The Roosevelt Recession: A Tale of Two Dips

“If the US government had a dollar every time someone proclaimed to learn the lessons of the Great Depression, we probably wouldn’t have a budget deficit” (Auerback 2010). Indeed, the Great Depression does offer an abundance of applicable information to aid in the understanding of business cycles and the subsequent methods of countering and avoiding them. In particular, the so-called “Roosevelt Recession” was most likely an avoidable second dip in economic growth. After the Great Depression ended in 1933, the United States was experiencing record growth and was well on the way to a full and sustainable recovery. However, premature fiscal austerity measures to balance ballooning deficits helped cause the economy to stumble again. Consequently, President Roosevelt reversed the policies and the economy once again regained traction. Fast forward to the present day United States and the same calls for fiscal austerity and balanced budgets in a slumped economy laden the mainstream media. Though many would disagree that this is the correct action to take, it seems to be a losing battle.By analyzing the alleged lessons of the Great Depression, policy makers of today would have a better understanding of what impacts fiscal austerity in a slump will have on output and unemployment, not mention the deficits.

The recovery from the Great Depression that took place between 1933 and 1937 was substantial but not complete. According to Christina Romer (1993), during this period “monthly industrial production increased by 79 percent” and “real GNP grew at an average rate of nearly 10 percent per year” (p. 34-35). Moreover, unemployment dropped from roughly a quarter of the labor force to about 14.3 percent (Burkett 1994). Though substantial progress was made since the trough of the Great Depression, a full recovery was yet to be experienced.

Unfortunately for the recovery efforts, the economy plunged again in 1937 with lightening speed and mammoth force. The United States experienced a second dip in economic growth in what has been dubbed the Roosevelt Recession. Though this recession was short lived and only lasted until 1938, it was a particularly painful event and a major setback. François R. Velde (2009) notes that “industrial production declined 32 percent…and stock prices declined by over 40 percent” (p. 17). Moreover, unemployment increased from (a still relatively high) 14.3 percent to 19.0 percent(Burkett 1994). Velde, adds that if it were not for this recession, the economy would have made a full recovery from the Great Depression three or four years earlier.

The so-called Roosevelt Recession occurred, at least in part, due to premature contractionary fiscal policy. During the period of recovery after the Great Depression, the New Deal initiatives were financed through debt. As expected, President Roosevelt was met with opposition over this and cries for budgetary restraint rang throughout the political sphere (Goldston 1968). According to Julian Zelizer (2000), Roosevelt was influenced by fiscal conservatives within his Administration, such as Treasury Secretary Henry Morgenthau Jr., to balance the federal budget. Thus, during The Budget and Relief Message of 1937, Roosevelt announced his proactive agenda to balance the budget. In June of 1937, “Roosevelt had slashed spending to the bone. He had cut WPA rolls drastically and slowed PWA projects to a standstill” (Goldston 1968, p. 181).Ultimately, “net government contribution [to income] fell $3.3 billion, from $4.1 billion in [calendar year] 1936 to $.8 billion in 1937” (Roose 1954, p. 70). “In cutting spending Roosevelt had jovially referred to taking off ‘the bandages and throwing away the crutches’ to see if the patient could walk. The patient collapsed” (Goldston 1968, p. 182).

At the same time stimulus spending was being slashed, fiscal austerity also took the form of higher taxes. The Revenue Act that was passed in June 1936 dramatically changed the income tax structure. According to Velde (2009), under this new aggressive tax policy, the top income tax brackets now paid up to 75 percent. As a result, tax revenues increased 66 percent from 1936-37. Velde also notes that the Social Security tax started at the beginning of 1937 and it accounted for “10.5 percent of total federal tax receipts” that year (pp. 19).

Following the economic calamity in 1937, Roosevelt reversed some of the fiscal austerity measures in April 1938 and the economy once again resumed its recovery. The tax rates from the Revenue Act and the new Social Security tax remained the same. However, funding for WPA increased to $1.25 billion, another $1 billion went to other Federal and state public works programs, and an addition $1 billion went to emergency loans (Kindleberger 1973). Shortly thereafter, GNP resumed rising at average of 10 percent a year until the onset of World War II (Romer 1993).

So why did Roosevelt decide to take it upon himself to make the dramatic shift towards fiscal austerity and balance the budget by slashing the New Dealstimulus spending and raising taxes in 1936-37? Zelizer (2000) attributes it for a number of reasons. As mentioned earlier, Treasury Secretary Henry Morgenthau Jr., long time friend of Roosevelt, helped influence the policy decisions of the Administration. Lewis Douglas, Director of Budget 1933-34, also maintained a campaigned of strict fiscal conservatism during his high position in the Administration. Certainly Morgenthau and Douglas both had their impacts on policy. However, according to Zelizer, there was a much deeper underlying factor at work here. Evidently, Roosevelt did not adhere to a strict ideological position. As such, he could change the direction of policy initiatives at whim. In fact, Zelizer goes as far as saying that Roosevelt “played [his] advisers off each other and followed those who made the most compelling political argument at a given time.” (p. 333). Ultimately, Roosevelt gave into the cries for balanced budgets in tough economic times and experimented with fiscal austerity.

Now, for the sake of completeness, it is also fair to note that there are other theories circulating that concerned additional factors that helped cause the 1937-38 recession. During the period leading up to the recession, monetary policy also tightened up. According to Velde (2009), the Fed significantly raised reserve requirements and the Treasury sterilized gold inflows by not converting it to money. In essence, the contractionary reserve requirements caused banks to hold more reserves than they would have otherwise and the sterilization caused the monetary base to grow more slowly than it would have otherwise. “Friedman and Schwartz (1963, p. 544) see monetary policy (that is, the increase in reserve requirements and, ‘no less important,’ the gold sterilization program) as ‘a factor that significantly intensified the severity of the decline and also probably caused it to occur earlier than otherwise.’”(Velde 2009, p. 22)

Fast forward to present day United States and much of the same dire economic circumstances as in the 1930s can be witnessed. Currently, after years in a slump, output is not at potential, the unemployment rate is remaining persistently high, and the housing market is still a disaster. As the Obama Administration attempts (at least on some level) to battlethe on-going economic slump, cries for fiscal austerity from Republicans, conservative Democrats, and even some prominent economists are echoing throughout the media.Though the American Recovery and Reinvestment act of 2009managed to pass in this harsh political climate, the stimulus has seemingly long since expired. Since then, the Obama Administration seemed to of wiped their hands clean of any expansionary fiscal policy. To make matters worse, the debates in Washington D.C., including from the President, seem to gravitate around contractionary policies in order to reduce the deficits.

Christina Romer (2010), former chairwoman of President Obama’s Council of Economic Advisors and Great Depression scholar, is not convinced that fiscal austerity in the face of our currently slumped economy is the best policy to pursue. Rather, she believes that the government should only focus on deficit reduction after the unemployment is back down to natural levels and once the economy has experienced a greater degree of recovery. In the meantime, Romer advocates that any attempts to reduce the budget will only cause additional unemployment and hinder the recovery effort. She even goes as far as warning that the United States might go into another double-dip recession like the Roosevelt Recession if austerity measures such as tax increases and spending cuts are enacted.

Indeed, the Roosevelt Recession of 1937-38 was most likely an avoidable event. President Roosevelt, for whatever reason, whether it be from influence from within his own Administration or outside, or from experimental policies or from a personal initiative, decided to pursue contractionary fiscal policies. His decision to try to balance the budget in the face of a slumped economy helped contribute to the recession that followed. Perhaps he cannot take all the blame for the recession, surely monetary policy also had its dirty little hand in the mess too. However, in the end, Roosevelt reversed the policies and the economy once again regained traction. Today, the Obama Administration faces a similar challenge. Cries for fiscal austerity during a slump are coming from all angles. As a result, there have not been much, if any, expansionary policies since the 2009 stimulus package. Rather, the debate has been focused on balancing the budgets. Perhaps if President Obama, and his economic advisors, were more versed in the Great Depression and the subsequent Roosevelt Recession, the current state of the economy would be in better shape today.


Works Cited

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