A neo-Monetarist perspective on FDR

The conservatives chime in with their vision of the Great Depression and FDR's response. And I clash my cymbals in reesponse, as shown in bold-face. His headlines are in italics.

The New York Times / November 23, 2008

Economic View
The New Deal Didn't Always Work, Either
By TYLER COWEN

MANY people are looking back to the Great Depression and the New Deal for answers to our problems. But while we can learn important lessons from this period, they're not always the ones taught in school.

The traditional story [by whom?] is that President Franklin D. Roosevelt rescued capitalism by resorting to extensive government intervention; the truth is that Roosevelt changed course from year to year, trying a mix of policies, some good and some bad. It's worth sorting through this grab bag now, to evaluate whether any of these policies might be helpful.

If I were preparing a "New Deal crib sheet," I would start with the following lessons:

MONETARY POLICY IS KEY As Milton Friedman and Anna Jacobson Schwartz argued in a classic book, "A Monetary History of the United States," the single biggest cause of the Great Depression was that the Federal Reserve let the money supply fall by one-third, causing deflation. Furthermore, banks were allowed to fail, causing a credit crisis. Roosevelt's best policies were those designed to increase the money supply, get the banking system back on its feet and restore trust in financial institutions.

This is simplistic, to say the least: the adherence to the gold standard (until 1933) prevented the use of monetary policy to stimulate the economy, while banks opposed such policies. The dominant view of the monetary establishment at the time (the Fed's Board, including the Secretary of the Treasury, Andrew Mellon) was that the economy would recover automatically after purging imbalances from the economy. In other words, the Milton Friedmans and Tyler Cowens of that day did not want to use monetary policy. Nature would take its course, automatically solving the economy's problems. The gold standard was part of the solution, not part of the problem.

(These folks were "Austrian" in their temperament: the 1929-33 recession was simply punishment for the sins of over-expansion during the 1920s. Expiation was needed. Interestingly, there are a lot of so-called "Austrian" economists where Cowen teaches. I wonder it he's arguing against them.)

In addition, this story ignores the steep fall in fixed investment and exports in the 1930s, which could not have been counteracted easily: fixed investment is hard to stimulate when unused capacity and/or debt is large (and expectations are pessimistic), while exports are hard to encourage when there's a trade war going on.

Once deflation hits, expansionary monetary policy loses its usefulness. Nominal interest rates can't go below zero, while falling prices raise the real interest rate. When real interest rates (which are what counts in affecting the economy's path) rise, that encourages recession. BTW, this problem is currently on the horizon, cramping Bernanke's style.

MF and A.J. Schwartz's Big Book is totally descriptive, by the way. It's not very analytical at all. They really don't posit any understanding of how the money supply affects the economy or how the Fed controls the money supply. They don't look at the political economy of the era at all. (Along with Capitalism and Freedom, the book is worshiped by the Chicago-schoolers like Cowen. This fits the way that MF is seen as their prophet and the free market as their one true God.)

A study of the 1930s by Christina D. Romer, a professor at the University of California, Berkeley ("What Ended the Great Depression?," Journal of Economic History, 1992), confirmed that expansionary monetary policy was the key to the partial recovery of the 1930s. The worst years of the New Deal were 1937 and 1938, right after the Fed increased reserve requirements for banks, thereby curbing lending and moving the economy back to dangerous deflationary pressures.

The economy was also stimulated by government deficits at the time. It's a mistake to look for only one cause. However, Romer is a good economist, whose research shouldn't be rejected before reading it.

Today, expansionary monetary policy isn't so easy to put into effect, as we are seeing a shrinkage of credit and a contraction of the "shadow banking sector," as represented by forms of derivatives trading, hedge funds and other investments. So don't expect the benefits of monetary expansion to kick in right now, or even six months from now.

Still, the Fed needs to stand ready to prevent a downward spiral and to stimulate the economy once it's possible.

Gee, isn't it doing so already?? Where has Cowen been?

GET THE SMALL THINGS RIGHT It's not just monetary and fiscal policies that are important. Roosevelt instituted a disastrous legacy of agricultural subsidies and sought to cartelize industry, backed by force of law. Neither policy helped the economy recover.

It was Hoover who started the ag. subsidies, while if expansionary fiscal and monetary policy aren't being used (as they weren't), cartels and the like prevent deflation, which was a total disaster. Cowen wants to put all the weight on monetary policy, it seems. Cartels aren't pretty, but they may have been what more sophisticated economists than Cowen call "second best" solutions. That is, when real-world markets don't work as desired and are not likely to work well in the near future, adding non-market elements (what Cowen would call "imperfections") can actually be beneficial. This is well-known to economists outside of George Mason University.

I'm no fan of agricultural subsidies, but why are they "disastrous"? more disastrous than the Depression itself? They seem to be so horrible because Cowen is comaparing an imaginary Eden of the Perfect Market to the one sullied by the Snake of subsidies.

He [FDR] also took steps to strengthen unions and to keep real wages high. This helped workers who had jobs, but made it much harder for the unemployed to get back to work. One result was unemployment rates that remained high throughout the New Deal period.

This is silly! Serious macroeconomists know that the main factor determining employment in a depression is aggregate demand and the amount of production, not the wage. Suppose real wages fall, as Cowen recommends. Why would an employer hire more workers, if the extra output can't be sold??

In any event, falling wages make matters worse on the demand side, as Keynes pointed out. Among other things, falling wages cause deflation, which even Cowen admists is a bad thing, encouraging depression.

Today, President-elect Barack Obama faces pressures to make unionization easier, but such policies are likely to worsen the recession for many Americans.

That's Cowen's opinion; he's anti-union.

DON'T RAISE TAXES IN A SLUMP The New Deal's legacy of public works programs has given many people the impression that it was a time of expansionary fiscal policy, but that isn't quite right [as has been known for a very long time, i.e., since E. Cary Brown's path-breaking research]. Government spending went up considerably, but taxes rose, too. Under President Herbert Hoover and continuing with Roosevelt, the federal government increased income taxes, excise taxes, inheritance taxes, corporate income taxes, holding company taxes and "excess profits" taxes.

Right. We should note, however, that raising taxes and government spending at the same time can stimulate aggregate demand, as in the famous but Cowen-forgotten "balanced budget multiplier" theorem.

When all of these tax increases are taken into account, New Deal fiscal policy didn't do much to promote recovery. Today, a tax cut for the middle class is a good idea — and the case for repealing the Bush tax cuts for higher-income earners is weaker than it may have seemed a year or two ago.

Right. In fact, at this point it looks like Obama is not going to abolish the Bush rewards for being wealthy and well-connected. Instead, he's just going to let them lapse. If he abolished them (a good thing to do), the middle-class tax cut or (even better) working-class tax-cuts would have to be larger to counteract the depressive effects of immediate abolition.

WAR ISN'T THE WEAPON World War II did help the American economy, but the gains came in the early stages, when America was still just selling war-related goods to Europe and was not yet a combatant. The economic historian Robert Higgs, a senior fellow at the Independent Institute, has shown in his 2006 book, "Depression, War, and Cold War," just how much the war brought shortages and rationing of consumer goods.

Right. We knew that: WW II started before the US got in -- as did the stimulative effects on the US economy. Cowen seems to be eliding the fact that the shortages and rationing happened only when the war became a total war.

By the way, even if war wasn't "the weapon" back at the cusp of the 1940s does not mean that it can't be so now. We can learn from history, but when dealing with the present it's a mistake to rule out alternatives that didn't actually happen in the past. Cowen could just as well say that monetary policy "isn't the weapon" because it wasn't used successfully during the 1930s.

While overall economic output was rising [once it had been stimulated by military spending], and the military draft lowered unemployment, the war years were generally not prosperous ones. As for today, we shouldn't think that fighting a war is the way to restore economic health.

War does promote the demand side, which is what the US economy needed at the time (in the late 1930s). In the long run, I think that war and military spending are bad for supply side growth (i.e., for long-term trend of real GDP) because they are tremendously wasteful.

On the other hand, WW II and the early Cold War may be the exceptions. The working class was strong enough to win the GI Bill (partly because our rulers remembered the negative effects of soldiers being abandoned after WW I), which helped supply-side growth. That, plus Cold War related infrastructural investment and subsidies for housing, helped create the so-called "golden age" of the US economy. Also contributing, of course, was US dominance in the manufacturing, financial, and military realms.

YOU CAN'T TURN BAD TO GOOD The good New Deal policies, like constructing a basic social safety net, made sense on their own terms and would have been desirable in the boom years of the 1920s as well.

Now there's an irrelevant point! Was Cowen around back in the 1920s to convince Coolidge and Hoover of this point? Can he guess why they opposed a social safety net?

The bad policies made things worse. [well, duh! ] Today, that means we should restrict extraordinary measures to the financial sector as much as possible and resist the temptation to "do something" for its own sake.

I don't know who it is who is proposing to "do something" simply for its own sake. This seems the old ruse of seting up a scare-crow, just to knock it down.

In short, expansionary monetary policy and wartime orders from Europe, not the well-known policies of the New Deal, did the most to make the American economy climb out of the Depression. Our current downturn will end as well someday, and, as in the '30s, the recovery will probably come for reasons that have little to do with most policy initiatives. [That's Cowen's faith.]

Tyler Cowen is a professor of economics at George Mason University.

Copyright 2008 The New York Times Company

--
Jim Devine / "Nobody told me there'd be days like these / Strange days indeed -- most peculiar, mama." -- JL.

Why a New New Deal is No Deal

by the Sandwichman

The New Deal came about, according to historian Benjamin Hunnicutt, because Roosevelt needed to "do something" to ward off the Black-Connery 30-hour bill.

UPDATE: The new New Deal stimulus spending bandwagon is getting ready to roll, with cheer leading from Paul Krugman, Robert Reich, Brad DeLong, Eric Rauchway. But this time around is it sustainable?

In a letter to Arthur Schlesinger dated April 9, 1958, Leon Keyserling stressed that Roosevelt came to Washington without a "systematic economic program." The "highly experimental, improvised and inconsistent" programs of the first New Deal defy categorization. They were the products of "schools of reformers" that had been promoting diverse programs that Roosevelt, higgledy-piggledy, picked up.

According to Keyserling, the PWA, CWA, NIRA, and the rest were not parts of any systematic plan or overall purpose. The only coherence given these events came from outside the administration. It was the "desire to get rid of the Black bill" that prompted the administration to draw up such things as the NRA, "to put in something to satisfy labor." This same point was made by other notables in Roosevelt's administration, among them Raymond Moley.

Throughout the depression, 30-hour legislation goaded Roosevelt to action. The Black-Connery bill, introduced in each depression Congress until passed in highly modified form as the Fair Labor Standards Act [FLSA] in 1938, with all the work-sharing teeth pulled, continued to function as a sort of reverse polestar, enabling Roosevelt to chart his course by the simple expedient of sailing in the opposite direction. Roosevelt's instinctive reaction against 30 hours matured to positive approaches to industrial stabilization and reemployment. They were built on work creation, not work spreading, founded on industrial growth and increased spending as the wellsprings of progress. In the process, he and his administration discarded the century-old notion that work reduction had the potential for social and individual advancement.

From the point of view of someone like Representative William Connery, who pushed for 30 hours from 1932 to 1937, the New Deal had a coherence, a reason for happening when and as it did, that was lost on others not so positioned. From Connery's perspective, the New Deal was what it was because of its opposition to 30 hours. -- Hunnicutt, Work Without End, pp.248-49

Another Greenspan Gem

Here Greenspan describes the new technologies that have revolutionized banks' "basic business ... to measure, manage, and accept risk ... permitting ... the unbundling of risks, improvements in the measurement of risk, and revamping of risk management process."

"There are some who would argue that the role of the bank supervisor is to minimize or even eliminate bank failure; but this view is mistaken in my judgment. The willingness to take risk is essential to the growth of the free market economy …. [i]f all savers and their financial intermediaries invested in only risk-free assets, the potential for business growth would never be realized."

Greenspan, Alan. 1994. The New Risk Management Tools in Banking: Address to the Garn Institute of Finance, University of Utah, November 30, 1994.
http://fraser.stlouisfed.org/historicaldocs/ag94/download/27991/Greenspan_19941130.pdf

Why Only 2.5 Million New Jobs?

The good news is that Obama wants to push fiscal stimulus ala public investment, but this seems way too conservative:

American workers will rebuild the nation's roads and bridges, modernize its schools and create more sources of alternative energy, creating 2.5 million jobs by 2011, Obama said in the weekly Democratic address, posted on his Web site.

With the employment-population ratio at 61.8% and population at 234.6 million, creating 2.5 million new jobs NOW would still leave the employment-population ratio below 63%. Over the next couple of years, we would new about 2.5 million new jobs just to be around a 62% employment-population ratio. I hope his goals for a recovery are more ambitious than this sounds.

Healthcare Debate: So This is Why Conservatives Hate Social Security

Michael Cannon of Cato comes out against Obama’s health care plan – no surprise there. James Pethokouskis makes it explicit as to Cannon’s real concern:

Passage would be a political gamechanger. Recently, I stumbled across this analysis of how nationalized healthcare in Great Britain affected the political environment there. As Norman Markowitz in Political Affairs, a journal of "Marxist thought," puts it: "After the Labor Party established the National Health Service after World War II, supposedly conservative workers and low-income people under religious and other influences who tended to support the Conservatives were much more likely to vote for the Labor Party when health care, social welfare, education and pro-working class policies were enacted by labor-supported governments."

As Hilzoy notes:

An honest conservative might accept this claim and say: well, I guess our ideas are unpopular, so we'll just have to make our case more persuasively. But that's not the conclusion they draw. Pethokoukis and Cannon say: because people will like health care reform, if we do not block it, our party will lose support. So precisely because people would like it if they tried it, we need to make sure that it fails. At least they're honest about it.

Truth be told – this is a major reason why conservatives want to undermine the Social Security program. Yes – they do try to tell us it’s some sort of Ponzi scheme, which of course, is just blatant dishonesty. But the real reason that they hate Social Security is that it is popular – as well as good policy from the perspective of those who care at least as much about the working class as the investor class.

Update: Steve Benen takes us back to late 1993 and the Kristol memo:

Leading conservative operative William Kristol privately circulates a strategy document to Republicans in Congress. Kristol writes that congressional Republicans should work to "kill" - not amend - the Clinton plan because it presents a real danger to the Republican future: Its passage will give the Democrats a lock on the crucial middle-class vote and revive the reputation of the party. Nearly a full year before Republicans will unite behind the "Contract With America," Kristol has provided the rationale and the steel for them to achieve their aims of winning control of Congress and becoming America's majority party. Killing health care will serve both ends. The timing of the memo dovetails with a growing private consensus among Republicans that all-out opposition to the Clinton plan is in their best political interest.

Kristol does belong to the wing of the Republican where good policy and good politics have been at war for years.

My Lecture on the Economic Crisis

I have posted my talk for the San Francisco Peace & Freedom Party on the economic crisis at

http://www.archive.org/details/perelman-econ-crisis

Has Monetary Policy Been Contractionary?

Greg Mankiw and Paul Krugman have been providing graphs of certain interest rates and the exchange rate with a little commentary. Greg poses this query:

You observe an economy sinking in recession. As this occurs, real interest rates are rising, and the currency is strengthening. What shock, or set of shocks, could have caused these events?

Paul notes:

Bernanke’s problem, and ours. This picture shows the target Fed funds rate, the usual tool of monetary policy; the 10-year Treasury rate; and two rates that actually matter to the private sector, the mortgage rate and the rate on Baa-rated corporate bonds. The Fed has had no success in reducing mortgage rates, and corporate borrowing costs have gone up, not down. Add in falling expectations of inflation, and in real terms monetary policy has gotten tighter, not easier.

House Slaves and Hidden Imams

Ayman al-Zawahiri, the #2 of al-Qaeda, has issued a tape denouncing Obama. The headlines have screamed "racial slur!" and the "official" translation had him describing Obama as a "house negro." The actual term was "abd al-bayt," which literally means, "house slave," not flattering, but not a racial slur, and also inaccurate, given that he is about to become the house master, arguably, something that makes the al-Qaeda crowd unhappy.

Now while Obama has promised to go after Osama, I think the fact that al-Zawahiri has been doing these tapes since 2004 with no appearances by Osama means that the latter is either incapacitated or dead. If dead, I can see them keeping the illusion of him still alive going. Although they are Sunnis, this sort of resembles the Shi'i cult of the missing 12th Iman, who supposedly went into Occultation and will reappear in the world as a messianic savior at some point, with various current leaders claiming access to him. Osama could be the radical Sunni Hidden Imam, with Obama chasing a Hidden Imam Osama.

Now That's Leverage!

"Tangible assets, which don't include goodwill or intangibles, are 55 times the bank's tangible equity .... Citi's leverage worries some investors. Furthermore, possibly making matters worse are proposed accounting-rule changes that, if adopted, will prompt banks in 2010 to bring some off-balance-sheet assets back onto their books.

Tangible assets rise to nearly 59 times tangible equity if Citi has to bring about $120 billion in credit-card assets back onto its books in 2010, as is likely. Citi also may have to consolidate some of the roughly $670 billion in mortgage assets currently held by off-balance-sheet vehicles.

If the bank had to consolidate just 20% of these mortgage assets, tangible assets would rise to about 63 times tangible equity.

Reilly, David. 2008. "Job Losses Won't Cut It for Citigroup." Wall Street Journal (18 November): p. C 10.

Unions, Unemployment & Shorter Hours

by the Sandwichman

What's up? Unemployment is up. What to do about it?

Samuel Gompers said, in 1887, "The answer to all opponents to the reduction of the hours of labor could well be given in these words: 'That so long as there is one man who seeks employment and cannot obtain it, the hours of labor are too long.'"

In 1932, President William Green of the A. F. of L., "estimated that if the hours actually being worked at the present time were distributed on the basis of thirty hours a week among the working population the 12,000,000 now unemployed could be put to work."

In 1962, the AFL-CIO Federationist put the case this way:

The case for shorter hours does not rest on the notion it is the best way. It is based rather on the view, supported by ample evidence in the past decade of mounting unemployment, that: (1) other economic measures to achieve full employment are not being applied and perhaps cannot be applied; and (2) even if other economic policies are successful in stimulating greater growth in the period ahead, the rate of advance in technology and other labor-displacing changes is gathering such momentum that, unless part of the gains in efficiency are distributed in reductions in hours, it is virtually inevitable that it will show up in persistent and increased unemployment.

"There's no question that the long-term salvation of work lies in reducing working hours," said Thomas R. Donahue, secretary-treasurer of the AFL-CIO in 1993.

So today, 2008, with unemployment on the rise, what's the word from the AFL-CIO on shorter hours?

Bailouts and JAWBS

by the Sandwichman

Presumably... implicitly... tacitly... these bailouts are all about saving JAWBS.

I mean, is there any other rationale for them that would pass political muster? So can someone direct the Sandwichman to an econometric study that estimates just how many net JAWBS are saved or created per Billion Bail Dollars (BBD)? Note I said net JAWBS -- I don't want to hear any lump-of-labor silliness about the amount of work being fixed so that if someone gets laid off from CitiBank there won't be any new dog-walking or paid blogger positions opening up.

Obviously, economists have studied this matter thoroughly and there's a consensus out there about this stuff. Right?

Unemployment in the Automobile Industry

PS: Dan Becker also told me that he just testified before Congress in the automobile hearings, shocking the politicians are telling them that there are now more unemployed automobile workers than employed.

Did Al Gore Almost Save the Automobile Industry?

The automobile industry is on the ropes, dying a death of 1000 cuts, most of them self-inflicted. Virtually everybody knows about the stubborn reliance on SUVs and other gas hogs, as well as the foray into non-automobile finance. I heard an interview with Dan Becker, the director of the Safe Climate Campaign, described another angle that in my ignorance I had not heard before.

I contacted Dan for some more information. What follows are my rough notes from my phone conversation regarding The Partnership for New Generation of Vehicles:

Vice President Al Gore told the Big Three that he wanted them to develop a sedan-size car that could get 80 miles a gallon. What is surprising is that they complied. Each one produced a prototype -- a single prototype and then left the project to die. What was striking about Dan's presentation was that the prototypes seem to have been relatively solid.

Word of Detroit's success helped to spark Japanese interest in developing something similar. Coming from an island far from its oil supplies, MITI was interested in transportation alternatives. Of course, California's requirement for zero emission vehicles (which my neighbor was instrumental in squashing) also played a role in interesting the Japanese, but the Gore angle and the successful prototypes were new to me.

Amity Schlaes Criticizes Lord Keynes Only to Display Her Own Ignorance

Why did Bloomberg print this nonsense?

The Great Society of that period was the ultimate Keynesian experiment, and it didn't work very well ... The jobs that Keynes emphasized were AWOL: America became accustomed to high levels of unemployment.

Paul Krugman objects:

The Great Society wasn’t deficit spending, it wasn’t intended to create jobs, and the economy of the 1960s wasn’t depressed. It was social engineering; we can talk about how well or badly it worked, but it had nothing whatsoever to do with Keynesian economics. Now, LBJ did engage in some Keynesian economics: namely, he imposed a contractionary fiscal policy in the form of a tax surcharge in an effort to cool an overheating economy.

Paul is basically correct but let’s go further. The big Keynesian fiscal experiment was that 1964 tax cut, which did seem to work fairly well as the economy returned to full employment by late 1965. While Paul and I were both too young in 1965 to have been included in the discussions between the Council of Economic Advisors and President Johnson, I have had the pleasure of hearing from those who were what kind of macroeconomic advice the CEA gave the President during December 1965. Realizing that the economy was at full employment and seeing the triple whammy of tax cuts, proposed Great Society domestic spending, and the run-up in Defense Department spending from the Vietnam War, the CEA strongly urged the President to push for fiscal restraint lest the Federal Reserve would have to raise interest rates to choke off excessive demand. The President fired back that the Great Society was important to him and that he was not ready to pull out of Vietnam. The President also noted that getting a reversal of the 1964 tax cuts would be politically difficult. The Federal Reserve did raise interest rates in 1966 leading to the 1966 Credit Crunch, which held inflation at bay. However, the Federal Reserve later reversed course unfortunately. So we eventually got a delayed and lukewarm version of the fiscal restraint that the CEA recommended way back in late 1965 – as Paul noted. Too little and too late.

For Schlaes to blame the run-up in inflation on the Keynesian economists that advised President Johnson only shows she has absolutely no clue. But then we knew that already.

Force Them to Lend?

My restful sleep continues to be disturbed by Willem Buiter, who writes

I am in Slovenia today, talking to bankers, entrepreneurs, managers, politicians, government officials and academics. The story is the same here as in every country I have visited since mid-September 2008: the banks aren’t lending. They don’t lend to each other. They don’t lend to non-financial businesses and they don’t lend to households....The macroeconomic consequences of this lending paralysis are potentially disastrous. It could turn a global recession into a global depression, with many years of stagnation and cumulative declines of GDP of 10 percent or more.

His solution?

I propose the following form of forced lending by banks to non-financial businesses. Every loan that matures during the coming year gets extended/renewed for another year on the same terms as the maturing loan. This applies to both secured and unsecured loans. Likewise every credit line or overdraft facility that expires during the coming year gets extended/renewed for another year. Expiring loans, credit lines or overdraft facilities that had an original maturity of less than a year or more than a year will have the same interest rate for the one-year extension/renewal as the original arrangement.

Yes, force them to lend. This is a rather blunt instrument, I would say. It would roll over some loans that should absolutely not be renewed, and it would not direct financing to new, previously unfinanced projects. I think bankers won’t like it. They wouldn’t like my “Plan B”, creating a public competitive financial entity, either. So which one should it be?

Buiter’s approach has the advantage of using the existing institutions: the same personnel, the same chains of command, the same office layouts—nothing new that could create friction or delay at a time when we particularly don’t need it. My approach would be vastly less expensive for the public (and therefore more feasible in direct financial terms) and would be capable of making more rational distinctions at the micro level. But one way or the other, we have to shift the narrative quickly. What needs to be rescued are not the financial markets but the real economies, the incomes and employment, that are the substance of our standard of living.