Post by Elfie on Jul 5, 2005 20:12:41 GMT -5
Another excerpt from explanations I occaisionally provide on random topics:
The primary problem with the Great Depression was a massive lack of demand in the economy. Unfortunately, this demand was not cyclical, as the Hoover administration proved. As they cut back on spending to try to maintain a balanced budget, they put government employees out of work, which in turn put unemployment even higher than it had already been. Unfortunately, the people didn't see the benefits of the cuts in spending in the forms of tax cuts that would encourage them to spend because the greater unemployment meant less tax revenue for the government overall, which created a downward spiral of less and less demand coupled with higher employment.
F.D.R. started to fix this by following the advice of John Maynard Keynes. *watches all the conservatives in the room shudder* Let me say that name once more, just for effect: John Maynard Keynes. Keynes pointed out that if the government borrowed money to spend on public works, as F.D.R. did, this would create jobs. These working people would not only be producing something for the economy, which was good, but they would also be getting paid, which was money they would turn around and spend, thus creating even more demand in the economy. For those not aware with this phenomenon, it's called the multiplier effect. Most will note that the Depression took its most dramatic downturn under F.D.R. when he thought the economy had recovered enough and cut back on the spending a little. It hadn't, and it began to sink back down again. You can fault him for this misstep if you're still looking for a reason to hate him, but overall his policies were working.
The problem most conservative economists have is that they assume the depression was cyclical and that the economy would pull out on its own, but as I explained, this wasn't the case. Had the government continued to cut spending, the demand in the economy would have been reduced more and more drastically. Remember, the issue wasn't that the ability to produce had been compromised, but rather the ability to demand to what had been produced. People had no money, so businesses had no target market, so businesses were closing, which in turn was putting people out of work and meant those people had no money. Notice the cycle?
For the record, a monetary policy of printing more money would have been capable of saving the economy in today's world, but America was still attached to the gold standard at the time, which made this difficult. Lowering interest rates wouldn't have done anything because no one was keeping their money in banks anyway. This left only fiscal policy, and considering that in many ways the currency was actually going through deflation, the trade-off of spending away unemployment and picking up some inflation was win-win. The only two issues Roosevelt had to worry about were accumulating a debt, which would be easily paid off if he could get the economy to expand, and experiencing a crowding-out effect, which was not going to happen because there was no investment on the private side anyway.
So that's why Roosevelt acted as he did, at least from the economic theory point of view. How well did all of this work in reality? Well history showed an upturn in the economy consistently throughout his depression years with the exception of around 1937 where he began to cut spending again. This would seem to indicate that he was taking the right action. As for the rest of what the did, he may not have reflected American values, but he certainly reflected Canadian values, which I've always thought to be better anyway.
Later this came along:
Now this is getting interesting:
I understand exactly what you are saying, but I think you're still making a few assumptions that aren't as well-founded as they could be.
First, I'm not saying Keynes' proposed solution to the Great Depression would have made economic sense over the long run. I agree that deficit spending like that is not economically sustainable. That said, it is common economic policy for governments to spend more than they have during economic downturns and save up/pay off debt in times of prosperity. Some governments take it too far, but given the extreme nature of the circumstances regarding the Great Depression, I would say that's a great example of a time when a government would be well-advised to run a short-term deficit to push America out of the depression. I believe Keynes knew this as well, as his economic policy was more that the government should be prepared to intervene than that the government must constantly intervene, as it is commonly misunderstood.
Second, Keynes did not believe that government spending and a balanced budget would always grow the economy. As you mentioned earlier, the crowding-out effect does come into consideration in his policies. That said, at the time of the Great Depression, private investment was practically non-existant, which is FDR ignored the risk of reducing private investment when he started to spend more. Simply put, somebody had to create the initial investment to kick-start private investment, which is precisely how and why the government stepped in. Again, the additional spending was not supposed to be permanent. It was merely supposed to be a kick-start. This is why FDR tried cutting back in '37, which I think you'll agree turned out rather disastrously.
Third, it doesn't matter what the government project is as long as it creates jobs and produces something. It's easy to say those roads from x to y didn't really do all that much, but consider exactly what the bombs did during the war. They exploded, and that was it. At least those roads are still here today. The most you can find of a WWII bomb is shrapnel. My point isn't to comment on WWII, rather to point out that it didn't really matter at all what the government spent money on as long as it created jobs that would put money into the country. That's precisely, ignoring the crowding-out effect for a moment, why government spending is more effective than a tax cut.
I would like to add a fourth point to this debate as explanation for why the situation improved more rapidly under the war than under the New Deal, as I don't believe that answer is based upon any government economic policies. We all know that most beliefs held by the populace about the future of the economy are self-fulfilling. Bearing this in mind, it has been said that the Great Depression was a time of irrational pessimism, in contrast to the roaring 20's and their irrational optimism. This, I believe, was one of the most forceful obstacles to economic recovery during this time, and part of the reason why economic recovery did take so long: the people simply didn't believe anything would work, and that became self-fulfilling. At the outbreak of WWII, however, national patriotism was stirred and people quite suddenly began to have pride in their country, which led them to have pride in the economy. This optimism, well-founded or not, in turn affected the economy, which is why the economy seemed to recover so much quicker during the war. The belief that war spending was any different from New Deal spending is a fallacy, in my opinion. Rather, the war's great contribution to the economy was that it drastically changed public opinion, making prosperity infinitely more accessible.
EDIT: Also note that unemployment went down during the New Deal.
And:
statistics
The primary problem with the Great Depression was a massive lack of demand in the economy. Unfortunately, this demand was not cyclical, as the Hoover administration proved. As they cut back on spending to try to maintain a balanced budget, they put government employees out of work, which in turn put unemployment even higher than it had already been. Unfortunately, the people didn't see the benefits of the cuts in spending in the forms of tax cuts that would encourage them to spend because the greater unemployment meant less tax revenue for the government overall, which created a downward spiral of less and less demand coupled with higher employment.
F.D.R. started to fix this by following the advice of John Maynard Keynes. *watches all the conservatives in the room shudder* Let me say that name once more, just for effect: John Maynard Keynes. Keynes pointed out that if the government borrowed money to spend on public works, as F.D.R. did, this would create jobs. These working people would not only be producing something for the economy, which was good, but they would also be getting paid, which was money they would turn around and spend, thus creating even more demand in the economy. For those not aware with this phenomenon, it's called the multiplier effect. Most will note that the Depression took its most dramatic downturn under F.D.R. when he thought the economy had recovered enough and cut back on the spending a little. It hadn't, and it began to sink back down again. You can fault him for this misstep if you're still looking for a reason to hate him, but overall his policies were working.
The problem most conservative economists have is that they assume the depression was cyclical and that the economy would pull out on its own, but as I explained, this wasn't the case. Had the government continued to cut spending, the demand in the economy would have been reduced more and more drastically. Remember, the issue wasn't that the ability to produce had been compromised, but rather the ability to demand to what had been produced. People had no money, so businesses had no target market, so businesses were closing, which in turn was putting people out of work and meant those people had no money. Notice the cycle?
For the record, a monetary policy of printing more money would have been capable of saving the economy in today's world, but America was still attached to the gold standard at the time, which made this difficult. Lowering interest rates wouldn't have done anything because no one was keeping their money in banks anyway. This left only fiscal policy, and considering that in many ways the currency was actually going through deflation, the trade-off of spending away unemployment and picking up some inflation was win-win. The only two issues Roosevelt had to worry about were accumulating a debt, which would be easily paid off if he could get the economy to expand, and experiencing a crowding-out effect, which was not going to happen because there was no investment on the private side anyway.
So that's why Roosevelt acted as he did, at least from the economic theory point of view. How well did all of this work in reality? Well history showed an upturn in the economy consistently throughout his depression years with the exception of around 1937 where he began to cut spending again. This would seem to indicate that he was taking the right action. As for the rest of what the did, he may not have reflected American values, but he certainly reflected Canadian values, which I've always thought to be better anyway.
Later this came along:
Now this is getting interesting:
Okay, down to business:
I understand the theory perfectly well. It states that every dollar spent by the government will raise production by whatever the income multiplier is. And it makes perfect logical sense until one realizes that it completely undermines the economy’s capacity for long-term growth, since it consists of taking money and resources from one place and sending it to Bumble****, Indiana. And the same mathematics the Keynesians use suggest the economy will always grow as long as government spending grows and maintains a balanced budget.
And World War II deficit spending differs from Great Depression deficit spending for multiple reasons:
1. Dollars spent for bombs are dollars spent increasing the actual production capacity of the economy, as opposed to spending dollars on a damn in the middle of nowhere or for people who do not work.
2. During war, there is HUGE incentive for technological progress, a foundation for economic growth that closing recessionary gaps simply ignores. Thus, the deficit spending during the Great Depression created only short term “growth”, whereas the war spending created technologies that continued to pay dividends for years.
3. Rationing and War Bonds greatly reduced the effects of government investment crowding out private investment and extreme inflationary pressures during World War II. (Yes, those government debts have to come from somewhere. Printing more money just causes inflation)
FDR did NOT end the Great Depression. Another decade of him and the economy would’ve been experiencing sky high inflation, which would eventually lead to sky high unemployment and inflation, and the economy would be back in depression. Except, of course, printing more money would solve nothing since every dollar was already being used.
I understand the theory perfectly well. It states that every dollar spent by the government will raise production by whatever the income multiplier is. And it makes perfect logical sense until one realizes that it completely undermines the economy’s capacity for long-term growth, since it consists of taking money and resources from one place and sending it to Bumble****, Indiana. And the same mathematics the Keynesians use suggest the economy will always grow as long as government spending grows and maintains a balanced budget.
And World War II deficit spending differs from Great Depression deficit spending for multiple reasons:
1. Dollars spent for bombs are dollars spent increasing the actual production capacity of the economy, as opposed to spending dollars on a damn in the middle of nowhere or for people who do not work.
2. During war, there is HUGE incentive for technological progress, a foundation for economic growth that closing recessionary gaps simply ignores. Thus, the deficit spending during the Great Depression created only short term “growth”, whereas the war spending created technologies that continued to pay dividends for years.
3. Rationing and War Bonds greatly reduced the effects of government investment crowding out private investment and extreme inflationary pressures during World War II. (Yes, those government debts have to come from somewhere. Printing more money just causes inflation)
FDR did NOT end the Great Depression. Another decade of him and the economy would’ve been experiencing sky high inflation, which would eventually lead to sky high unemployment and inflation, and the economy would be back in depression. Except, of course, printing more money would solve nothing since every dollar was already being used.
I understand exactly what you are saying, but I think you're still making a few assumptions that aren't as well-founded as they could be.
First, I'm not saying Keynes' proposed solution to the Great Depression would have made economic sense over the long run. I agree that deficit spending like that is not economically sustainable. That said, it is common economic policy for governments to spend more than they have during economic downturns and save up/pay off debt in times of prosperity. Some governments take it too far, but given the extreme nature of the circumstances regarding the Great Depression, I would say that's a great example of a time when a government would be well-advised to run a short-term deficit to push America out of the depression. I believe Keynes knew this as well, as his economic policy was more that the government should be prepared to intervene than that the government must constantly intervene, as it is commonly misunderstood.
Second, Keynes did not believe that government spending and a balanced budget would always grow the economy. As you mentioned earlier, the crowding-out effect does come into consideration in his policies. That said, at the time of the Great Depression, private investment was practically non-existant, which is FDR ignored the risk of reducing private investment when he started to spend more. Simply put, somebody had to create the initial investment to kick-start private investment, which is precisely how and why the government stepped in. Again, the additional spending was not supposed to be permanent. It was merely supposed to be a kick-start. This is why FDR tried cutting back in '37, which I think you'll agree turned out rather disastrously.
Third, it doesn't matter what the government project is as long as it creates jobs and produces something. It's easy to say those roads from x to y didn't really do all that much, but consider exactly what the bombs did during the war. They exploded, and that was it. At least those roads are still here today. The most you can find of a WWII bomb is shrapnel. My point isn't to comment on WWII, rather to point out that it didn't really matter at all what the government spent money on as long as it created jobs that would put money into the country. That's precisely, ignoring the crowding-out effect for a moment, why government spending is more effective than a tax cut.
I would like to add a fourth point to this debate as explanation for why the situation improved more rapidly under the war than under the New Deal, as I don't believe that answer is based upon any government economic policies. We all know that most beliefs held by the populace about the future of the economy are self-fulfilling. Bearing this in mind, it has been said that the Great Depression was a time of irrational pessimism, in contrast to the roaring 20's and their irrational optimism. This, I believe, was one of the most forceful obstacles to economic recovery during this time, and part of the reason why economic recovery did take so long: the people simply didn't believe anything would work, and that became self-fulfilling. At the outbreak of WWII, however, national patriotism was stirred and people quite suddenly began to have pride in their country, which led them to have pride in the economy. This optimism, well-founded or not, in turn affected the economy, which is why the economy seemed to recover so much quicker during the war. The belief that war spending was any different from New Deal spending is a fallacy, in my opinion. Rather, the war's great contribution to the economy was that it drastically changed public opinion, making prosperity infinitely more accessible.
EDIT: Also note that unemployment went down during the New Deal.
And:
statistics