Past Is Prologue: What We Can Learn From FDR's Biggest Blunder
If you haven't done so already, take three minutes and read James Stewart's piece in the NYT on the parallels between the 1937 recession and where the U.S. economy stands today (others have noted the connection, but this is a good synopsis).
In essence, FDR blew it. With the economy finally emerging from its shell following the Great Depression, he buckled to political pressure to balance the federal budget, proceeding to slash government spending and jack up tax rates. The Federal Reserve piled on by raising the amount of reserves banks needed to have on hand to guard against losses, stifling lending. Big mistake:
The Dow Jones industrial average dropped 49 percent from its peak in 1937. Manufacturing output fell by 37 percent, a steeper decline than in 1929-33. Unemployment, which had been slowly declining, to 14 percent from 25 percent, surged to 19 percent. Price declines led to deflation.As Stewart says, liberals and conservatives seize on different aspects of the episode to buttress their view of the world. Keynesians focus on the spending cuts, supply-siders on tax hikes. That debate (never to be resolved) is less important than understanding this: It was the headlong rush to lower the deficit that threw a recovering economy into an abrupt tailspin.
And today? Through the first half of the year, government spending cuts reduced economic growth by 0.7 percent. Reports the WSJ:
Typically, that would be no disaster. Trouble is, this recovery has been unusually weak. So the government cutbacks effectively halved real GDP growth in the first half of 2011, leaving it at just 0.8 percent annualized.The recent debt-ceiling deal will cut $917 billion in federal expenditures over the next decade, with a congressional "supercommittee" set to convene to identify another $1.5 trillion in savings. If the panel fails to reach agreement or Congress doesn't act on them, as many expect, automatic spending cuts of $1.2 trillion would ensue.
To put it bluntly, that would deliver a massive kick to the economy's groin. Some economists project it would reduce GDP growth in fiscal year 2013 by as much as 0.7 percent (see chart above). When growth slows, obviously, unemployment rises and tax revenue falls. Further deficit reduction in this environment is akin to bringing the nose down in a burning plane.
The historical precedent is clear. We ignore it at our peril.
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