An Answer to Critics: 'Krugman's Prescription for Disaster'


"Economics of Contempt" and to some extent Per Paterson have raised some questions and challenges to my blog, "Krugman’s Prescription for Disaster." I will try to answer them as best I can. "Economics of Contempt" writes:

the logical implication of Krugman’s argument is that the New Deal would have made the Great Depression at least somewhat shorter than it would have been had we followed the old approach for curing recessions. How do you know that the old anti-recession policy would have made the Great Depression shorter than it actually was? How do you know that in the absence of the New Deal, the Great Depression wouldn’t have been longer than the Long Depression? You don’t.

I don’t know for sure that that the old anti-depression policy would have made for a shorter downturn but, then, Krugman doesn’t know that the reverse is true. I point to the historical evidence from previous depressions that were fought by using the old anti-depression policy. These were mostly over in two or three years.

If Krugman believes that the decade-long Great Depression was exceptional in nature compared to previous depressions and could only be fought with a new Keynesian approach, he needs to give some evidence for that claim. As far as I can tell, however, he doesn’t try. Pending such an attempt, the main burden of proof is on him, not me.

Also, comparing the Great Depression with the recession in 1921–1922 is ridiculous. Output in 1929 alone contracted more than twice as much as output contracted in the entire 1921–1922 recession. And 1929 was before Hoover started his expansionary fiscal policy (which I agree Hoover never gets credit for, although you’d probably call it "blame" rather than "credit"!).

It is not ridiculous at all, that is if the goal is to understand why we had an unprecedented decade long depression. The comparison becomes especially instructive if we limit the analysis to the first year of both downturns. Between 1921 and 1922, there was a significantly faster drop in prices and GDP and a greater rise in unemployment than between 1929 and 1930. From 1921 to 1922, Unemployment advanced from 4 percent to twelve percent, the gross national product fell by a staggering 17 percent. All this was in one year. By contrast, unemployment was still well under 10 percent at the end of 1930.

Hoover may not have started his expansionary fiscal policy until later when, for example, he ramped up agricultural loans in 1930 and 1931 but his began his ultimately more destructive high policy only a month or so after the Crash.

During that period, he called the first of several White House conferences. He successfully used these to pressure employers to maintain nominal wage rates. Henry Ford actually raised wages for his workers after attending. Later, Hoover reinforced this high wage policy through Smoot-Hawley (which kept out low wage competition) and Davis-Bacon (which required prevailing (e.g. union) wages for federal contractors. The upshot, as I said, that nominal wages did not begin to fall into 1931 and real wages were actually 12 percent higher in 1932 than they had been in 1929. Even Keynes, Krugman’s hero, often commented that "downward stickiness" of wages had not occurred during previous depressions.

By contrast, Harding allowed wages, prices, profits, and the GDP to fall relatively unobstructed from 1921 and 1922. As a result, by the beginning of 1923, unemployment was down to 1921 levels. By allowing the malinvestments to readjust, Harding, unlike Hoover, had prevented a very steep initial downturn from turning into a decade long depression.

Much of this is dealt with at length in Lowell Vedder and Richard Gallaway, Out of Work: Unemployment and Government in Twentieth Century America and the works by Higgs cited in the previous blog.

November 15, 2008