The writer and philosopher, George Santayana, is famous for his aphorism, “Those who cannot remember the past are condemned to repeat it.” As we await future unemployment statistics from the government, we should take time to look back at out two most sever economic downturns to see which policies did and did not work.
Last week’s unemployment claims pushed the two-week total to 6.6 million, which puts March’s total at roughly 10 million, to put that in context, nine million jobs were lost in the 2008 recession. It’s easy to see that the coming recession (in terms of unemployment) could more closely resemble the Great Depression than the recession of 2008, with some economists talking about unemployment rates exceeding 15 percent. But while the unemployment rate may harken back to the Depression, the amount of actual economic deprivation should be far less than what we saw in 2008 because of ability to better manage the economy.
Most people think of The Great Depression as having lasted from 1929 to the beginning of WWII. But actually the “depression” was a combination of two recessions. One from 1929 to 1936, and a second starting in 1937 ending in 1938, although the unemployment remained at 10 percent through 1940.
In 1936, Roosevelt was under pressure to reign in the government’s budget deficits, even though FDRs deficits as a percent of GDP only averaged 3 percent. So in 1937, Roosevelt decided to balance the budget by raising taxes. At the same time, the Federal Reserve raised reserve ratio requirements for member banks, leading to a contraction in the money supply. The economy slumped back into recession.
As it turns out, FDRs deficits were actually too small to end the Depression but expenditure programs were on the right track. The Home Owners’ Loan Corporation was created in 1933 to assist in the refinancing of homes. In fact, one million people received long-term, low-interest loans, which saved their homes from foreclosure. The Works Progress Administration (WPA) was created in 1935. As the largest New Deal agency, the WPA affected millions of Americans and provided jobs across the nation. Unfortunately the Civil Works Administration created in 1933 to create jobs for the unemployed in high-paying jobs in the construction was terminated in 1934 because of opposition to its cost.
In December of 1941, the unemployment rate in the US was still 9.9 percent. During the next four years (WWII), the unemployment rate fell to a low of 1.2 percent with the four-year average being 2.4 percent. The reason WWII spending was so much more successful than FDR in ending the Great Depression was its sheer size. Government budget deficits peaked in 1943 at 26.9 percent of GDP with the four-year average (1942-1945) being 20 percent. Did the government spending have to be defense spending to be effective? No. Any spending of that size would have been just as effective. This was the ultimate proof that increasing demand (or incomes) via government spending can effectively end any recession.
By contrast, the Obama stimulus package passed in 2019 was too small. Over the first four years of Obama’s Presidency, his deficits as a percent of GDP averaged only 8.3 percent, only 41 percent of what it took during WWII to move the nation to full employment. Between 2007 and 2016 there were 7.8 million home foreclosures in the US. The Obama era Home Affordable Modification Program was designed to help four million home owners afford their homes, but only about 1.6 million borrowers saw their mortgage payments lowered through the program with nearly 70 percent of the homeowners who applied for the program being rejected. If we can ask restaurants to close to forestall the spread of COVID-19 to save lives, we can ask mortgage service providers to forgive mortgage payments to help forestall a housing collapse.
Unlike its poor performance during the Depression, Fed actions during the recession of 2008 essentially prevented the world economy from falling into another 1930s style recession by providing roughly fifteen trillion dollars to foreign commercial and central banks, and as with the $700 billion bailout for domestic banks, practically all this money was eventually repaid, with interest.
So what do WWII spending and Fed actions in 2008 tell us? First, the federal government has the power to restore full employment by fiscal actions that restore people’s incomes. Second, the Federal Reserve has unlimited ability to prevent a financial and economic collapse. And finally, the deficits created in returning the economy to full employment have never had a negative effect on the economy. Unfortunately if we fail to act on what we’ve learned for fear of budget deficits, we will damage the economy for years to come.