Conservatives are making a push to rewrite the constitution. One of their improvements would be a balanced budget amendment. This would preclude a number of activities, including war. Such an amendment also would preclude managing the economy (which is it’s point). What could go wrong?
When the stock market crashed in 1929, both the Fed and Herbert Hoover punted.[i] Not until Franklin Roosevelt took office in 1933, three and a half years after the collapse, did the government make a serious attempt at reviving the economy. The New Deal was not perfect: it was breaking new ground in a ground-breaking depression. And, as with any policy, it was made by committee and then subject to compromise. Still, it was far more productive than its detractors would have us believe.
According to Christina Romer, a professor of economics at the University of California, Berkeley and a former Chair of the Council of Economic Advisers in the Obama administration, “the truth is the recovery in the four years after Franklin Roosevelt took office in 1933 was incredibly rapid.” And that is given that Roosevelt faced a banking system that had seized up, a country full of Hoovervilles, and lines of the unemployed filling the sidewalks in front of soup kitchens. He took action, implementing bailouts and expansionary monetary and fiscal policies, all at the expense of a balanced budget. The result? It was said that Roosevelt saved capitalism in 8 days. He may have save democracy in the rest of his first term.
Then came a misstep. As Romer explains, “that growth was halted” by a “switch to contractionary fiscal and monetary policy.” Patricia Waiwood of the Federal Reserve Bank of Cleveland points to a reduction in the money supply by the Federal Reserve and the Treasury Department and to tax increases by the administration. People were looking to transition from active recovery policies to a more neutral stance, specifically, to a balanced budget. It was too soon.
The resultant recession of 1937 must have felt devastating to the country. Fortunately, Roosevelt maintained his vision. The Fed and the Treasury rolled back their policies, and Roosevelt turned back to expansionary policies. Waiwood notes that the “recovery from 1938 to 1942 was spectacular: Output grew by 49 percent, fueled by gold inflows from Europe and a major defense buildup.” She also connects both the recession and the recovery within a recovery to “changes in the net effect of government spending [which] have been heavily emphasized as a cause of both the recession and the revival of 1937‒38.”
The market had crashed and the bottom had fallen out of the economy. Years of the government doing little or nothing had made it worse. Keynesian stimulative policies turned it around. Premature withdrawal of stimulative policies brought on renewed recession. That was turned around, again, by expansionary policies. You can argue the fine points around the boundaries or suggest ad hoc explanations for certain events during the Great Depression and the recovery, but the envelope of events is clear, and it supports both Roosevelt’s intuition and John Maynard Keynes’ analyses.
In Nazi Germany, the economic minister borrowed money and printed more to finance a public works program. The German economy was reborn. In Britain, the May Committee proposed cutting government expenditures, including unemployment benefits. The alarmist tone regarding the deficit “shocked the markets” and made things worse. Keynes called the report “the most foolish document I have ever had the misfortune to read.”
Since the Great Depression, the idea of government stimulating the economy to turn around a recession has proven itself in multiple if less consequential cases. The opposite has been demonstrated as well: putting the brakes on an economy too hard resulting in a recession. And, of course, there have been misapplications of Keynes along the way: expansionary policy was never presented as a cure-all and can do damage in the wrong situation. However, the National Bureau of Economic Research has data on recessions back to 1854 that suggests that “the business cycle has become less severe,” and one of the factors thought to be involved is “the adoption of interventionist Keynesian economics and the increase in automatic stabilizers in the form of government programs (unemployment insurance, social security, and later Medicare and Medicaid).”
We still don’t have a surfeit of data, but setting policy cannot wait for definitive proofs. There is enough data to suggest policy directions: clear indications from real-life cases. It would be foolish to ignore them in favor of political bias.
Unless, of course, you had a convenient excuse. In 1998, Alberto Alesina and Silvia Ardagna published a paper in Economic Policy, summarized here. The paper presents the “recently observed phenomenon of fiscal tightening that produces (non-Keynesian) expansionary effects.” That is, they claim that economic growth can be produced by what popularly is called austerity, the opposite of Keynesian stimulative policy.
If that gave the drown-the-government-in-the-bathtub crowd a tingling sensation all over, it got better. “For this effect to produce an expansion, the tightening must be sizeable and occur after a period of stress when the budget is quickly deteriorating and public debt is building up.” And the icing on the conservative cake: “Typically, a fiscal consolidation based on tax increases is short-lived. To be long lasting, it must include cuts in public employment, transfers and government wages.”
The paper came out in plenty of time to be assimilated before the Great Recession. Of course, you might think that previous, real-life experiences would have given at least pause to those who embraced a paper on a “recently observed phenomenon” that contradicted previously observed phenomena. But this was not about economics. It was politics. By 2009, Alesina and Ardagna were preaching everywhere to small-government choirs. The confidence fairy was born. Alesina and Ardagna were saying that large spending cuts during drastic downturns would give the private sector confidence. (It would turn out that the private sector could have used a little cash, instead.)
In 2010, Greece collapsed, and the anti-Keynesians came out of the closet. Europe turned to austerity with a vengeance. But austerity made things worse, often much worse. This really should not have been a surprise. The Roosevelt Institute explained why we had to relearn what we already knew, at least in technical terms: the Alesina and Ardagna work included enough cherry-picking of data and enough assumptions that, by 2013, it had been reduced to an offhanded reference to discredited ideas in one of Paul Krugman’s book reviews. Politics is the explanation for why a paper that never should have passed the “smell test” was so widely and unhesitatingly embraced.
The damage had been done, though, and, worse, was just starting here at home. Our initial response to the Great Recession was dominated by policy makers who had paid attention, who had learned that government spending could create jobs during severe downturns while deficit spending would not bring on the apocalypse. Ben Bernanke was able to stop the freefall using monetary intervention. The Federal Reserve slashed interest rates and bought long-term debt. An additional $800 billion dollars in tax cuts and spending increases by the Obama administration began an American recovery. Some thought this stimulus insufficient, but what matters is that enough politicians, economists, and policy makers did the right thing. The Bush recession remained the Great Recession rather than a second Great Depression.
Amazingly, knowing that, knowing the history of the Great Depression and of the years between, knowing what austerity was doing in real-time to Europe, American voters gave the Tea Party, the bat-shit crazy wing of the Republican Party, a voice in congress in 2010. (Of course, it didn’t help that Democrats, rather than standing up for what they had accomplished, lay curled up in fetal positions during the entire election.)
Professor Romer called the recession of 1937 “a cautionary tale.” The Tea Partiers steadfastly refused to learn from either the past or the present. Cheered on by the Republicans they soon would come to dominate, they forced Sequestration in 2013, creating a massive drag on an already slow recovery.
The Fed has keep rates low, but monetary policy can do only so much when fiscal policy is working against it. Ben Bernanke told the Senate Banking Committee, “There’s a mismatch with the timing of the spending cuts. The problem is long-term, but the cuts are short-term and do harm to the recovery.” Europe, of course, still is struggling and in need of government investment. Paul Krugman makes the point most broadly in condemning the IMF for advocating fiscal contraction almost worldwide even when “inflation is below-target everywhere despite unprecedented monetary expansion.” In short, “our sole reliance on central banks isn’t working.”
Roosevelt knew by instinct that increasing unemployment in times such as the Great Depression was destructive and pointlessly cruel. As part of a 1925 critique of Churchill’s return to the gold standard, John Maynard Keynes said,
“The proper object of dear money is to check an incipient boom. Woe to those whose faith leads them to use it to aggravate a depression!”
Roosevelt also understood that taking money out of a sickly, wounded economy was just dumb. He did the opposite, and, during his first term, industrial production doubled and the GDP grew 40%. The Tea Party looked to Europe and said, “We’d rather be like them.”
The data are neither extensive nor definitive, but they are consistent with government intervention during extreme downturns, they are consistent with deficit spending during downturns, and they are consistently anti-austerity. At this point, it becomes an I.Q. test.
[i] In the months after October of 1929, the Fed did reduce rates and inject money into the banking system, just too timidly. And in early summer of 1930, it reversed itself. The economy immediately worsened. The Fed also completely ignored the default of virtually all of central Europe in 1931 and, in 1932, defaulted on its own responsibility to be the lender of last resort. Hoover, equally timid in his actions, allowed a deficit budget, but the government was too small relative to the GDP for his minimal effort to have an effect.