QUESTION: FDR'S 1937 ECONOMIC STIMULUS SCALE-BACK

Miscellaneous History
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This is a request for comments on a Jan 25 article on Dailykos.com by Jed Lewison. His opinion is based largely on Dr. Paul Krugman’s Nov 10, 2008 article in the NY Times, Fiscal FDR. Links to both follow, along with the text of Lewison’s article. From anyone with subject matter info, I’d like an Austrian school view of FDR’s decision to scale back on his economic stimulus policies and the resulting consequences, which, according to Krugman, were negative for the economy. Thanks.

http://www.dailykos.com/storyonly/2010/1/25/203449/362

http://krugman.blogs.nytimes.com/2008/11/10/fiscal-fdr/

Unimaginable stupidity### by Jed Lewison

Mon Jan 25, 2010

So the Obama Administration is preparing to announce a freeze on Federal discretionary spending through 2013.

And they are proposing it in the middle of a the deepest recession since the Great Depression.

Apparently, it’s a political decision made in response to a single election. Great. A single U.S. Senate race in Massachusetts is now dictating fiscal policy for the next three years.

It might at least make some sense if it were a smart political decision. But there’s nothing to suggest that it’s anything but unalloyed idiocy.

In 1937, FDR followed the same course, pulling back his stimulus programs that had been boosting the economy. The results were catastrophic. The economy tanked. And so did the fortunes of the Democratic Party. Predictably, Republicans won 79 seats in the 1938 midterms.

Fortunately, FDR recognized his mistake and reversed course, increasing spending and boosting the economy – even before the start of World War II.

Flash forward seventy years, and President Obama is making the same mistake, probably with the same consequences.

Except this time he’s got the benefit of history. But he’s refused to learn history’s lesson.

It seems impossible to believe, but there it is. One of the worst decisions – if not the worst decision – that the administration could make. And they’ve made it.

Such a waste.

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Under Hoover and FDR the economy was cartelized and the markets were unable to clear. Removing government spending in that environment was certain to cause a crash.

It was only the war that gave the government the power to crush labor unions and industry cartels and subject them to the war machine. This is why when the military was demobilized after the war (with a corresponding decrease in government spending), the economy experienced its biggest growth surge in history.

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As I recall it was Thomas Woods (might be somone else) who calculated that without the New Deal then the unemployment level would have been about 8 percent lower. But of course when you stop pumping in huge amounts of money into the economy there is going to be “good” economic consequences which prevent actual recovery from taking place.

When you take somone off of a drug they will crash, only then can they actually start recovering. Also the great depression only ended after the federal government spending dramatically.

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People need to give up on the theory that anything that hurts in the short term is bad. You have to clear the malinvestments that were made in the boom (and subsequent propping up), which is caused by government monetary manipulation and government spending packages. You want to see a country that does hardcore “stimulus” for 20 years? Japan. And now they are screwed, stock market is 80% lower, and their debt is over 2x GDP.

From Dailykos: “In 1937, FDR followed the same course, pulling back his stimulus programs that had been boosting the economy. The results were catastrophic. The economy tanked.”

First off, there were factors such as federal reserve activity and unionization (causing higher real wages) that contributed to the economic decline. But, look at what the DailyKos storyline is based on: economic went bad, hence this is a bad thing. But why? There are intertemporal tradeoffs, and having government keep spending ridiculously sells out the long term to gain a bit in the short term. When prices adjust in the future and resources are diverted from activities that are in line with consumer demand, this strategy will fail hard (this is the long term). You have to let the malinvestments clear, and after a short delay (can be very fast, see after ww1 and ww2), resources that were once employed in one line of unproductive work - propped up by government - will be liquidated and put back to work in activities that are in line with consumer demand.

http://www.economicthought.net/2009/12/the-dangerous-“lessons”-of-1937/ → written by mises forum member

Don't the events of 1937-1938 prove (to some extent) keynesian economics? —> recent thread on the lessons of 1937

My comments on the previous thread:

"The “stimulus” is a malinvestment and as soon as spending is reduced to bring debts down, the economy goes back into recession (the recession being a period of necessary readjustment). It shows how dumb stimulus is… when you stop it, you slide back into recession cause the activities you propped up aren’t desired by actual consumer demand.

The artificial bubble is the bad thing, and the bust is the necessary correction obligated by the boom. If the economy didn’t have to undergo a correction after the artificial bubble - it would have been a free lunch. It’s not."

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Thanks New Liberty and to all for the helpful comments, suggestions and links. I’m brand new here in the Mises community. It’s good to hear from people with clear, insightful minds on economic policy.

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EDIT: Nvm, I see someone already linked it.

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New Mises Blog Post that covers this territory:

http://blog.mises.org/archives/011570.asp

It makes the same point I did about post ww2 prosperity.