Let's learn from Depression what works, what doesn't
The Indianapolis Star
Wednesday, Feb. 25, 2009
Opinion column by: Peter Grossman, Clarence Efroymson Professor of Economics
A letter to the editor in The Star Feb. 9 praised a column I wrote last fall critiquing President Franklin Roosevelt's policies during the Great Depression. While it's always nice to be complimented, there was a problem with the letter: I didn't write the column on the subject.
But I thought I'd express my actual views on the Depression and its relevance for our current economic slump.
The conventional view of the era is that President Herbert Hoover did nothing, preferring that the market solve the problems in the economy. Roosevelt, meanwhile, was an activist who had the right idea but didn't go far enough. It took the massive spending of World War II to pull us out of the worst economic period in American history. According to this view, the Obama administration needs to spend much more than it already has. Paul Krugman, economist and newspaper columnist, has argued that we need a stimulus at least double the current $787 billion package.
But both the analysis and prescription are wrong. The historical record suggests that it was what Hoover, Roosevelt, Congress and the Federal Reserve did that hurt the economy most. It wasn't what they didn't do.
Hoover didn't simply wait for the market to solve the problem. In fact, he increased government spending significantly and adopted that most popular stimulus program: infrastructure spending. But why then did a nasty recession turn into the Great Depression? Part of the fault lay with the Federal Reserve and its policies. But Hoover compounded them when he raised taxes and signed the Smoot-Hawley tariff that was intended to protect American jobs and prop up prices for U.S. producers. Instead, it stifled world trade.
Roosevelt made the same kinds of mistakes. He also raised taxes and tried to prop up prices, not through trade barriers, but by allowing businesses to collude, stifling competition. Although he put some people to work, the fact is that by the end of the 1930s 15 percent of the work force was still unemployed and his policies were partly to blame.
For all his mistakes, though, Roosevelt did a couple of things right. First, he made people feel optimistic. Expectations matter, and people expected things would improve because Roosevelt was confident and seemingly in control. We had nothing to fear except fear itself.
President Barack Obama has been the voice of fear itself. We are on the verge of a catastrophe, he tells us, when in fact we are nowhere near the desperate straits of the 1930s. In the meantime, a sense of panic has produced a bill more than 1,000 pages long that no one has read, that can be considered a stimulus in only the loosest sense and that seems to have been foisted on Obama by a partisan and basically clueless Congress.
The confusion spread by Obama and government has led to a standstill in parts of the economy as people wait to see just what the government is going to do next.
Roosevelt also put some useful policies in place that have no counterparts in current legislation. Most important, he enacted so-called "automatic stabilizers" like unemployment benefits. Unlike the early 1930s, now there's a mechanism for people to retain an income to buy necessities and allows them to look for work instead of scrounging for a dime.
Another Roosevelt-era measure, the Federal Deposit Insurance Corporation, also created lasting benefits. During the Depression, many banks failed because worried depositors demanded their money. This time there are no lines of anxious bank customers, even when a bank is, like Citibank, facing massive losses from stupid, greedy practices.
Such stabilizing mechanisms can keep catastrophe at bay and permit markets to slowly make the adjustments necessary to restore economic growth. That is, unless Congress and the Obama administration embark on the kind of counterproductive policies that can turn a recession into a depression. And with Congress attempting to put protectionist "Buy American" rules into the stimulus and House Speaker Nancy Pelosi still demanding higher taxes on the "rich," I'm not confident of the outcome.
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