A History Lesson To Help Understand Today

Below are some juicy bits from an article by Bruce Bartlett in Forbes magazine. Barlett has "seen the light" and rejects the voodoo economics of the current Republican party: Bruce Bartlett is a former Treasury Department economist and the author of Reaganomics: Supply-Side Economics in Action and Impostor: How George W. Bush Bankrupted America and Betrayed the Reagan Legacy. He writes a weekly column for Forbes.com.

This article points out how the Republicans are re-enacting the same mistakes as they did under Hoover and FDR:

One reason why Republicans strenuously oppose the Obama administration's fiscal stimulus plan is because it repeats the errors of Franklin D. Roosevelt. To them, the New Deal was mainly about vastly expanding government spending and deficits, which Republicans believe made the Great Depression worse rather than better. Therefore, doing so again in the present downturn will also lead to failure.

The true New Deal legacy, however, is more complicated. Serious mistakes were indeed made. In particular, the National Industrial Recovery Act was fundamentally ill-conceived and retarded economic recovery. But in terms of fiscal policy, Roosevelt's error wasn't that he spent too much, but that he didn't spend nearly enough.

As economists Milton Friedman and Anna Schwartz proved to the satisfaction of most economists, the core economic problem in the early 1930s was a contraction of the money supply by a third. This caused the general price level to fall by about 25%.

Deflation caused real wages to rise, forcing employers to lay off workers to reduce labor costs; it forced businesses to go bankrupt because they had to sell goods for less than they cost to produce; it magnified the burden of debts as borrowers had to repay loans in dollars worth more than those they were lent; and it increased real interest rates and the real burden of taxation.

But neither Roosevelt nor the Federal Reserve really understood that monetary policy was the root cause of the deflation. Insofar as they did, they thought that the gold standard was the basic problem. In fact, the Fed was not constrained by the gold standard; it simply didn't do its job when it really mattered. (See this paper by economists Michael Bordo, Ehsan Choudhri and Anna Schwartz.)

Consequently, Roosevelt's efforts to staunch the deflation were highly inappropriate. He arbitrarily raised the price of gold from $20.67 per ounce to $35, thinking that this would automatically increase liquidity. It didn't because 1) all the privately owned gold had previously been confiscated by the government and 2) it didn't change Fed policy.

...

The critics were also totally opposed to deficit spending. As with Republicans today, they said that federal borrowing would simply draw funds out of productive uses in the private sector to be squandered on make-work government jobs, pork barrel projects of dubious value and welfare programs that would sap the dynamism of the American economy.

Apparently, it didn't occur to these critics that the existence of vast unemployment, closed factories, abandoned farms and extremely low interest rates meant that much of the private sector's resources were simply idle. Borrowing them by running deficits didn't reduce private output because there were no alternative uses available.

Furthermore, an expansive fiscal policy was essential to recovery because without it monetary policy was impotent and deflationary conditions continued. Although Roosevelt had economists like Leon Henderson and Lauchlin Currie around him who perfectly well understood this, he did not heed their advice.