In today’s Wall Street Journal, Harold Cole and Lee Ohanian try to teach us some lessons from the Great Depression. According to Cole and Ohanian, those of us who believe that increasing aggregate demand had anything to do with recovery from the Great Depression are totally misguided.
[B]oosting aggregate demand did not end the Great Depression. After the initial stock-market crash of 1929 and subsequent economic plunge, recovery began in the summer of 1932, well before the New Deal. The Federal Reserve Board’s Index of Industrial Production rose nearly 50% between the Depression’s trough of July 1932 and June 1933. This was a period of significant deflation. Inflation began after June 1933, following the demise of the gold standard. Despite higher aggregate demand, industrial production was flat over the following year.
Though not wrong in every detail, the version of events offered by Cole and Ohanian is still a shocking distortion of what happened before FDR took office in March 1933. In particular, although Cole and Ohanian are correct that the trough of the Great Depression was reached in July 1932, when the Industrial Production Index stood at 3.67, rising to 4.15 in October, an increase of about 13%, they conveniently leave out the fact that there was a double dip; industrial production was flat in November and started falling in December, the Industrial Production Index dropping to 3.78 in March 1933, barely above its level the previous July. And their assertion that deflation continued during the recovery is even farther from the truth than their description of what happened to industrial production. When industrial production started to rise, the Producer Price Index (PPI) increased almost 1% three months in a row, July to September, the only monthly increases since July 1929. The PPI resumed its downward trend in October, falling about 9% from September 1932 t0 February 1933, at the same time that industrial production peaked and started falling again.
That is why most observers date the trough of the Great Depression in the US not in July 1932, but in March 1933 when FDR took office in the midst of a banking crisis that threatened to drive the US economy even deeper into deflation and depression than it had been in July 1932. So when Cole and Ohanian assert that recovery from the Great Depression started in July 1932, and go on to say that the recovery took place during a period of significant deflation, it is hard to avoid the conclusion that they are twisting the facts to suit their own ideological predilection.
The misrepresentation perpetrated by Cole and Ohanian only gets worse when they describe what happened during the period of true recovery, April through July 1933. Contrary to their assertion, deflation stopped in February 1933, the PPI hitting its low point of 10.3. Prices began to rise as soon as FDR suspended the gold standard shortly after taking office in March (not June as Cole and Ohanian mistakenly assert) 1933, the PPI rising to 11.9 in July (an increase of about 14% over February) when industrial production hit a peak of 5.95, 57% above the March low point.
The two attached charts (supplied courtesy of Marcus Nunes) illustrate the sequence of events that I have just described. The close correlation between the PPI and industrial production is especially striking.
To assert that the rapid price increases from March to July, a proxy for increased aggregate demand, played no role in what was then (and remains) the fastest increase in industrial production in any four-month period in American history is a gross misrepresentation of the facts. What is perhaps even more shocking is that Cole and Ohanian would misrepresent facts so easily ascertainable.
Nevertheless, not everything Cole and Ohanian say is wrong. They properly criticize New Deal policies that slowed down the spectacular recovery from April to July 1933 to almost a crawl. What stopped April to July recovery almost in its tracks? The answer is almost certainly that FDR forced his misguided National Industrial Recovery Act through Congress in June, and by July its effects were beginning to be felt. Simultaneously forcing up nominal wages in the face of high unemployment (though unemployment started had falling rapidly when recovery started in April) and cartelizing large swaths of the American economy, the NRA effectively shut down the recovery that was still gaining momentum. As shown in the chart representing industrial production, industrial production resumed its rapid expansion almost immediately after the NIRA was unanimously struck down by the Supreme Court in May 1935. The aborted recovery was a tragedy for the American economy and for the world, but the premature end of (or extended pause in) the recovery tells us nothing about whether an economy can recover from a depression with no increase in aggregate demand.
Another point overlooked by Cole and Ohanian, presumably because it doesn’t exactly fit the ideological message that they want to propagate, is that the timing of the recovery — immediately after the monetary stimulus resulting from suspension of the gold standard – shows that monetary policy can be effective with little or no fiscal stimulus. It is hard to see how any fiscal stimulus could have taken effect by April 1933 when the recovery had already begun. Moreover, Roosevelt campaigned as a fiscal conservative, so it would not be easy to argue that anticipated fiscal stimulus was being felt in advance of its actual implementation.
The real lesson the Great Depression is that monetary policy works — for good or ill.
HT: Bill Woolsey, Marcus Nunes, Scott Sumner