Great Myths of the Great Depression

The New Deal deficit spending helped boost the economy and bring the unemployment rate down to single-digit levels, but fear of deficits limited the scale of New Deal programs and caused Roosevelt to reverse course and cut back on spending in 1937, just as the economy was gaining momentum.

So writes Dean Baker in the New Republic. This is marginally better than the myth I learned in high school: FDR saved capitalism from itself by embracing the wisdom of Keynesian economics. He “primed the pump” with massive deficit spending and lifted the economy out of the Great Depression.

My high school story was a tad inconvenient for those who are fans of both Keynes and FDR: In 1940—7 years after the New Deal had begun—the unemployment rate still hovered at an astounding 14.6 percent.

But the high school myth turned out to be wrong: Keynesian economics didn’t end the Great Depression because Keynesian economics was never tried. Keynes, remember, called for deficit-financed spending during downturns (and surpluses during times of plenty to pay off the debt). The data show that FDR (and Congress) implemented half of the Keynesian stratagem: real spending dramatically increased throughout the Great Depression. 

The problem—from a Keynesian perspective—is that they also massively increased (already-high) taxes so that, even as the economy collapsed, revenue soared.  



A seminal piece in the American Economic Review by Cary Brown exploded the myth that Roosevelt was a Keynesian:

The primary failure of fiscal policy to be expansive in this period is attributable to the sharp increases in tax structures enacted at all levels of government.  Total government purchases of goods and services expanded virtually every year, with federal expansion especially marked in 1933 and 1934.  [But] the federal Revenue Act of 1932 virtually doubled full employment tax yields.

But notice, Brown doesn’t say that FDR failed to be Keynesian because he stopped spending; he failed to be Keynesian because he also raised taxes. But that doesn’t stop many in the punditry from claiming that, in his later years, FDR was converted into some sort of proto-Paul Ryan.

See this excellent post by Alex Tabarrok on the subject. See, also, these posts by Tyler Cowen.