Monday, May 2, 2011

Those Pesky Postwar Recessions

Well, the debate over my post on Keynes on central planning has gone viral all over the place, and I shall make no attempt to link to all of it. However, I do want to comment further on a point raised actually in Facebook debates on this by one of the makers of the video in question, John Papola. This has to do with the accusation that Keynes was (maybe) a supporter of what has been called "military Keynesianism," with the point being made in the video that unlike what lots of Keynesians supposedly said (Samuelson being provided in the debates as an example in 1943, although not Keynes himself), we did not go into a deep depression after WW II, even though there was no massive fiscal stimulus and there was this sharp drop in government spending with the end of the war.

This curiously relates to a matter that has been much argued about previously on various blogs, namely the nature of the short and sharp post-WW-I recession of 1919-20. Some have argued that this shows how wrong Keynes was, because laissez-faire was followed, including letting prices (and some wages) fall sharply in 1921, with the economy bouncing back very nicely, after having the unemployment rate soar from 5% in 1920 to 9% in 1921. Most economic historians have attributed this recession to "postwar adjustment problems."

OTOH, some of those making a big fuss about that recession somehow fail to notice that in fact there was a post-WW-II recession, if also very brief, if sharp. It occurred in 1945 with the sharpest decline in wartime spending, although not much remembered. However, the official stats have US declining in GDP by a whopping -12.7% in that year, although that number must be taken with some grains of salt due to all kinds of measurement issues and restructurings. Some say this exaggerates things as the unemployment rate only went from 1.5% to about 3.6%, a rise, but not all that much to get worked up about.

Two points. The first is that this latter event does not account for the massive decline in female labor force participation that occurred in 1945, from about 38% to about 30%. We all know (or should) that those withdrawing from the labor force do not count in the unemployment rate. That not very large increase in the UR does not disprove that there was a sharp (if short) decline in GDP. (Rosie the Riveter went home to boom out those babies, and to buy houses to be built, given that basically none had been for about 15 years in the US).

The other point, which is perhaps more cogent for the debates here, involves monetary policy. Frightened of rising inflation, the inexperienced Fed raised the discount rate sharply during 1919-20, halting doing so in June, 1920 as it became clear that the economy was plunging into recession. OTOH, the very loose monetary policy of WW II basically continued during the immediate postwar years, only finally ended with the Fed-Treasury Accord of 1951 in the face of rising inflation tied to the Korean War. So, it may well have been that the Fed was listening to Samuelson and was slow to tighten monetary policy, thereby helping to ease that postwar transition and make sure that the one after WW II was not as sharp as the one after WW I, despite the much larger adjustments that were made.

Added: For some strange reason the system is not allowing me to comment. So, I shall reply to some comments here in the main post.

To John Papola.

OK, I grant that you have "Keynes" saying "too bad" about the wartime achievement of full employment and accept that you recognize that he was a pacifist prior to WW II. In the same place he made his statement you quote he expressed optimism that full employment could be achieved after the war with aggregate demand management without interfering with individual decisionmaking.

I am not sure why you cite Higgs on reduced consumption levels due to rationing and so forth in WW II. Everyone knew about that, certainly including Keynes who discussed such matters in his "How to pay for the war," which was all about restraining the excessive aggregate demand associated with the war.

I continue to maintain that one needs to track labor force participation. Womens' participation rose at the beginning of the war above anything previously seen and then fell at the end of the war sharply. Anyone who quotes unemployment rate changes without noticing that is being disingenuous at best. I have no problem at all with tracking employment rates (percent of working age employed) rather than unemployment rates, which have always been known to suffer from these problems.


The recession started in Feb. 1945, but went on for 8 months, with NBER giving the GDP decline as -12.7%, larger than any since, including our most recent recession. Sure, there were measurement issues and index number problems with all that restructuring, but the 2% increase in the official unemployment rate combined with the 8% decline in female labor force participation is consistent with a pretty sharp decline in GDP, if not necessarily a full -12.7%.


John Papola said...

I have a few points.

First, regarding "military Keynesianism"… our "Keynes" says in the song "TOO BAD that only happens when there's a world war". This is a lament, not a celebration, and one that was made by Keynes in his 1940 piece in the The New Republic.

Here's the Master himself:

"It is, it seems, politically impossible for a capitalistic democracy to organize expenditure on the scale necessary to make the grand experiments which would prove my case — except in war conditions"

(via Bruce Bartlett

Given the level of intense scrutiny of "your central plan" in some quarters including by yourself (though much more honestly and charitably than some others), and even in light of the fact that this line is directly inspired by our conversation with Robert Skidelsky (as you'll soon see), I would have liked to see a little more acknowledgement of "too bad". Is there a three word minimum on taking rap verses seriously. (I'm being a little glib here, but my point is made).

The man who wrote "The Economic Consequences of the Peace" was not a war-monger. I've never said otherwise.

Regarding the post WWII recession in 1945, it seems to me like the problems with nominal GDP data in a world transitioning away from large scale price controls are more than a sidetone. They are central. I direct you to Robert Higgs for that argument, who is the inspiration of our "Hayek" in those verses. Links are available at to learn more. I'm not an economist, I just read a lot. Robert can defend his work. It seems compelling and logical.

It is crucial that unemployment only went up to 3.6%, Barkley. The ENTIRE premise behind Keynesian policy is maintaining "full employment". THAT is the goal. So a collapse of nominal GDP with a minor bump up in unemployment only serves to further the case for skepticism about the relationship between employment and aggregate demand. My understanding is that Samuelson's doomsday predictions (and they were grim in light of being in a depression) were not an outlier, but a representation of the consensus among Keynesians at the time. If this is wrong, please let me know.

John Papola said...

As for Rosie the Riveter… if we apply this standard equally, then surely we should push the depression unemployment numbers quite a bit higher, should we not? After all, Rosie the Riveter began her riveting career out of utter necessity since Ricky the Ratchet man went off to war. Was she "unemployed" before that? This line of argument is what I believe to be called "moving the goalpost". In fact, if we're going to move said goalpost and judge unemployment based on the population of stay-at-home moms and wives, the entire post war era needs some adjustments does it not?

As for the 1920s and 1950s and monetary policy, I have a few additional thoughts.

Your wording makes it seem as if the inflation post WWI was exogenous to Fed policy instead of being the direct result of it. This is a common tone I've found in Keynesian exposition of monetary policy (not that you're a Keynesian. I don't know.) The Fed was CAUSING the inflation of post WWI period and it stopped. The recession that followed, in line with an Austrian analysis, was one of "recalculation" and despite the deflation which David Frum and others have treated like an inescapable black hole of despair, the recession was deep but short. Where for art thou, sticky wages and underemployment equilibrium?

It is incomplete to look at the Fed hiking rates in the 1919-1920 as the "cause" of the recession and treat the policy as if they were "fighting inflation" (to quote others). They caused the inflation. They stopped. The only thing they were fighting was themselves. Paul Krugman talks of the 1982 recession in the same way. It's weird to me. The alternative was to keep going with the pedal to the monetary metal, with even greater inflation. Why is this not discussed? Where was the alternative in 1920 or 1980 if the Fed's policy was somehow avoidable?

Maybe I'm just confused because I'm a member of the "pointless pain caucus" (not your words, I know). So far, I don't know where to look for the policy that actually avoid pain in reality.

John V said...

Now there's supposed support by Keynes for "military keynesianism" in the video?

Come on. *shakes head incredulously*

All these "debates" about the video are purely the result of reaching and paranoia.

I think the debate on the real premise would be much more informative.

Mark A. Sadowski said...

In a sense what Keynes and Hayek actually thought or said doesn't really matter anymore because in the long run they're both still dead.

However, the debate reveals much about where we are today with respect to macroeconomic stabilization policy. This quote from Hayek in 1977 comes to mind:

"From that point of view, Milton's monetarism and Keynesianism have more in common with each other than I have with either."

The divide is not really between advocates of fiscal stimulus and those who do not think it is necessary, but between those who think that macroeconomic disequilibria can occur (and consequently something should be done about it) and those that do not.

The postwar recessions are frequently sited by Austrians as thought they prove their case but close examination reveals the opposite. The post WW II recession was mild not because the economy automatically found its equilibrium but because the Federal Reserve managed to pursue an appropriate policy in the face of a negative shock to AD from the decline in wartime spending and a negative shock to AS from Rosie's exit from the labor force.

Mark A. Sadowski said...

And the 1920-21 recession is always sited as proof by Austrians that tax cuts are the best way to end recessions. But the timing for the role of tax policy is all wrong. The recovery from the recession started in August 1921. The Revenue Act of 1921 was not signed into law by Harding until November and was not implemented until 1922. By the time the Revenue Act was passed industrial production had already risen over 10%, and by the time it was implemented it was up over 15%. Furthermore it's not clear that the Revenue Act of 1921 was really a tax cut. The top rate was reduced from 73% to 58% but the base at that rate was broadened from all income over $1,000,000 to all income over $200,000. The average effective tax rate actually rose from 3.7% to 4.0%.

The recession of 1920-21 is a complicated story involving a shift from a wartime to peacetime production and sudden deflation in the price goods that were severely inflated during the war (clothing and food). But I think it's clear that, similar to the post WW II recession, monetary policy was the primary driver in both the recession and the subsequent recovery.

The discount rate was the policy instrument in those days. It was raised from 4.5% in January 1920 to 7% in July 1920. The recession started in January but industrial production didn't begin its swift decline until August. The discount rate was reduced steadily to 4.5% between April and December 1921, and it was further reduced to 4% by July 1922. Although technically the recovery began in August, industrial production didn't begin to recover in earnest until October. It's fairly well established that monetary policy lags were somewhat shorter in the pre-WW II period.

A good paper that sets the record straight on the 1920-21 recession is here (paid content unless you're associated with a university):

All of this is relevant now. Something can and should be done (unless you really think 9% unemployment is the new normal).

RussRoberts said...

The NBER identifies a mild recession in February 1945 (while the war was still going). The drop in GDP, as John points out, was due to measurement issues as price controls were dropped and measured prices rose.

If you go to the links we have posted about the ideas in the video (, check out the articles by Woytinsky and Hagen. They are academic articles of the day (from JPE and ReStat) about the miserable predictive performance of the Keynesian model in the aftermath of WWII. Woytinsky, an anti-Keynesian chronicles the failure and Hagen, a defender of the models, explores what went wrong. They are very interesting. You'll also find the Higgs work posted on that page that looks at wartime consumption rather than just GDP.

John V said...


"And the 1920-21 recession is always sited as proof by Austrians that tax cuts are the best way to end recessions."

I have never seen that claim. Ever. And it was made, I am not aware of it and I read quite a bit.

The most common conclusion that I see drawn from the 1920-21 recession is that doing nothing and letting the market adjust on its own caused a efficient and painful but brief recession. That's it. You'll find that citing quite a bit.

John V said...


Robert Higgs at the Independent Institute has written quite a bit on the economics of WW2 and post-war conditions. His take is worth reading.

Mark A. Sadowski said...

Robert Murphy, Thomas Woods, and Jim Powell have all made that claim. And it is repeated ad nauseum in the Austrian blogdom echo chamber. See the link I posted above for a critique.

John V said...


That link to springerlink is to an intro...which says nothing about tax cuts. I'm not paying $34 to read it either.

I read Murphy now and then and have never seen such a claim. But that's not a denial that he made that argument. I just haven't seen it.

Mark A. Sadowski said...

John V,
Yes, sorry about that. One my perks as a doctoral candidate/adjunct is that I have free access.

Here's what Thomas Woods has said for example:

"Instead of “fiscal stimulus,” Harding cut the government’s budget nearly in half between 1920 and 1922. The rest of Harding’s approach was equally laissez-faire. Tax rates were slashed for all income groups. The national debt was reduced by one-third. The Federal Reserve’s activity, moreover, was hardly noticeable."

Glenn Beck parroted these claims on air as recently as April 2010. But like I've said, the tax cut meme is everywhere and has multiple sources.

John Papola said...

Barkley, for some reason, the last part of my reply kept getting bumped. Here it is…

Maybe I'm just confused because I'm a member of the "pointless pain caucus" (not your words, I know). So far, I don't know where to look for the policy that actually avoid pain in reality.

Lastly, everyone (especially David Frum) needs to come to grips with the fact that F. A. Hayek's actual policy norm called for the maintenance of nominal spending by way of momentary policy to accommodate excess demands for money. As Scott Sumner has repeated proclaimed, his approach is very similar to Hayek's. So the claim that monetary policy post WWII helped to ease the transition probably has merit, but it surely doesn't counter Hayek nor favor Keynes over Hayek (or Friedman).

What made Keynes different from Hayek was his insistence that interest rates didn't coordinate saving with investment, that "liquidity preference" defined the interest rate, and that monetary policy would become stuck in a "liquidity trap", hence the need for Fiscal policy.

I turn your attention to this article:

“It is agreed that hoarding money, whether in cash or in idle balances, is deflationary in its effects. No one thinks that deflation in itself is desirable.” - 1932.
Now hear this. F. A. Hayek and Lionel Robbins were proclaiming in 1932 in the pages of the Times that "NO ONE THINKS THAT DEFLATION IN ITSELF IS DESIRABLE".

Money is a specific good. Creating more of it to meet demand is a very different kind of economic process than treating "goods in general" as some blob which can have a "glut". So I do not see monetary policy to maintain NGDP as being similar to keynesian fiscal stimulus. But that's for another time…

Mark A. Sadowski said...

John V.,
Here's what Jim Powell has claimed:

"With Harding’s tax and spending cuts and relatively non-interventionist economic policy, GNP rebounded to $74.1 billion in 1922. The number of unemployed fell to 2.8 million — a reported 6.7 percent of the labor force — in 1922. So, just a year and a half after Harding became president, the Roaring 20s were underway."

Robert Murphy wrote this:

Murphy does not specifically address the tax cut aspect of this argument. But his article repeats the same themes and is similarly missleading.

John V said...

Damn. My last comment was lost. How frustrating.

John V said...

Let's try again but in briefer form:


All those quotes basically confirm what I had always heard: that Harding didn't do anything of a countercyclical nature to combat the contraction/adjustment of capital and labor.

Now, beyond that, I wasn't aware that he also slashed spending and taxes while cutting the national debt by one third...all during a recession! (Sounds like a pipe dream in the modern context).

But the way that you present it above is that these Austrians were pushing some tax-cuts lead to prosperity schtick. But that is neither what they said nor how I read it nor how it should be read. Reading their quotes, I see what I expected plus more. The point of their arguments is not the tax cuts. The point is there was neither stimulus nor any attempt to prop up prices nor interfere with capital reallocation. THAT is the point they were making...a point I have seen many times.

Much like Barkley on the video, I think you are overemphasizing and misconstruing small bits of info while ignoring the larger point.

Mark A. Sadowski said...

John V,
Well everyone's entitled to their own interpretation I guess (after all, opinions on the shape of the planet do differ). But it seems pretty clear to me that at least Powell and Woods are explicitly claiming that tax cuts were a major reason for the recovery from the 1920-21 recession. Moreover, legions of their followers are making the same claim in comment sections all across the econ blogdom as we speak.

And of course there was a stimulus, it just wasn't fiscal (it was monetary).

John V said...

Again, Mark,

It's not an interpretation.

The argument I always hear has to do with allowing the market to adjustment, reallocate and recover quickly. And this involves not interfering with prices and, by extension, the price signals for capital and labor redeployment. It's really not an interpretation of mine. It's what they say...including in the quotes you cite. Those simply have even more info to contrast with fiscal stimulus.

I am not interested in what some with a narrow tax cut agenda are saying upon reading what these guys write. We are talking about the economists. And I know what their arguments on are when it comes to recessions.

#1: Don't interfere with price mechanism.

#2: (extension of #1) Allow misallocated capital and labor to be reconfigured in sustainable ways.

That's a pretty standard Austrian argument in terms of what the government should do.

Beyond that, if they are throwing in a call for fiscal discipline and/or austerity, that's simply more on top of the main argument.

BTW, if you in grad school for economics, I would hope that you were introduced these arguments. They are hardly unique to the economists you cite. It traces back to Hayek and even further.

Barkley Rosser said...

John P. and Russ,

See my comments in my main post. I am coming in here through viewing the changes. I would only add, if this makes it in, that probably Barro needed to be told about Higgs' work, given that somehow he thought that measuring consumption multipliers in WW II, a period of consumption rationing, had anything to say about them in other circumstances.

Mark A. Sadowski said...

John V,
I have no quarrel with noninterference with prices. I know of few economists who don't love free markets. The problem is there is this phenomenon known as "sticky prices" that means that disequilibria can often last a long time.

The current problem is not one of missallocated capital or labor. We're suffering a"general glut". The reallocation following the housing bubble was going just fine until we allowed nominal GDP to implode in late 2008.

Yes I'm almost finished my doctorate in economics. And I'm very familiar with Hayek's writings. Although he wrote and said many contradictory things, it comes as a shock to many Austrians that later in life also advocated a policy of stabilizing nominal income.

John V said...

Couple things, Mark:

I don't see the relevance of "Sticky prices" here....nor do I see how this is happening right now.

I generally don't think in terms of equilibrium. I don't find it very useful in seeing the world. The world is never at equilibrium. I just think about market process.

As for general glut, I think that's a non-explanatory and unhelpful way of seeing misallocation of capital. General Glut is good example of why Keynesian thinking strikes me as so inadequate. All it's saying is that there is too much supply and not enough demand. That's superficial and unhelpful. Such things happen for a reason and that's why misallocation of capital and labor is better.

Rather than allow that capital to adjust in prices in the face of economic realities (see construction and housing industry) there have been enormous efforts to interfere and preserve home values while attempting to put some of the overstock of construction workers to work via stimulus. All that is interference. That's preventing capital from adjusting in a profit and loss system. It's prolonging the pain.

The general glut, AD and stimulus are all tied to way of thinking that ignores the complexity of layers of capital formation. It disregards (or isn't able to) why we are in this state.

In a hayekian policy prescription, I would prefer better unemployment benefits coupled with no interference whatsoever in the price system. It's cheaper and allows the market to adjust more quickly.

Mark A. Sadowski said...

John V,
In order for the missallocation thesis to work there must be some factor input that is in short supply. By every conceivable way of measuring this (factor numbers, factor prices)there is currently a surplus of factor inputs in the United States.

The majority of the decline in housing prices and the level of residential investment (hitherto)had declined by July 2008 relatively uneventfully. What happened next was purely about a dramatic decline in nominal GDP, nothing to do with the reallocation of factor inputs.

I do not agree with efforts to prop up housing prices. They are counterproductive.

The late life Hayekian solution would be to stabilize nominal income and let the markets handle the rest.

Construction workers are a rather small proportion of the current number of unemployed by my count. And employment is down in sectors accounting for 85% of employment after three years. Doesn't sound like a missallocation at all to me. Sounds like a "general glut".

John Papola said...

Nominal income stabilization is not a “late life” Hayek policy. It’s in Prices and Production which was published in 1931. He employed that framework when he wrote this in 1932 in the Times:

"It is agreed that hoarding money, whether in cash or in idle balances, is deflationary in its effects. No one thinks that deflation in itself is desirable."

People saying Hayek favored do-nothing monetary policy simply don’t know Hayek.

Mark A. Sadowski said...

Thanks. I was looking for an early reference. My memory was that he didn't start advocating stabilizing nominal income until after WW II.

John V said...

I can't believe I just lost another comment. UGH

Andrew Bossie said...

I hope this conversation isn't dead. I'm a graduate student and my dissertation is mainly on the post WWII business cycle and the part of it I've actually written deals directly with Robert Higgs' claims about the immediate post war.

Anyway, I disagree with the facts but not the principle Barkley Rosser is asserting.

My reply is too long and involved (there is a table) for the comments section here so I posted it to my blog:

RussRoberts said...


February 1945 is not "post WWII."

Mark A. Sadowski said...

Russ Roberts,

You wrote
"February 1945 is not "post WWII.""

I fail to see the point.

Could you be more explicit so those of us who are somewhat slower get it?

James Macdonald said...

It is true that there were postwar recessions. However, the important point is that they were remarkably modest compared to the withdrawal of fiscal stimulus. Budgets went from deficits of 25%+ of GDP to suplus (not just reduced deficit)in two years. This is far more extreme than any fiscal retrenchment that is being proposed currently - even for countries like Greece.

The crucial issue in the outcome is not fiscal policy, but monetary policy. As long as monetary policy is accomodative and not tied to an overvalued exchange rate, there is no reason why even extreme retrenchment should lead to a long-term downturn.

I gave a presentation on this issue last year which included the UK's experience. The UK is significant because of its very different outcome after WWI as a result of a overly restrictive monetary policy designed to effect an "internal devaluation" so as to return to the gold standard at the prewar parity. The result was not a short, sharp recession, but a multi-year depression.

The link is: can history teach us about the sovereign debt crisis.pps
(appears to prefer Firefox or Chrome to open)

Methinks said...

Sorry, Eric.

Lipstick did nothing for that pig.

John V said...


Is there a reason why my comment keeps vanishing?

John V said...



OK, after losing my last response to the glitches of Blogger, I'll try to re-convey some thoughts again:

"In order for the missallocation thesis to work there must be some factor input that is in short supply. By every conceivable way of measuring this (factor numbers, factor prices)there is currently a surplus of factor inputs in the United States."

I can't agree with that logic because it completely misses the mark at a conceptual level while being stilted, one-dimensional and overly simplified from my POV.
Misallocation doesn't need a factor in "short supply". It means the capital structure is such that factors are misapplied or poorly allocated based on error or bad information. When it happens on a large scale, the massive reallocation is painful and we have a recession. But the problem I have with your view is that it all seems too linear and aggregated and fails to explain what's really happening.

To restate, there are not shortages and surpluses of factors, there are bad allocations and distortions. A surplus of factors is conceptually wrong to me. Perhaps there's a surplus of a factor based on a snapshot at some point in time with no context but that doesn't get to the heart of the matter and is not useful nor insightful. A "surplus" implies that there are factors with few uses at a somewhat rigid price that are sitting idle. That's wrong. What I see are factors that no longer have the same value for past uses in an ever different and changing capital structure that no longer applies in the present. Their idleness is a sign that they are not reflecting a market price that allows them to be acquired and reallocated in an ever morphing capital structure. Some would call it "liquidating", I simply call it self-correcting of distortions.

When prices freely fluctuate, capital finds uses. It may mean heavy losses for the seller or current holder but real growth and new patterns of trade will emerge and the pain will subside faster. This has not happened.

Barkley Rosser said...


Sure, the 1945 recession started before the war ended and ended after the war ended. All commentaries on it identify it with end-of-war cutbacks.

Anonymous said...

On World War 1: the British left the gold standard during the war so they could run the presses. When they re-established the link after the war, they wrenched the pound back to its prewar value. That's monetary deflation.

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