What Got Us Out of the Great Depression?
By David Henderson
UCLA vs. UCLA
UCLA economics professor Lee Ohanian and co-author Harold Cole of the University of Pennsylvania had a piece in the Wall Street Journal this week, “Stimulus and the Great Depression: The Untold Story.” There’s a lot of good content in it: for instance, how the National Industrial Recovery Act actually slowed recovery. How so? They write:
The NIRA, for example, fostered monopoly and raised wages well above underlying worker productivity by a quid pro quo arrangement of relaxing antitrust enforcement in exchange for industry paying substantially higher wages.
In other words, FDR forcibly cartelized a bunch of industries: you shouldn’t expect that to raise output. (See Gene Smiley, “Great Depression,” The Concise Encyclopedia of Economics, for more on this.)
But Cole and Ohanian also write:
But boosting aggregate demand did not end the Great Depression. After the initial stock market crash of 1929 and subsequent economic plunge, a recovery began in the summer of 1932, well before the New Deal. The Federal Reserve Board’s Index of Industrial production rose nearly 50% between the Depression’s trough of July 1932 and June 1933. This was a period of significant deflation. Inflation began after June 1933, following the demise of the gold standard. Despite higher aggregate demand, industrial production was roughly flat over the following year.
This is badly misleading. And the person who pointed it out effectively is another UCLA economist (he earned his Ph.D. at UCLA), David Glasner.
Though not wrong in every detail, the version of events offered by Cole and Ohanian is still a shocking distortion of what happened before FDR took office in March 1933. In particular, although Cole and Ohanian are correct that the trough of the Great Depression was reached in July 1932, when the Industrial Production Index stood at 3.67, rising to 4.15 in October, an increase of about 13%, they conveniently leave out the fact that there was a double dip; industrial production was flat in November and started falling in December, the Industrial Production Index dropping to 3.78 in March 1933, barely above its level the previous July. And their assertion that deflation continued during the recovery is even farther from the truth than their description of what happened to industrial production. When industrial production started to rise, the Producer Price Index (PPI) increased almost 1% three months in a row, July to September, the only monthly increases since July 1929. The PPI resumed its downward trend in October, falling about 9% from September 1932 to February 1933, at the same time that industrial production peaked and started falling again.
That is why most observers date the trough of the Great Depression in the US not in July 1932, but in March 1933 when FDR took office in the midst of a banking crisis that threatened to drive the US economy even deeper into deflation and depression than it had been in July 1932. So when Cole and Ohanian assert that recovery from the Great Depression started in July 1932, and go on to say that the recovery took place during a period of significant deflation, it is hard to avoid the conclusion that they are twisting the facts to suit their own ideological predilection.
Not that Glasner disagrees with everything they write. He disagrees that monetary policy was unimportant. That’s why his criticism matters so much now: many generally free-market economists are claiming that monetary policy is impotent. It’s not.
Glasner does agree, though, that FDR’s cartel policy was a bad one. He writes:
Nevertheless, not everything Cole and Ohanian say is wrong. They properly criticize New Deal policies that slowed down the spectacular recovery from April to July 1933 to almost a crawl. What stopped April to July recovery almost in its tracks? The answer is almost certainly that FDR forced his misguided National Industrial Recovery Act through Congress in June, and by July its effects were beginning to be felt. Simultaneously forcing up nominal wages in the face of high unemployment (though unemployment started had falling rapidly when recovery started in April) and cartelizing large swaths of the American economy, the NRA effectively shut down the recovery that was still gaining momentum. As shown in the chart representing industrial production, industrial production resumed its rapid expansion almost immediately after the NIRA was unanimously struck down by the Supreme Court in May 1935. The aborted recovery was a tragedy for the American economy and for the world, but the premature end of (or extended pause in) the recovery tells us nothing about whether an economy can recover from a depression with no increase in aggregate demand.
Bottom line: in writing their “untold story,” Cole and Ohanian left out a big part of the story.