Business Cycle Data in the 1930s

1
Business Cycle Data in the 1930s

• 1929-1933 Recession
• 1933-1937 Expansion
• 1937-1938 Recession
• 1938- Expansion
• By 1941 the economy had finally returned to its
  1929 level in both Real GDP and unemployment.
  From this, the New Deal does not lead to recovery.

2
Growth Rates in the 1930s

• In terms of Real GDP, the economy exceeded the
  1929 level in 1937.
• However, the 1933-37 recovery did not produce
  growth rates substantially different from the
  full employment economy of the 1920s.
• Why would we expect a difference? Growth rates
  reflect percentage changes. Given the severity
  of the contraction, percentage increases should
  be relatively high.

3
Unemployment in the 1930s

• Unemployment remained above the natural rate
  throughout the 1930s.
• Natural rate - rate of unemployment that reflects
  job-switching rather than structural or cyclical
  factors

4
Regional Differences in Unemployment

• The South did relatively better. Employment in
  the South Atlantic region only declined 14
  during the initial recession and by 1940 was 26
  above its 1929 level. Why did the South fare
  better than the rest of the nation?
• Southern industry was primarily light, as opposed
  to the heavy Northern industry.
• Southern workers were not typically covered by
  Social Security and unemployment insurance taxes,
  which had negative impacts on employment. Why?
  Farm labor was excluded from these policies.
• Other regions In Illinois and Massachusetts,
  employment declined 48 and 35 (respectively)
  during the initial downturn.

5
Age and Occupational Differences in Employment

• The work of Robert Margo.
• With respect to age, unemployment rates followed
  a U-Shape. Both the old and young fared worse
  than middle-age workers.
• In Philadelphia (1936)
• Unskilled workers - 44 unemployment rate
• Clerical workers - 21 unemployment rate
• Managerial workers - 12 unemployment rate

6
More from Margo

• For the nation? (March, 1933)
• Construction workers - 73 unemployment rate
• Manufacturing workers - 40 unemployment rate
• Agriculture workers - 14.5 unemployment rate

7
Why the Expansion?

• Friedman and Schwarz Expansionary monetary
  policy by the Fed
• Liquidationists or AustriansRemoval of weaker
  firms
• Keynesian New Deal spending boosted aggregate
  demand
• Temin and Barrie Wigmore New Deal policies of
  Roosevelt altered expectations and stimulated
  investment. Specifically the devaluation of the
  dollar led to a rise in prices and incomes.

8
Keynesian Economics, Again

• A brief review of Keynesian Economics
• AD C I G NX
• Negative expectations lead to a decline in C and
  I, which leads to a decline in AD.
• If prices do not adjust, output declines, causing
  further declines in confidence and further
  declines in AD.
• The solution Increase government spending. This
  is done by both increasing spending and
  decreasing taxes. The result is a budget deficit.

9
Was Roosevelt a Keynesian?

• E. Cary Brown (1956) estimates that federal
  fiscal policy was expansionary in six of the
  seven Roosevelt years. Only in 1937 would there
  have been a budget surplus at full employment.
  Relative to GNP, though, the fiscal stimulus of
  Roosevelts budgets were quite small.
• If one includes the actions of state government,
  the net impact of all government spending on
  aggregated demand was negative in four out of the
  seven Roosevelt years (1933-1939).

10
Hoover as a Keynesian?

• Relative to Hoover (1930-32), the total impact of
  state and federal spending was less Keynesian
  during the Roosevelt years.
• Why was Roosevelt not a Keynesian?
• With only classical macro theory to guide policy
  makers, the prevailing view was that deficits had
  a negative impact on the economy. It should be
  noted that any departure from prevailing economic
  wisdom may have further weakened the peoples
  faith in the economy.

11
The Recession of 1937-38

• Why did the economy decline in 1937-38?
• The contractionary fiscal policy of the Roosevelt
  administration
• International economic downturns
• Anti-inflation policies of the Federal Reserve.

12
The Focus of the Fed in 1936

• The Fed was concerned about rapid increases in
  the money supply, the large excess reserves of
  banks, and the inflation of 1936. In an effort
  to avoid further inflation, the Fed increased
  reserve requirement, which caused interest rates
  to rise and business confidence to collapse. The
  result was the third largest decline in the money
  supply.
• Two largest declines 1920-21 and 1929-33
• Hence the monetarist explanation of the Great
  Depression

13
New Deal Spending Objectives

• If Roosevelt is not a Keynesian, what was the
  point of the New Deal?
• The research of Don Reading
• Relief vs. Reform
• Review table 22.4 New Deal Outlays per Capita, by
  State, 1933-39

14
Relief vs. Reform

• Relief Repair the immediate economic damage of
  failed business and unemployment.
• Reform
• Failure of the Federal Reserve System
• Uncontrolled stock market
• Falling wages and prices
• Farm crisis
• Structural causes of poverty
• Racial discrimination
• Unequal distribution of income

15
Readings Empirical Results

• Per-capita New Deal aid f(Relief variables
  percent decline in income, unemployment rate)
  (Reform variables per-capita income, percentage
  of tenant farmer, African-American population)
• Results New Deal aid was primarily a function of
  relief variables, not reform variables such as
  per-capita income. In other words, declines in
  income attracted aid, not absolute levels of
  income.
• Why? People react politically to declines in
  incomes, not absolute levels of income.

16
The research of Gavin Wright

• Where should Roosevelt the politician spend
  money? In states where elections are likely to be
  close and voter sentiment can be swayed by
  government action.
•  According to Wright 80 of New Deal spending
  can be explained by the number of electoral votes
  per-capita, variability in previous elections,
  and closeness of 1932 election.

17
More from Wright

• When one adds Readings variables of percentage
  decline in per-capita income and the unemployment
  rate to Wrights simple model, these variables
  are shown to have no statistical impact.
• Result Who received the money?
• Western State received the greatest amount of
  aid. Southern states the least.
• Why? Southern states were firmly Democrat.

18
The Glass-Steagall Act of 1933

• Separates commercial banks from most securities
  business.
• This was a response to the perception that banks
  failed because these institutions were too
  heavily involved in the securities industry,
  hence there was a possibility of fraud and
  insider trading.
• The Glass-Steagall Act was effectively repealed
  by the Gramm-Leach-Bliley Financial Services
  Modernization Act of 1999.

19
Federal Deposit Insurance Corporation

• Moral Hazard and the FDIC. If the government
  guarantees deposits, will depositors pay
  attention to the actions of banks? If no one
  pays attention to the action of banks, what stops
  the banks from making loans with potential high
  payoffs and equally high risk?
• Moral hazard Problem created by asymmetric
  information after the transaction occurs.
• After an agreement is reached, one player can
  take an action that affects the payoffs of the
  other, and this action cannot be perfectly
  observed by the other player.

20
Bank Act of 1935

• Board of Governors is given discretionary control
  over bank reserves and margin requirements for
  loans on securities.
• The Governors Committee, innovated by Benjamin
  Strong, was renamed the Federal Open Market
  Committee. The FOMC had 12 members, seven of
  which were governors of banks.
• The Secretary of the Treasury and the Comptroller
  of the Currency was removed from governing the
  Fed. The FOMC was in charge of monetary policy,
  and the majority of its members were political
  appointees (the governors).