Obama’s economists are repeating the mistakes of the past by pulling back financial stimulus too soon
Paul Krugman
Here’s the situation: The United States economy has been crippled by a financial crisis. The President’s policies have limited the damage, but they were too cautious, and unemployment remains disastrously high.see anything like the miracle of the 1940s happening again.
THE NEW YORK TIMES
The writer is a professor of economics and international affairs at Princeton University. He received the Nobel Prize in Economics in 2008.
More action is clearly needed. Yet the public has soured on government activism, and seems poised to deal Democrats a severe defeat in the mid-term elections.
The President in question is Franklin Delano Roosevelt; the year is 1938. Within a few years, of course, the Great Depression was over. But it’s both instructive and discouraging to look at the state of America circa 1938 — instructive because the nature of the recovery that followed refutes the arguments dominating today’s public debate, discouraging because it’s hard to
Now, we weren’t supposed to find ourselves replaying the late 1930s. President Barack Obama’s economists promised not to repeat the mistakes of 1937, when FDR pulled back fiscal stimulus too soon.
But by making his programme too small and too short-lived, Mr Obama did just that: The stimulus raised growth while it lasted, but it made only a small dent in unemployment — and now it’s fading out.
And just as some of us feared, the inadequacy of the administration’s initial economic plan has landed it — and the nation — in a political trap.
More stimulus is desperately needed, but in the public’s eyes the failure of the initial programme to deliver a convincing recovery has discredited government action to create jobs.
In short, welcome to 1938.
The story of 1937, of FDR’s disastrous decision to heed those who said that it was time to slash the deficit, is well-known.
What’s less well-known is the extent to which the public drew the wrong conclusions from the recession that followed:
Far from calling for a resumption of New Deal programmes, voters lost faith in fiscal expansion.
Consider Gallup polling from March 1938. Asked whether government spending should be increased to fight the slump, 63 per cent of those polled said “no”. Asked whether it would be better to increase spending or to cut business taxes, only 15 per cent favoured spending; 63 per cent favoured tax cuts. And the 1938 election was a disaster for the Democrats, who lost 70 seats in the House and seven in the Senate.
Then came the war.
From an economic point of view World War II was, above all, a burst of deficit financed government spending, on a scale that would never have been approved otherwise.
Over the course of the war the federal government borrowed an amount equal to roughly twice the value of GDP in 1940 — the equivalent of roughly US$30 trillion ($40.3 trillion) today.
Had anyone proposed spending even a fraction of that much before the war, people would have said the same things they’re saying today. They would have warned about crushing debt and runaway inflation.
They would also have said, rightly, that the Depression was in large part caused by excess debt — and then have declared that it was impossible to fix this problem by issuing even more debt.
But guess what? Deficit spending created an economic boom — and the boom laid the foundation for long-run prosperity.
Overall debt in the economy — public plus private — actually fell as a percentage of gross domestic product, thanks to economic growth and, yes, some inflation, which reduced the real value of outstanding debts. And after the war, thanks to the improved financial position of the private sector, the economy was able to thrive without continuing deficits.
The economic moral is clear: When the economy is deeply depressed, the usual rules don’t apply. Austerity is self-defeating:
When everyone tries to pay down debt at the same time, the result is depression and deflation, and debt problems grow even worse. And, conversely, it is possible — indeed, necessary — for the nation as a whole to spend its way out of debt: A temporary surge of deficit spending, on a sufficient scale, can cure problems brought on by past excesses.
But the story of 1938 also shows how hard it is to apply these insights. Even under FDR, there was never the political will to do what was needed to end the Great Depression; its eventual resolution came essentially by accident.
I had hoped that we would do better this time.
But it turns out that politicians and economists alike have spent decades unlearning the lessons of the 1930s, and are determined to repeat all the old mistakes.
And it’s slightly sickening to realise that the big winners in the midterm elections are likely to be the very people who first got us into this mess, then did everything in their power to block action to get us out.
But always remember: This slump can be cured.
All it will take is a little bit of intellectual clarity, and a lot of political will. Here’s hoping we find those virtues in the not too distant future.
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