Policy Failure During the Great Depression
with Charlie Mathews
Generations of students learned that the Great Depression was a conspicuous failure of free-market capitalism that only ended with the New Deal. Instead, the New Deal and other policies enacted to fight the Depression prolonged it. The Smoot Hawley Tariff was a conspicuous political failure. The New Deal was a conspicuous fiscal failure. The Federal Reserve’s response was a conspicuous monetary failure. Altogether, they worsened the depression.
With the onset of the Depression, people panicked and adopted isolationist, protectionist attitudes. To soften the Depression’s blow, Congress passed a sweeping tariff that raised import duties. Over the objections of 1,028 economists who signed an open letter urging him not to, President Herbert Hoover signed it. The effects were familiar. Americans wasted resources producing what they used to import domestically. There was deadweight loss because consumers could not consume as many of the newly-protected goods. The tariff made goods like Swiss watches much more expensive. American factories could no longer import the parts and materials they needed. This video from Marginal Revolution University explains:
The Smoot-Hawley Tariff was the first (perhaps unintentional) shot in a trade war. Not to be outdone by Americans, Europeans retaliated with tariffs on American goods. As a result, unemployment rose, industries failed, and the global economy became less efficient because of less specialization.
The Federal Reserve did not help matters. Its responsibilities include maintaining full employment and stable prices. Monetary policy during the early years of the Depression failed on both counts. A rapidly-contracting money supply and the subsequent deflation bankrupted farmers and others responsible for repaying debts in appreciated, harder-to-get currency. The money supply fell by some 30%. Loans and mortgages went unpaid. Bank runs and panics happened across the country. As Anna Schwartz and Milton Friedman would later explain, monetary mismanagement turned what might have been an ordinary recession into a Great Depression.
Upon taking office, President Franklin Delano Roosevelt inherited an economy already in shambles. So he set out to implement the New Deal, a sweeping array of programs to stabilize the economy and help Americans recover from the economic devastation. Instead, Roosevelt oversaw a massive increase in spending and a sweeping assumption of new powers by agencies like the National Recovery Administration and the Agricultural Adjustment Administration. These agencies and others, some of which ultimately did not survive challenges in the Supreme Court, aimed to correct “underconsumption” and “overproduction” and to keep farm prices high so that farmers’ incomes would rise and they would have more money to spend.
Efforts to control prices and centrally plan production, however, did not work. As the economic historian Robert Higgs has argued, the New Deal’s challenge to established property rights created regime uncertainty, with many people deciding not to invest out of the fear that their government would expropriate them.
Economists and historians will continue to debate the causes and consequences of the Great Depression, and as they make discoveries, they will refine their explanations. They will no doubt find that many supposed “cures” actually made the disease worse. The response to the Great Depression combined political, fiscal, and monetary failure in a way that made the Depression longer rather than shorter.
Charlie Mathews is a student, and Art Carden is an economics professor at Samford University.
Feb 17 2023 at 3:23pm
“Economists and historians will continue to debate the causes and consequences of the Great Depression”
That has always amazed me. We see it again with the causes of the Great Recession. It’s like the blind men describing the elephant.
Thomas Lee Hutcheson
Feb 17 2023 at 11:50pm
Missed opportunity funing SS with a VAT, abolishing the corporate income tax
Feb 18 2023 at 1:53am
One of the few New Deal programs that was (by most accounts I’ve read) largely successful was the Works Progress/Project Administration (WPA). Despite its criticisms, the WPA was extremely popular among the people it employed and its legacy continues to be celebrated for the vast improvements to infrastructure that occurred under its aegis.
Perhaps some credit should be given where credit is due?
Feb 18 2023 at 10:18am
Banks didn’t have the eligible collateral to discount, and even if they did, there was a severe shortage of hard currency in which to dispense.
Feb 18 2023 at 6:03pm
If govt actions prolonged the Depression are we now willing to accept that the initial causes that started it were largely market failures?
Feb 19 2023 at 7:02am
The latter doesn’t follow from the former. That the Depression was prolonged by government failure doesn’t imply that the Depression wasn’t also caused by government failure.
By way of metaphor, assume I set my roof on fire. If I dump gasoline on the fire, the fire will prolong. The fact my actions prolong the fire doesn’t mean my actions didn’t start the fire.
Feb 20 2023 at 10:34pm
Allow me to double down on blaming the government. The market responds to incentives. If government gives perverse incentives, the market provide perverse results. It’s likely the government set up perverse incentives, the market responded in kind, and then the government reacted to make it worse.
Feb 21 2023 at 1:32pm
Shortages of “hard currency?”. What is that exactly? The Federal Reserve issues currency. It could have undertaken open market operations rather than depend on banks borrowing, so collateral is not necessary. There was no need to raise reserve requirements, though that disaster did come later. I do agree that devaluation may well have been necessary to keep the demand for output growing at the pre-depression trend. But the Fed failed to do what it could and accumulated rather than lost gold reserves
Feb 21 2023 at 1:37pm
What market failures supposedly caused the great depression? In the U.S. the Fed tightened monetary policy to control stock market speculation. That was inappropriate.
Richard W Fulmer
Feb 22 2023 at 12:06pm
Prior to the stock market crash, the Fed increased the money supply by some 50%, which contributed to wildly inflated stock market prices. In his book, The Way the World Works, Jude Wanniski makes a compelling argument that the 1929 crash was sparked by the debate over what became the Smoot-Hawley Tariff Act of 1930. Others argue that the trigger was the Fed’s tightening of the money supply.
Regardless of what set off the crash, the stock market bubble caused by the Fed’s policies would have popped eventually. Prior to the crash, soaring stock prices led investors to believe that buying shares was a surefire way to get rich quick. As a result, many bought on margin driving up stock prices even higher. When prices eventually began falling, panic selling drove the market into a downward spiral.
Boom-and-bust cycles driven by monetary expansions have been common throughout history. The Dutch “Tulip Mania” is another such example.
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