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The Need for a Third Stimulus

In The Economist this week, Christina Romer tells "the story of 1937."

The recovery from the Depression is often described as slow because America did not return to full employment until after the outbreak of the second world war. But the truth is the recovery in the four years after Franklin Roosevelt took office in 1933 was incredibly rapid. Annual real GDP growth averaged over 9%. Unemployment fell from 25% to 14%. The second world war aside, the United States has never experienced such sustained, rapid growth.

However, that growth was halted by a second severe downturn in 1937-38, when unemployment surged again to 19% (see chart). The fundamental cause of this second recession was an unfortunate, and largely inadvertent, switch to contractionary fiscal and monetary policy. One source of the growth in 1936 was that Congress had overridden Mr Roosevelt’s veto and passed a large bonus for veterans of the first world war. In 1937, this fiscal stimulus disappeared. In addition, social-security taxes were collected for the first time. These factors reduced the deficit by roughly 2.5% of GDP, exerting significant contractionary pressure.

"The 1937 episode provides a cautionary tale," she concludes. "The urge to declare victory and get back to normal policy after an economic crisis is strong. That urge needs to be resisted until the economy is again approaching full employment. Financial crises, in particular, tend to leave scars that make financial institutions, households and firms behave differently. If the government withdraws support too early, a return to economic decline or even panic could follow." We're not, in other words, out of the woods yet.

In response, Free Exchange, the magazine's blog, is hosting a roundtable on the question. Mark Thoma advises that we "assume the worst." A world in which we overspent to forestall a depression that never comes is preferable to a world in which we underspent and triggered a crisis that we could have avoided.

Brad DeLong basically agrees and calls for a new stimulus on the order of trillions of dollars. In particular, he makes the point that the administration's white paper arguing for a stimulus last year assumed an unemployment peak of 7.9 percent in 2009. As the following graph shows, we far above that already, and pretty sure to hit 10 percent this year:


To paraphrase Keynes, what should you do when the facts that led to your stimulus change? Why, you change your stimulus accordingly.

By Ezra Klein  |  June 19, 2009; 12:26 PM ET
Categories:  Charts and Graphs , Economic Policy  
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You know what would make a good stimulus. Medicare for all without health insurance (payment plus 14% so doctors sign on) to all without health insurance. That would cause people to consume a lot of goods.

Posted by: JonWa | June 19, 2009 12:40 PM | Report abuse

Like the civil rights movement before, the right doesn't see (or is willingly not seeing) what is in front of their eyes. The need for another stimulus is clear. When will the democrats grow pair and insist on getting the economy back on track instead of playing games with the future of this country.

Posted by: srw3 | June 19, 2009 12:58 PM | Report abuse

This is word for word what Krugman said we had to do, and why, including exactly how much too much optimistic their forecasts were.

Posted by: JaneG | June 19, 2009 1:04 PM | Report abuse

I love it. We need another stimulus package when the one we have has yet to show any effectiveness.

Posted by: BeatKing11 | June 19, 2009 1:13 PM | Report abuse

Yes, Krugman said it wasn't enough - and Brad DeLong said it was.

Posted by: uberblonde1 | June 19, 2009 3:50 PM | Report abuse

Check out the update to Krugman's column this morning. Gallup polling from the mid-1930's on the desirability of deficit spending is frighteningly analogous to today's numbers. If we choose to listen to advice on fixing the economy from the same great minds who destroyed it, we could yet see another depression.

@BeatKing11: "I love it. We need another stimulus package when the one we have has yet to show any effectiveness."

Which neoconservative talking head did you get that whopper from? Stick to whatever it is you know, kid, because economics isn't it.

Posted by: BigTunaTim | June 19, 2009 4:04 PM | Report abuse

Here we are 4 months after the so-called stimulus bill was passed, and according to Tyler Cowen, less than 10% of the stimulus money has been spent. The government is inefficient, you know. The agency I deal with has been glacial in delivering so-called stimulus funds -- predictably glacial I might add. Only a moron would have predicted otherwise.

You nonetheless want another so-called stimulus bill. Money won't flow, no, make that dribble, out of that bill for a long time, and will consume precious resources.

So, you'd rather have the government spend money on a load of crap than on health reform. It's your choice, but I find it bizarre.

Posted by: ostap666 | June 19, 2009 4:11 PM | Report abuse

Well yes, of course we need another stimulus. All the people who needed payoffs after the election, like the son of David Obey, whose client got a bundle, have run through their initial stimulus loot.

Posted by: truck1 | June 20, 2009 11:39 AM | Report abuse

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