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The Keynesian Desperation Regarding 1920-21 Is Now Embarrassing

The Keynesian Desperation Regarding 1920-21 Is Now Embarrassing
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In a previous post, I discussed the newfound interest in the United States’ depression of 1920-21 because of Jim Grant’s book. As I explained in my post, Grant is following in the tradition of several free-market writers (including me) who think the 1920-21 depression shows the flaws in Keynesian thinking. Specifically, the depression after World War I was sharp but short, with the economy snapping back into recovery without Keynesian “stimulus”–indeed despite massive doses of “austerity” to use the modern lexicon.

Naturally the Keynesians (and others) pushed back, arguing that the Fed was decisive in ending the contraction. But analysis by Jeff Herbener (via Tom Woods) and George Selgin show that that narrative doesn’t work; the timing is simply off. The economy had clearly bottomed out and was recovering before the Fed loosened up the monetary spigots, looking at various criteria. (I should admit that the argument for monetary stimulus does have some support if we look at interest rates, rather than monetary growth. I will elaborate on this in a future blog post.)

But if the attempt to attribute the recovery from the 1920-21 depression to monetary policy is dubious, Barkley Rosser ups the ante by bringing in fiscal stimulus as well. After writing a blog post making the familiar argument about the 1920-21 being a textbook case of tight/loose money, Rosser then follows in the comments with this jaw-dropping argument and “history”:

…Herbert Hoover really does come out looking not so bad, partly thanks to all these people who think that 1921 was the way to go criticizing him. In fact, he was Commerce Secretary under Harding, and while it has not been widely advertised (supposedly there was no fiscal stim in 1921), by the end of 1921 there was in fact an increase in public works spending coming down that was driven by Hoover. So, the bounceback from the 1921 decline was aided by both fiscal and monetary policy stimulus, which you do not hear from Grant or any of these others.

Indeed, Hoover attempted fiscal policy after 1929, mostly for investment in airports and dams (they do not call it the Hoover Dam for nothing), but he was somewhat held back by Congress, and, ironically, FDR criticized him for his deficit spending and [FDR] ran on a balanced budget platform…only to abandon it once in office…This is all a bit more complicated than many like to acknowledge.

Do you see how wonderful this is? Rosser is saying the recovery from 1921 is partly thanks to the big-spending Herbert Hoover. Apparently, as Commerce Secretary, he was able to push through Keynesian fiscal stimulus, but as president, the conservative Congress forced him into the mold of the tight-fisted budget balancer that we all learned about in school (and that Krugman used as the villain in his 2008 column “Fifty Herbert Hoovers” to warn against state budget cuts).

Even though we can understand the rhetorical need to tie himself in such knots, Rosser’s version of history is so ludicrous that I don’t have to do much except show the relevant budget figures, put out by the White House (Table 1.1, p. 23):

Federal Outlays FY 1919 1924

As the chart above indicates, total federal outlays fell every single year from Fiscal Year 1919 through 1924. Do you see any evidence of the “fiscal stimulus” that helped pull the economy out of the 1920-21 depression? Now in general, we might have to worry about the calendar/fiscal year mismatch. For example, “Fiscal Year 1921” ran from July 1, 1920 through June 30, 1921. (Note that the start of the federal government’s fiscal year shifted to October 1 in 1976.) So when Barkley Rosser says there was a spurt of “public works spending” at the end of 1921, maybe he is referring to the calendar year?

But, as the chart shows, it doesn’t matter: there were steady and significant drops throughout the entire depression and recovery. Federal outlays dropped by a whopping 66% from FY1919-1920, by another 20% from FY1920-21, and then another 35% from FY1921-22. (For purists, in the following years it fell an additional 4.5% and 7.4%.) This is not “fiscal stimulus,” and the only reason Rosser is forced into suggesting such an absurdity is that he recognizes the awkwardness of this episode for traditional Keynesian policy prescriptions. (Note that I don’t deny that there may have been specific spending projects at the end of 1921–but clearly there is not “fiscal stimulus” on balance.)

Things are equally grim for the other end of Rosser’s historical narrative. The following chart shows federal spending when Hoover actually did have something to say about it:

Federal Outlays FY 1928 1933

Here we see that federal spending went up every year that Hoover was in office, except the last. (Remember that Fiscal Year 1933 ran from July 1, 1932 through June 30, 1933, and that Franklin Roosevelt was not sworn in until March 4, 1933.) Hoover was sworn in on March 4, 1929, and the stock market crash of October 1929 technically happened in Fiscal Year 1930. Rounding, the increases in federal spending from the previous year were 6% and 8% in FY 1930 and 1931, followed by a whopping 30% boost in FY 1932. Remember, this was happening as tax receipts were collapsing and prices were falling, making these nominal increases even more impressive.

Finally, as everyone knows, Hoover was a coldhearted “budget balancer” and slashed spending in FY 1933 by 1.3%, bringing it down to “only” 47% above the level that Calvin Coolidge had bequeathed, at the end of the Roaring Twenties. It’s worth pointing out that in this allegedly austere year, the budget was hardly balanced–the federal deficit was still $2.6 billion, or 4.5% of GDP.

It is truly amazing to see the contortions into which some analysts twist themselves, trying to make the historical facts fit their economic models. (I realize such is a common complaint that Keynesians level against their intellectual opponents; irony abounds.) When it comes to the depression of 1920-21, the central bank and federal government did the opposite of what Keynesians recommend. Nonetheless, recovery ensued despite continued budget cutting and a loosening of monetary policy that happened well after the recovery was underway.

In contrast, both the Fed and the feds engaged in monetary and fiscal “stimulus” after the 1929 stock market crash. Nonetheless, things just kept getting worse, so that the Keynesians have no explanation except to say, “too little, too late.”

In summary, things make perfect sense if we accept the hypothesis that government spending wastes resources. This really shouldn’t be such a scandalous suggestion, especially since it fits the empirical evidence so neatly.

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Robert P. Murphy is the Senior Economist at the Institute for Energy Research, and a Senior Fellow with the Fraser Institute. He holds a PhD in economics from New York University. Murphy is the author of Choice: Cooperation, Enterprise, and Human Action (Independent Institute, 2015) as well as numerous other books and hundreds of articles.

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