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Stimulus: Can it work like Roosevelt's New Deal?

Why government spending plus easy money could pull US out of recession by year's end.

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Another difficulty is the need for further bank rescue. The Obama administration calculates that as much as $2 trillion is needed to clean out the toxic assets held by banks and put them in better shape for lending. The battle in Washington over "nationalization" of troubled banks is in part a dispute over who bears the losses: bank shareholders and bondholders, or the taxpayer.

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A byproduct of the political dispute over the stimulus package has been an argument among economists over the effectiveness of President Roosevelt's New Deal.

Economist Kasriel's analysis, presented in an article tltled, "Just the Facts, Ma'am," finds that the stimulus worked. In the four years after Roosevelt took office, ending in 1937, the nation's gross domestic product (GDP – its output of goods and services) grew at a real compound annual rate of 9.4 percent. That's fantastic, close to China's growth rate in recent boom years. But, Kasriel notes, the recovery from the four-year Depression started just at the time Roosevelt took office.

Economists critical of the stimulus package tend to talk of the unemployment rate. For example, Amity Shlaes, an economic historian at the Council on Foreign Relations, notes that unemployment in the Roosevelt era averaged "well above 10 percent."

Economists, though, call the unemployment rate a "lagging indicator." It takes time to ease after an economic recovery starts. During the New Deal recovery, unemployment fell by more than half to 11 percent in July 1937. Then it rose again in a second slump that lasted through June 1938. Kasriel blames this slowdown on major tax increases and tighter Fed monetary policy in 1936 and 1937.

Attempts by some economists to downplay the effect of the New Deal annoy Charles McMillion, a Washington consulting economist. He calls them "antigovernment myths and ideology." He notes that real GDP surpassed its 1929 peak in 1936 and never again fell below it, despite the "trial and error" policies of Roosevelt.

Today the Fed is making an astonishing drive to turn the economy around. The basic money supply grew at a blazing 33 percent annual rate in the fourth quarter of last year. It is acting like a huge commercial bank itself, notes Kasriel, and it has "an infinite amount of capital." It's buying commercial paper, mortgage-backed securities, credit-card debt, etc. This quarter, Kasriel predicts, will be the worst of the current economic contraction. "The streams are beginning to flow," he says.

Let's hope so.