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The past mirror: notes, surveys, debates
I
The recent US financial crisis and deep recession has led to renewed interest in the Great Depression of the 1930s.2In particular, the disappointing US recovery from the economic collapse in late 2008 and early 2009 has sparked a debate over the merits of fiscal and monetary policy in addressing the situation. Some economists, such Paul Krugman and Christina Romer, have worried that if measures to provide monetary and fiscal stimulus are withdrawn too soon, the US economy could fall back into recession, just as the recovery from the Depression was interrupted by the recession of 1937-8. Yet there are many unanswered questions about the causes of that recession that make it worthy of reconsideration.
The recession of 1937-8 was America's second most severe economic downturn in the twentieth century, after the Great Depression itself. Real GDP contracted 11 percent and industrial production plunged 30 percent between the second quarter of 1937 and the first quarter of 1938. The civilian unemployment rate, still high in the aftermath of the Great Depression, rose from 9.2 percent to 12.5 percent.3Because this sharp downturn occurred when recovery from the Depression was far from complete, it became known as the 'recession within a depression'. It set back the recovery from the Depression by two years.
The recession is often blamed on the tightening of fiscal and monetary policies. In terms of fiscal policy, the Roosevelt administration became concerned about large budget deficits and began reducing the growth in government spending and increasing taxes.4In terms of monetary policy, the Federal Reserve and Treasury became concerned about the inflationary potential of excess reserves in the banking system and large gold inflows and therefore decided to double reserve requirements and sterilize gold inflows.
Yet the evidence that these policy changes were responsible for the severe downturn is underwhelming. Although Brown (1956) finds that the fiscal contraction amounted to a swing in demand of 2.5 percent of GDP in 1938, Romer (1992, p. 766) finds a relatively small fiscal multiplier during this period and argues that 'it would be very difficult' to attribute most of the decline in output to fiscal policy.5And while...