“That Really Worked in 1937”

This is a comment that I have heard a few times in the past few weeks regarding the issue of austerity. The Tea Party forced the GOP to embrace austerity, and we know that when FDR mistakenly listened to Treasury Secretary Morgenthau in 1937 and cut back on expenditures, the economy entered a rapid decline. The lesson, of course, is that austerity can impose a terrible cost on an economy that has not yet recovered.

As most Pileus readers will undoubtedly note, 1937 may be rich in lessons. As we know, the Federal Reserve imposed significant increases in reserve requirements. FDR’s rhetoric (remember that delightful phrase from the state of the union: “In spite of our efforts and in spite of our talk we have not weeded out the overpriviledged”) and efforts to introduce confiscatory tax rates created extreme regime uncertainty. As for fiscal policy, I am uncertain that there are great lessons to be learned.

I was updating some data I have generated on per capita domestic spending. The figures exclude defense spending, not because defense isn’t important but rather to get a sense of the trend line absent international crises, wars, etc.  The figures are adjusted for inflation (all presented in 2005 dollars) and the raw data is drawn from the typical sources (e.g., OMB Historical Tables, Census Bureau population figures). These figures are presented graphically below.

The most striking thing about these figures is how miserly the New Deal was by contemporary standards. The peak level of New Deal domestic spending in the 1930s was $809 per capita. This occurred after the “War Springs conversion” when FDR embraced active fiscal policy. The much cited austerity occurred after 1936, when per capita spending fell from $658 to $580. Remember, these figures are in 2005 dollars. In other words, the change in fiscal policy reduced federal domestic spending by approximately 21 cents per day per person.

A second striking thing about these figures is now much federal domestic spending per capita has increased overtime. Many look longingly to the good old days when the Gipper told us that government was the problem, not the solution. During his watch, domestic spending per capita increased from $4670 to $4951 (once again, in 2005 dollars). Once again, to place things in perspective, per capital domestic spending in 1988 was 6.12 times greater than the peak for the 1930s, in inflation adjusted dollars.

Moving forward, this year, the federal government’s per capita domestic spending is $7936. This is 9.81 times greater than peak per capita spending during the New Deal. Even if per capita spending were reduced to the levels of the last year of the George W. Bush presidency ($7066), it would be 8.73 times the New Deal peak (and for those who would rather look to more contemporary examples, 2.57 times greater than the peak of Great Society spending ($2746 per capita, 1968).

It is difficult to determine what the fiscal policy lessons of 1937 are when domestic spending per capita has increased so dramatically in the intervening decades. The biggest lesson is one that is often ignored. As much as many love to wag their finger at Lyndon Johnson or FDR, the levels of spending they engaged in was miniscule by today’s standards.  Critics may label any reduction in current spending as an exercise in austerity, but one wonders if we have any idea what austerity would really look like.

4 thoughts on ““That Really Worked in 1937”

  1. It seems doubtful to me that when we are dealing with numbers that small in the 1930s, fiscal policy could have had any kind of impact on the business cycle. Of course, the details of government programs and regulation (such as the NIRA) could still have significant microeconomic impact – but that’s a different issue.

  2. I don’t know whether looking at something as gross as per capita domestic federal spending is going to give you much insight into the effectiveness (or otherwise) of stimulus spending during the Depression, during the 2008-9 financial crisis, or during any of the intervening financial downturns. If you’re trying to draw conclusions about stimulus spending, it seems like you would want to analyze data that more closely reflects actual stimulus spending. Not being an economist, I’m not entirely clear on how you might do this, but one method might be to look at appropriations data and figure out what portion of annual appropriations were intended to be stimulative. The per capita representation of the actual stimulus amounts might give you a sense of scale of the “miserliness” of those appropriations. Comparing those appropriations to a) the total federal budge and, b) GDP might give you a sense of the potential impact they would have on the overall budget and on the economy as a whole.

    1. Well, the traditional Keynesian view is that it doesn’t really matter what it’s spent on, for purposes of boosting aggregate demand. You could drop the money out of helicopters or give it all to one corrupt contractor. So long as people spend it, it will improve AD. I’m not saying it’s a plausible theory, but that’s the theory as I understand it.

    2. Hey Everett:

      The goal of the post was not to draw conclusions regarding stimulus spending per se. In reality, I was using the recurring comment (“That really worked in 1937”) to place current levels of spending in historical context. The levels of per capita spending that we expect under normal conditions is rather staggering. Some of my friends on the Left–truly thoughtful individuals with well developed analytical skills–are shocked when I show them the data presented in the post. Few would believe that at the tail end of the so-called Reagan revolution, inflation adjusted domestic spending on a per capita basis was almost twice as great at the much maligned Great Society.

      Following Jason, when one considers that the cuts in 1937 eliminated a massive 21 cents per day per person (in 2005 dollars), it is hard to believe that we have a credible Keynesian story here. While I think the monetary policy story is far more credible, I would place my money on regime instability. Does that mean that today’s story is necessarily one of regime instability? No. But one has to note that corporations are sitting on a tremendous pile of cash and the seeming unwillingness to reinvest under conditions of uncertainty must have some impact on the rather pathetic pace of recovery.

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