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What ended the Great Depression?
There has been recent circulation of the older view that it is World War II, as a kind of giant public works project, which ended the Great Depression. This claim is not consistent with our best knowledge of the subject. To survey the cutting edge of the literature briefly:
Christina Romer writes:
This paper examines the role of aggregate demand stimulus in ending the Great Depression. A simple calculation indicates that nearly all of the observed recovery of the U.S. economy prior to 1942 was due to monetary expansion. Huge gold inflows in the mid- and late-1930s swelled the U.S. money stock and appear to have stimulated the economy by lowering real interest rates and encouraging investment spending and purchases of durable goods. The finding that monetary developments were crucial to the recovery implies that self-correction played little role in the growth of real output between 1933 and 1942.
Here is another interesting paper on the topic; it focuses on productivity issues and mean reversion. Here is from a paper by Cullen and Fishback:
We examine whether local economies that were the centers of federal spending on military mobilization experienced more rapid growth in consumer economic activity than other areas. We have combined information from a wide variety of sources into a data set that allows us to estimate a reduced-form relationship between retail sales per capita growth (1939-1948, 1939-1954, 1939-1958) and federal war spending per capita from 1940 through 1945. The results show that the World War II spending had virtually no effect on the growth rates in consumption that we examined.
Further debunking of the WWII idea can be found in this paper by Robert Higgs, who stresses the difference between standard gdp measures and actual economic welfare.
I also find the experience of the Latin American economies convincing. The economic recovery of Argentina, for instance, clearly was due to monetary policy, not fiscal policy, which remained tight throughout the period of recovery. Mexico recovered from the Great Depression relatively quickly and this history also does not fit the fiscal policy view. Later on, most of the Latin economies experienced commodity booms because of wartime demands and again this was not fiscal policy and of course they were not fighting the war themselves. The two countries where fiscal policy played a significant role in recovery are, not surprisingly, Germany and Japan and here I am referring to their prewar spending.
Posted by Tyler Cowen on November 11, 2008 at 07:14 AM in History | Permalink
Comments
How did gold inflows impact the money supply. Didn't the U.S. disconnect the dollar from gold in the mid-
1930s? Or do I have my dates wrong?
Posted by: Tim at Nov 11, 2008 7:36:02 AM
"Durable goods" are somehow a rarity. Even a car is made to be replaced in a few years.
Posted by: ups at Nov 11, 2008 7:40:07 AM
Here's a related question. I've read that as the war was winding down the government was scared to death that when all the soldiers came home we would go right back into Depression.
Why didn't this happen?
Posted by: whosonfirst at Nov 11, 2008 7:50:34 AM
I remember 1940-41. The Depression was over, in the past, but unemployment was still high. What WW II did was to end the unemployment.
Posted by: Diversity at Nov 11, 2008 8:12:54 AM
I need to read Romer's paper; huge inflows of gold caused by political instability in Western Europe and the East?
I remember a little ditty my late father used to say they repeated in the summer of 1945 while on occupation duty in Germany, awaiting orders to the Pacific, "the Golden Gate in '48, the Bread Line in '49."
Posted by: Dave Richardson at Nov 11, 2008 8:52:23 AM
I'd bet that shifting spending from small, useless roads to high capacity roads connecting active places was a big booster over time.
Posted by: aaron at Nov 11, 2008 8:57:11 AM
I think when people say that World War II ended the Great Depression, they mean it ended the unemployment problem. Or am I wrong here?
Posted by: kurt at Nov 11, 2008 8:59:00 AM
That, and training and disciplin learned during service.
Posted by: aaron at Nov 11, 2008 8:59:31 AM
More thoughts I should have had before posting the above: Selective Service Act in 1940 removed significant portion of young males from work force, bringing down unemployment and increasing personal income/consumption. Anecdotally I know from family stories this helped tremendously.
Also, effects of increasing war production; remember the war in Europe began in September, 1939, although Western Europe wasn't overrun until the Spring of 1940. How much did British purchases stimulate production, jobs, etc.?
Posted by: Dave Richardson at Nov 11, 2008 9:01:20 AM
Well, this is an extremely frightening post.
Posted by: cmp at Nov 11, 2008 9:10:51 AM
It's kind of funny seeing the libertarians and Republicans tying themselves up in knots over rewriting history.
Interestingly, Hoover and the Balanced Budget boys (Andrew Mellon at the top) had three years to get us out of the Depression. Instead the economy went into a tailspin unlike anything before or until now(?) Why aren't you looking at their 'success'. They tightened monetary policy, they nearly balanced the books...and then demand and employment fell off the cliff. Then after 1932, when another conservative , FDR, took office a bit of innovation occured, job growth was steady upwards, even though bumps along the road furnished by an very conservative Supreme Ct. Over at Yglesias' there's a chart showing job growth going up and up after '32 while the famous cliff of late '29 thru '32 is obviously being reinacted now (if we don't get crackin').
Following Conservative, Libertarian Ideology would be a Disaster for Our Country. (capitals only used for emphasis, not every letter!)
And final question: What got us into the Depression in the first place? Leverage, fraud, duplicity are all factors. And tariffs only came later, not before when the bubble was being formed.
Luckily, we at least had Banks relatively protected due to New Deal reforms. FDIC has so far saved most of the smaller banks that hadn't engaged in 'financial innovation'.
"Financialization" got us into this mess....so let's examine how we got into this mess.
Posted by: datadave at Nov 11, 2008 9:21:59 AM
Two questions:
1) Can´t you say that the massive amounts of gold fleeing instability in Europe were caused by war, or the fear of it?
2) The second paper (which I thought was great) refers only to the 1938 relapse and the recovery from it. Can you apply the same argument to the period before that?
Posted by: NPTO at Nov 11, 2008 9:25:14 AM
Link to your awesome paper on the Marshall Plan!
Posted by: Selfreferencing at Nov 11, 2008 9:31:45 AM
Isn't fiscal vs. monetary policy something of false dichotomy? Fiscal policy in the sense of deficit spending only works if its monetized. On the other hand, part of monetary growth, i.e. deposits created by loans is endogenous. Increase of demand caused by deficit spending stimulates more lending if monetary policy is accommodating. Compare the present: monetary policy is very stimulative but banks still don't want to lend; that's why so many economists are calling for fiscal stimulus.
Posted by: Phil P at Nov 11, 2008 9:39:11 AM
From the lay point of view, all this "what caused/prolonged/ended the Depression" talk sounds a lot like the blind men examining the elephant.
What "caused" the French Revolution? the Reformation? etc.
Something about the academic mind appears to recoil from the notion that "it was a lot of stuff happening together."
Posted by: Anderson at Nov 11, 2008 10:01:57 AM
Of course military spending had little or no impact on consumer spending during WW II because we had rationing. To purchase most consumer items during WW II you needed both dollars and a ration coupon. Many things such as autos and appliances were not even built during WW II. The rationing contributed to a surge in consumer savings and helped in shifting the rise in consumer spending to after the war.
Posted by: spencer at Nov 11, 2008 10:02:29 AM
If it helps, here is a timeline of the Great Depression, as the stock market saw it.
Posted by: Ironman at Nov 11, 2008 10:45:38 AM
Many of the above commenters should read Higgs' paper that was linked to.
Posted by: Yancey Ward at Nov 11, 2008 11:38:30 AM
This is interesting, but I'm always a bit cautious when evaluating accounts of what started/ended a specific event, in order to not become yet another victim of the narrative fallacy.
Posted by: Economatheek at Nov 11, 2008 12:22:31 PM
Isn't fiscal vs. monetary policy something of false dichotomy?
Yes and no. Monetary policy is relying on the market to allocate money, fiscal (deficit spending) policy on the government. But in both cases it's bringing extra money into the economy and hoping that there is A). no Ricardian Equivalence and B). excess capacity.
@sammy: Try to keep it civil please..
Posted by: JSK at Nov 11, 2008 12:34:33 PM
Great, great post. I think it's incredibly important for us to take C. Romer's analysis to heart: That the abandonment of the gold standard was the primary catalyst that ended the Great Depression. This is yet another reason to be extremely bearish medium-term, as the Fed will almost certainly have to adhere to a de facto oil standard over the next few years. Indeed, the Fed pretty much did that up until September or so, when they finally stopped sterilizing the liquidity facilities.
Of course, the 'oil standard' is far more difficult to abandon since oil plays a much more important role than gold in the real economy. Hence, I don't see how we can avoid another Great Depression (and perhaps a more enduring one).
Posted by: AndrewG at Nov 11, 2008 1:12:10 PM
@Andrew: I don't understand. The deflationary impact of the gold standard resided in the direct link between the nominal value of one's currency and a certain quantity of gold (hence making depreciation of your own currency in terms of gold impossible under the gold standard. Since the dollar has already depreciated plenty in terms of oil recently i do not see the gold standard of the thirties and the 'oil standard' of today playing equivalent roles.
Posted by: JSK at Nov 11, 2008 1:30:50 PM
"Many of the above commenters should read Higgs' paper that was linked to."
Maybe I should, but I can't bring myself to read stuff by Higgs. I looked him up on Youtube and the first thing I hear out of his mouth is that environmentalism is the new communism. Apparently a clean and sustainable environment does jibe with his radical world view. He's not my cup of tea, so I'll pass on stuff written by or referenced to him. I don't think he is intellectually honest, or particularly informative.
Posted by: Trumpit at Nov 11, 2008 2:01:22 PM
Sorry, I meant "doesn't jibe" in my above comment.
Posted by: Trumpit at Nov 11, 2008 2:05:29 PM
Does the broken window fallacy apply? As a popular American philosopher once said, "War, what is it good for? Absolutely nothing."
Do you know what a 1945 Ford (or Chevy, or Packard) looked like? It looked exactly like a 1941 Ford (Chevy, etc.) because that's what it was. The economy was on hold for the duration.
The death of FDR during the war meant he wasn't around to connect the pre war depression to the post war depression.
The GI Bill and the Marshall plan where two good things that came with the end of war. Education is the great value added factor for human beings. Breaking open the class bound universities was a good thing. The new lawyers, doctors, engineers, accountants, teachers and so many others are the ones who built the new post war economy and ended the depression.
Both Truman and Marshall were veterans of WWI. They had seen that left on their own, Europeans would be back at each others' throats in a generation in an unending civil war. WWI had cost America 116,000 dead. WWII had cost America 405,000 dead. Let's not do that again. So, after WWII the Americans stayed and for all practical purposes occupied former enemies and former allies. Pax Americana.
Europe has enjoyed a peace since WWII that is longer than any they organized on their own. They have prospered. Somehow they have avoided the need for another war to boost their economy. Just lucky, I guess.
Posted by: Max at Nov 11, 2008 2:06:16 PM
