IN LOST OPPORTUNITY OF 1932, ARE THERE LESSONS FOR TODAY ? / THE NEW YORK TIMES ( HIGHLY RECOMMENDED READING )

July 10, 2012, 6:00 am
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In Lost Opportunity of 1932, Are There Lessons for Today?
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By BRUCE BARTLETT

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By the summer of 1932, the Great Depression was three years old with no end in sight. The Hoover administration, like Republicans today, was adamant that economic stimulus was wrongheaded, that the big problem was business confidence, which would be restored by keeping the budget under control, and that under no circumstances should the Federal Reserve adopt policies that would ignite inflation.

 

However, it was painfully clear to farmers and business people that deflation – falling prices – was the root of the economy’s problem. Between 1929 and 1932, the consumer price index fell 20 percent and prices for many commodities had fallen much more.




As a consequence, producers could not make a profit, which led them to lay off workers. As workers lost income, they reduced their purchases, which intensified the downward pressure on prices.



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By early 1932, a growing number of prominent economists were openly advocating “reflation” – just enough inflation to get the price level back to where it was in 1929.




 
In January, the Columbia economist Frederick C. Mills said, “Recovery hinges to a considerable degree on an upward movement in some of the most seriously depressed commodity prices.” The recovery from every previous economic recession had been accompanied by rising prices, he argued.



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Mills urged the federal government to issue bonds to finance a large public works program, which would be supported by Federal Reserve open-market operations.





Also in January 1932, a group of 35 prominent economists, including a number of conservative “hard money” men, such as Edwin Kemmerer of Princeton and Walter Spahr of New York University, said that deflation had “gone far enough.” They advocated a “liberal” Fed policy “designed to check credit decreases and encourage some expansion.”




On Feb. 8, Winston Churchill, who had lately been Britain’s Chancellor of the Exchequer, spoke at the Hotel Astor in Manhattan. He attacked deflation and forcefully advocated restoration of the price level to its 1927-8 level, saying that joint action between the Federal Reserve and the Bank of England could probably accomplish this even without the assistance of other countries.




In a May 1932 article in The Atlantic Monthly, John Maynard Keynes agreed that deflation was the core economic problem and that cheap money was the necessary cure. But he warned that the economy’s downward momentum may have gone too far for conventional monetary policies to work:

I am not confident that on this occasion the cheap-money phase will be sufficient by itself to bring about an adequate recovery of new investment. It may still be the case that the lender, with his confidence shattered by his experiences, will continue to ask for new enterprise rates of interest which the borrower cannot expect to earn. Indeed, this was already the case in the moderately-cheap-money phase which preceded the financial crisis of last autumn.

Keynes warned that there might be “no means of escape from prolonged and perhaps interminable depression except by direct state intervention to promote and subsidize new investment.”




And in July, the Yale economist Irving Fisher said the deflation since 1929 had increased the real value of the dollar by 50 percent. The result was to also increase the real burden of indebtedness to the same degree. “Every debtor has to pay over $1.50 for every dollar he contracted to pay,” he explained. “The farm mortgages are today bigger, measured in terms of wheat and cotton, than ever before.”





The failure of the Federal Reserve and Hoover administration to address the problem of deflation led some maverick members of Congress to take matters into their own hands. In April, Representative Thomas Goldsborough, Democrat of Maryland, persuaded a House banking subcommittee to report a bill that would require the Fed to raise the price level to its 1926 level through monetary policy.





A few days later, the Goldsborough bill received the support of the full committee. The New York Times frowned on his effort. In an April 22 editorial, The Times said that the proposal was doomed to fail because it was impossible to “restore prosperity by fiat.” Nevertheless, on May 2, the House of Representatives approved the legislation, 289 to 60.





Again, The Times was critical. In a May 4 editorial, it argued that the Fed had already purchased an enormous quantity of Treasury securities and lowered the discount rate to a historically low level. The editorial questioned whether simply doing more of what was already not working would be of value.






On May 5, President Hoover attacked the Goldsborough bill directly. He argued that the nation’s true problem was not monetary, but fiscal. Balancing the budget by drastically cutting spending and raising revenue was what the economy needed. “Nothing will put more heart into the country,” Hoover said.





In testimony before the Senate Banking Committee on May 13, Fisher strenuously disagreed. He noted that the economy was showing some signs of life because of an expansion of the money supply that the Fed had adopted in the spring. But businesses had no assurance that it would continue, which was their prime source of uncertainty. The Goldsborough bill would guarantee a continuation of easy money until recovery had been achieved, Fisher argued.







He was prescient. In July, the Fed halted its policy of quantitative easing and the recovery was quickly aborted. In a March 2006 article in the Journal of Economic History, the economists Chang-Tai Hsieh and Christina Romer suggest that pressure from the regional Federal Reserve bank presidents was instrumental in ending the easing. With ample reserves in the banking system and very low interest rates there was nothing to be gained by further easing, they asserted.




On July 11, the Senate effectively killed the Goldsborough bill by substituting a Fed-approved measure that did not require it to do anything to stanch deflation. Meaningful action to end the Great Depression would have to wait until after the election and the inauguration of Franklin D. Roosevelt in 1933.





Bruce Bartlett held senior policy roles in the Reagan and George H. W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. He is the author of “The Benefit and the Burden: Tax Reform – Why We Need It and What It Will Take.”