Does the 1937-38 "Depression Within the Depression" Vindicate the Keynesians?
In the thread of my infomercial for my new book, a reader asks an excellent question:
Just yesterday I received your book and after skimming it, I must say that it looks like it is going to be excellent! Hopefully I can start reading it this weekend. One point though. In part of your first chapter you bring up the “depression within the Depression” of 1937/’38. In that chapter you describe what happened in that episode. However, when I searched the latter part of the book for your explanation of why that “depression within a depression” occured, I could not find it. I think that explaning why the ’37/’38 depression occured is important because I recall Krugman using it to defend Keynesian theory. If I recall correctly, he said that FDR decided to try to reduce the deficit at that time by raising taxes and cutting spending and for this reason the tenuous recovery was aborted. This, Krugman claims, is evidence that Keynesian theory is accurate. So, my question to you is, do you explain the cause of the depression of ’37/’38 in your book, and if so on what pages? If you don’t discuss it in your book, how would you answer Krugman?
My response:
Thanks for the note. You’re right, any Keynesian who reads the book is going to accuse me of deception for “glossing over” the 1937/38 episode.
There were a few things going on, which I didn’t go into because my editor was already pruning way back on the technical tangents.
So yes, FDR tried to close the budget deficit somewhat, and that’s what Krugman et al. think did it.
But there was also a doubling (I believe) of the reserve ratio for the banks, and that’s what monetarists point to, to prove their theory that it was insufficient money pumping.
Yet a third thing was that the Supreme Court upheld the NLRB, and union membership shot way up in one year, pushing up certain wages. Not surprisingly, this is the factor that I like. 🙂
So basically you had all kinds of stuff changing, and whatever the economist’s favored theory is, will be there for him to see.
I think I did a pretty good job exploding the alleged medicinal role of huge deficits by comparing Hoover’s experience with Harding’s. I.e. if it were really true (as Krugman claims) that cutting the deficit caused the problem in 37/38, then what Wilson/Harding did in 1920-21 should have yielded by far the worst economy in US history. But no, it paved the way for the best economy in US history (Roaring Twenties).
