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.
Posted by: JonWa | June 19, 2009 12:40 PM | Report abuse
Posted by: srw3 | June 19, 2009 12:58 PM | Report abuse
Posted by: JaneG | June 19, 2009 1:04 PM | Report abuse
Posted by: BeatKing11 | June 19, 2009 1:13 PM | Report abuse
Posted by: uberblonde1 | June 19, 2009 3:50 PM | Report abuse
Posted by: BigTunaTim | June 19, 2009 4:04 PM | Report abuse
Posted by: ostap666 | June 19, 2009 4:11 PM | Report abuse
Posted by: truck1 | June 20, 2009 11:39 AM | Report abuse
The comments to this entry are closed.