[At its peak in June 1920, the stock of money was roughly double its September 1915 level and more than double the level of November 1914, when the Federal Reserve Banks opened for business] Banks began to offer public credit to buy government bonds. The price level also expanded dramatically in response to monetary inflation. The false boom continued through 1918 until the war came to an end. The nation immediately went into recession, followed by another miniature boom-bust cycle from 1920 to 1921.
(taken from p. 66 End the Fed by Ron Paul)
How is it that once WWI came to an end, the nation went into recession? Doesn’t that validate Keynes to some extent?
The Fed created a monetary expansion to finance the government (that needed the money to pay for the war) and that created a bubble. Then the bubble burst and there was a recession.
Don’t Keynesians say that monetary and fiscal stimulus is needed to keep an economy from going into recession? And that if you remove stimulus, an economy goes into recession?
So, in the above example, WWI military expenditure and monetizing of debt was the “stimulus”. When that was removed (at the cessation of hostilities), the economy went into recession… which squares with what Keynesians argue.
No, it depends on where you put the start point and if you use real or imagined history. If you put the start point at the end of WW1 then it looks like Keynes is correct. When the massive expansion of government and government spending ended with the end of the war, the economy went into recession. If you put the start point in 1913 with the passage of Federal Reserve Act, you see a different picture. The economy was doing quite well in the early 1910s until the USA decided to bail out Britian and started lending them lots of money. This money was in effect a diversion of wealth from real wealth producers in the USA to wealth destroyers in WW1.
The real history is that the economy in the USA started to feel the stress of the stolen resources going to fight a pointless war. Some industries did great while others did poorly. There was war time rationing and what not as well. Eventually the USA got the Germans to attack the ship and that put the USA in the war. Then the loans to Allied countries and the military spending jumped up as did the burden of paying for the war. At the end of the war the burdens lessened but continued none the less. The USA had misdirected so many resources that the economy could not keep up and so it went into a recession in the late 19 teens.
Nobody is claiming economic indicators are not going to go up if you start spending (and printing to finance it). The question is: is that real growth or you are just holding up the bubble (or creating a new one)? Take for example what Greenspan did when the dotcom bubble went bust and then 911 happened. Someone looking at just that period would think that Greenspan was a genious because by just lowering interest rates avoided the crisis. We now painfully know that he just substituted the dotcom bubble with the housing bubble. The economy did not purge the excesses, it kept going. The growth was no real, it was a bubble. Its the same idea.
The fact that you boost economic indicators by spending and printing does not mean that the economy is really going better, because that growth is not real or sustainaible. If you keep spending and “stimulating” the economy what you are doing is avoiding the purge in the market and keeping the market from regenerating. The bad and inefficient companies dont fail (or at least not all) and keep using resources. If those companies would fail and free the resources, they could be used by new entrepeneurs to start productive companies. Obviously in this last case, you would have a big decline in the indicators initially, but then followed by a quick and strong recovery. If you keep proping up bad bussiness, like Hoover tried to do, you get the Great Depression.
Err, you seem to be focusing entirely on a strawman of Keynes. It is not that monetary and fiscal stimulus are needed to keep an economy from going into recession, but to rescue an economy from a recession. For whatever reason, ‘aggregate demand’ falls and there is a recession, and that is when the government must step in and boost aggregate demand and return the economy to full employment.
If you remove stimulus before the economy returns to full employment, then yes, the recession will worsen. But I believe Keynes specifically said that such measures should not be used when the economy is healthy, and that the debt should be repaid and the government return to balanced budgets once the crisis is over. At full employment, the government doesn’t need to (or simply cannot?) boost aggregate demand. One response Keynesians employ against their critics is that politicians don’t listen to this part of Keynes, and Keynesianism really does work if the government had the willpower to keep their spending in check during the good years. Hence, you get Krugman denouncing Bush for running a deficit in 2003, and then denouncing him for running too small a deficit in 2008.
But if everything people have written above is true, why didn’t the same thing happen at the end of the second World War? Why didn’t the economy go back to recession in 1946, due to the massive misallocation of resources fuelled by excessive monetary expansion and government spending during 1939-1945?
Austrians use the WWII example to back up their point that Keynesians can’t predict, but why ignore the first world war, when their theory (superficially, at least) predicted accurately?
I sent the following email to Robert Higgs. Let’s hope he responds:
I wonder if you could point me to a resource that would explain why the economy went into recession after World War I?
Is it due to the massive misallocation of resources in the prior boom?
Ok, let’s accept that. But then why didn’t the same thing happen at the end of World war II, when there was also malinvestment brought about by government intervention during 1939-1945? I know you have written about how 1946 runs counter to Keynesian predictions that the economy would go into recession at the end of the war.
But why was Keynesian theory seemingly “right” about the end of WWI, when the economy did go into recession upon the withdrawal of military stimulus?
From what I understand (hopefully someone more learned will check out the thread), there was a recession following WWII.* Which, come on, should be expected, given all the men returning home and the entire industries that no longer have a war government interested in their products. The downturn was short-lived, however, because of the liberalization of the American economy following the war. Wartime rationing and price controls were quickly abandoned, and so the economy quickly adjusted to the new reality (as, Austrians contend, it did following the 1920 bust).
I believe this is the part of the story that contradicts Keynesianism. At the time, Keynesians were predicting that the government could not just stop its massive spending. It needed to provide stimulus following the war, or the sudden post-war collapse in demand would ‘return’ the country to the Great Depression.
*EDIT: Whoops, I think I am mistaken here. I believe the government classifies 1945 as having a recession, due to the drop in GDP following the war (again, drastically cut government spending). But I guess unemployment was not a huge problem - or, again, not for very long.