Tuesday, March 10, 2009

Romer: Lessons from the Great Depression

Council of Economic Advisers head, Christina D. Romer, spoke at the Brookings Institution in Washington D.C., yesterday.

Her factual history of the FDR era is fascinating. Her policy prescriptions as a result of the specific period she discusses are sadly far off base.

The early hope I had, weeks ago, that she might understand that fiscal policy does not work to fix an economy was dashed by this speech. She makes perfectly clear that she holds no anti-fiscal policy views.

Indeed, she explains that the reason that she had previously said that fiscal policy had a small impact during the Great Depression is because she believes only a small fiscal policy was implemented during the Great Depression.

She writes:

At the same time that Roosevelt was running unprecedented federal deficits, state and local governments were switching to running surpluses to get their fiscal houses in order. The result was that the total fiscal expansion in the 1930s was very small indeed. As a result, it could only have a modest direct impact on the state of the economy.

And she does note, approvingly, that Obama has gone far beyond FDR:

This is a lesson the Administration has taken to heart [The lesson to battle the counter-stimulus actions of state and local governments]. The American Recovery and Reinvestment Act, passed less than thirty days after the Inauguration, is simply the biggest and boldest counter cyclical fiscal action in history. The nearly $800 billion fiscal stimulus is roughly equally divided between tax cuts, direct government investment spending, and aid to the states and people directly hurt by the recession. The fiscal stimulus is close to 3% of GDP in each of the next two years.
And, it appears that we will have more "stimulus" actions from this government as Romer advises:

This discussion of fiscal and monetary policy in the 1930s leads me to a third lesson from the Great Depression: beware of cutting back on stimulus too soon.
In her speech, her complete justification for calling for a huge Obama stimulus package seems to be that FDR didn't try it.

This is a quite bizarre speech. There is no mention at all as to why aggressive government spending will work. And it gets worse, since she properly notes that the Great Depression and the current crisis both suffered major declines in asset prices, but seems to think this phenomena fell out of the sky--rather than acknowledging that there is such a thing as a business cycle that might have something to do with it. She never mentions the change in Fed policy leading up to the 1929 crash, or the decline of money supply in the Summer of 2008 [In fact, I believe I am pretty much alone in focusing on the money supply decline of the Summer of 2008]. (Although, she does mention money supply contractions and expansion of the 1930's), She drops in the middle of the Depression and the current crisis and starts her "analysis" from there.

Of course, if she didn't start in the middle of the two crises, it would have been much more difficult for her to hide the true facts of the business cycle and the events that lead up to the Great Depression (The money contraction of 1929) and the current crisis (The money contraction of the summer of 2008). And, thus also make it much more difficult to applaud the outrageous "stimulus" spending of the Obama administration.

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