Embargoed until 3/9/09 at 1:30 p.m. ET
contraction in production and a terrible rise in unemployment.
This past year, there was hope that the current downturn might be mainly an American experience, and so world demand could remain high and perhaps help pull us through. However, duringthe past few months, we have realized that this hope was a false one. As statistics havepoured in, we have learned that Europe, Asia, and many other areas are facing declinesas large, if not larger, than our own. Indeed, rather than world demand helping to holdus up, the fall in U.S. demand has had a devastating impact on export economies such asTaiwan, China, and South Korea.This similarity of causes between the Depression and today’s recession meansthat President Obama begins his presidency and his drive for recovery with many of thesame challenges that Franklin Roosevelt faced in 1933. Our consumers and businessesare in no mood to spend or invest; our financial institutions are severely strained andhesitant to lend; short-term interest rates are effectively zero, leaving little room forconventional monetary policy; and world demand provides little hope for lifting theeconomy. Yet, the United States did recover from the Great Depression. What lessonscan modern policymakers learn from that episode that could help them make therecovery faster and stronger today?
One crucial lesson from the 1930s is that a small fiscal expansion hasonly small effects.
I wrote a paper in 1992 that said that fiscal policy was not the key engine of recovery in the Depression.
From this, some have concluded that I do not believe fiscal policy can work today or could have worked in the 1930s. Nothing could be farther than the truth. My argument paralleled E. Cary Brown’s famous conclusionthat in the Great Depression, fiscal policy failed to generate recovery “not because itdoes not work, but because it was not tried.”