Federal Deposit Insurance Corporation (http://www.fdic.gov), not a single depositor has lost a cent since the introduction of deposit insurance. [***The FDIC site (http://www.fdic.gov) provides a discussion the history of this fund and current activities. The discussion of “Who is the FDIC?” (http://www.fdic.gov/about/learn/symbol/index.html) is a good place to start.***] Finally, the 1930s was also the time of the introduction of Social Security and other measures to protect workers. The Social Security Administration (http://www.ssa.gov) originated in 1935. [***General information on social security is available at http://www.ssa.gov. The history of the legislation, including various House and Senate Bills, is also available athttp://www.ssa.gov/history/history.html. The original act included old-age benefits and the provision of unemployment insurance. The disability part of the program was created in 1956.***]

The New Deal brought about changes not only in policy but also in attitudes toward policymaking. Gardiner Means, who was an economic adviser to the Roosevelt administration in 1933, said of policymaking at the time:

It was this which produced the yeastiness of experimentation that made the New Deal what it was. A hundred years from now, when historians look back on this, they will say a big corner was turned. People agreed old things didn’t work. What ran through the whole New Deal was finding a way to make things work.

Before that, Hoover would loan money to farmers to keep their mules alive, but wouldn’t loan money to keep their children alive. This was perfectly right within the framework of classical thinking. If an individual couldn’t get enough to eat, it was because he wasn’t on the ball. It was his responsibility. The New Deal said: “Anybody who is unemployed isn’t necessarily unemployed because he is shiftless.” [***See Studs Terkel, Hard Times: An Oral History of the Great Depression (New York: Pantheon Books, 1970), 247.***]

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