Learning from history

Recent guest blogger NycWeboy argues over at his place that we need to scrap the stimulus and start over.  Frequent commenter Charlie raised the rumor that FDR caused the Great Depression with his economic policies.  Both have me pausing and wondering if we can all learn a little something from history about our current crisis, and what that can tell us about how to move forward on what does seem to be a far-too-anemic stimulus proposal.  Consider this part I of today's two part series on the stimulus.

First, as you likely know, the Great Depression was a global economic crash that began prior to FDR's election to office, around 1929 brought on by enormous bank failure near the end of that decade:

The even larger question is whether it was largely a failure on the part of free markets or largely a failure on the part of governments to curtail widespread bank failures, the resulting panics, and reduction in the money supply. Those who believe in a large role for the state in the economy believe it was mostly a failure of the free markets and those who believe in free markets believe it was mostly a failure of government that compounded the problem.

When FDR came into office 3 1/2 years later, he inherited the worst economic crisis of the 20th century.  FDR undermined his own economic recovery program, the New Deal, about 4 to 5 years in by acquiescing to conservative demands in Congress to balance the budget and cut spending, thereby undoing much of the economic gains of the prior four years.  As historian and Great Depression scholar Eric Rauchway writes, the New Deal "didn't go far enough fast enough."

Here's what FDR did right:

...New Deal intervention saved the banks. During Hoover's presidency, around 20 percent of American banks failed, and, without deposit insurance, one collapse prompted another as savers pulled their money out of the shaky system. When Roosevelt came into office, he ordered the banks closed and audited. A week later, authorities began reopening banks, and deposits returned to vaults.

Congress also established the Federal Deposit Insurance Corporation, which, as economists Milton Friedman and Anna Jacobson Schwartz wrote, was "the structural change most conducive to monetary stability since ... the Civil War." After the creation of the FDIC, bank failures almost entirely disappeared. New Dealers also recapitalized banks by buying about a billion dollars of preferred stock.

John Maynard Keynes wrote to Roosevelt in 1938 that these actions were "a prior condition of recovery, since it is no use creating a demand for credit, if there is no supply." Thus, the New Deal made recovery possible.

These actions immediately lessened the panic and fear that gripped investors and ordinary Americans.  What Rauchway points to as limiting the New Deal's success was a lack of authoritative leadership from our government, leading FDR to halt job creation programs too soon, for instance, or letting the "special interests," we might call them, call the shots.  For instance:

Early on, the New Deal put too much public power in private hands. Conservative critics now focus on the National Recovery Administration, which created government-licensed cartels so that industries could self-regulate. Modern NRA critics have good historical company: Many New Dealers disliked the NRA, and Roosevelt himself eventually admitted it was "pretty wrong." The NRA established boards to set prices, wages, and conditions of work. These boards were supposed to have representatives from management, labor, consumers, and government -- but in practice fewer than 10 percent had labor representatives, even fewer had consumer representatives, and the government representative was normally someone from the ranks of management. One New Dealer noted only two cases when the government enforced codes of behavior on businessmen against their wishes.

The piece goes on, detailing other timid and contrary decisions by FDR that resulted in a sort-of one-step-forward, two-steps-back economic recovery.

Historian Alan Brinkley has more to say on the qualified success of the New Deal in addressing the Depression, including the important point that many of the ideas for economic stimulation that we take for granted today - reducing interest rates, for instance, or spending in times of a recession - were brand new then and only began gaining legitimacy as they were put to the test in the 1930s.  He closes with a warning against failed economic orthodoxy:

Economic orthodoxy--which gave high priority to balanced budgets and fiscal restraint--remained a powerful force in the 1930s, even as its limitations became increasingly obvious. Similar arguments can still be heard today: While most liberals--and most financiers and economists--agree on the necessity of government doing something dramatic to jump-start the economy, there remain powerful voices, particularly on the right, that oppose such efforts on ideological grounds. Hence Republicans' initial opposition to the stimulus package in September and their more recent threat to block, through filibuster, federal aid to the auto industry. The New Deal was least successful when it was least aggressive--when it let concerns about fiscal prudence override the urgent need to pump enormous sums of money into a moribund economy. There is much for the Obama administration to learn from the many achievements of the New Deal. But there may be even more to learn from its failures.

I'll be back later today with more thoughts on the stimulus.