Are We About to Repeat the Mistakes of 1937?From my perspective on the sidelines, I would say the chances are awfully good for a 1937 repeat. Certainly the Republicans want the economy to shrink, throw more people out of work, scare people. Why? They figure they can win an election if they can pin "bad times" on Obama in 2012. Meanwhile, Obama seems determined to bring back 1937 because of his fascination with right wing talking points. He appears to be convinced that the "debt" is a bigger problem than "unemployment". Yes, that seems insane, but from all of his actions, it truly appears that Obama thinks that the current deficits are a bigger threat than mass unemployment.
Friday’s jobs report clearly indicates that the economy remains weak, yet the pressure to reverse stimulus and begin tightening fiscal and monetary policy has become overwhelming.
This combination of fiscal and monetary tightening – which conservatives advocate today – brought on a sharp recession beginning in May 1937 and ending in June 1938, according to the National Bureau of Economic Research. Real G.D.P. fell 3.4 percent in 1938, and the unemployment rate rose to 12.5 percent from 9.2 percent in 1937.
Economists are still debating the precise causes of the 1937-8 recession. While most say they believe that fiscal tightening is primarily to blame, some disagree. Perhaps it would have been positive if tightening was confined to the spending side of the budget, without the large increase in taxes. Maybe the fiscal contraction would have been benign if the Fed hadn’t tightened monetary policy simultaneously.
Given President Obama’s endorsement of large budget cuts, the only question now appears to be how much fiscal policy will tighten and how fast. If it is back-loaded and mainly involves cuts in transfer programs, the impact on growth may be modest. But if – as I suspect Republicans will demand – the spending cuts are front-loaded and involve reductions in government consumption and investment spending, the impact could be severe.
While it’s unlikely that the Fed will repeat its error of 1936-7 and raise reserve requirements or the federal funds rate, it has already begun de facto tightening by moving from monetary stimulus to a more neutral stance. Moreover, with interest rates on Treasury bills hovering near zero, there is little it can do to stimulate growth on the monetary side.
While the odds of another recession are still low, they are increasing. Given the economy’s fragility, policy makers need to be very careful, because it may take only a small misstep on either the monetary or fiscal side to tip the balance. The experience of 1937-38 should be a warning.
Who will stop a recurrence of 1937? I can't name any politician who is successfully making the issue of unemployment and slumping economy the top of conversation in Washington. Sadly, Washington is an island of millionaires more worried about their investments than in the American people.