Banking Act of 1935 + Fed’s Exercise of This Authority = New Deal PolicyRobert Higgs • Friday December 5, 2008 8:38 AM PDT •
The New Deal has been a hot topic recently. Aside from the looming likelihood of a new New Deal à la President Obama and company, the present recession, which many fear may turn into a serious depression, has given new currency to assessments of the original New Deal. It says something about the state of economics that economists continue to debate this topic almost as hotly now as they did seventy years ago.
Over the years, I have ventured to make small contributions to this debate, most notably in a 1997 article titled “Regime Uncertainty: Why the Great Depression Lasted So Long, and Why Prosperity Resumed after the War,” a modestly improved version of which now appears as the first chapter of my 2006 book Depression, War, and Cold War: Essays in Political Economy. (The first five chapters of this book, considered as a coherent whole, show why my hypothesis has the additional charm – lacking in virtually every other hypothesis about the economy’s course between 1933 and 1940 – of also explaining the operation of the wartime economy and the smooth postwar transition to genuine market-oriented prosperity.)
Defenders of the current orthodoxy, however, tend to pooh-pooh explanations such as mine. My story pertains to why the post-1933 recovery was such a drawn-out affair – I call this aspect of the Great Depression the Great Duration. In response to my claims and my evidence in support of them, the mainstreamers might (and at certain Web sites actually seem to, as it were) engage me in a dialogue as follows:
Higgs: blah blah blah, Great Duration, blah blah blah, New Deal, blah blah blah, regime uncertainty, blah blah blah, insufficient net private investment, especially long-term investment, to sustain a prompt, lasting recovery.
Mainstreamer: Nonsense. The recovery after the beginning of the New Deal in 1933 was rapid. Look at the data, you old fool. Real GDP rose by about 43 percent between 1933 and 1937. Splendid recovery. No problema. All it took was going off gold.
Higgs: Then why had the economy still not recovered fully as late as 1940, when the unemployment rate was almost 15 percent and the transition to the war-command economy was beginning to make standard interpretation of variables such as gross domestic product, the price level, and the rate of unemployment increasingly problematic?
Mainstreamer: The recovery would have been complete much earlier, thanks to various New Deal measures, especially its abandonment of the gold standard, but the Fed foolishly doubled the required reserve ratios for commercial banks during 1936-37, thereby triggering the sharp depression of 1937-38, which set the recovery back for three years.
Higgs: Even if we grant, which I will only for purposes of debate, that these Fed-mandated increases in required reserves constituted the sole important cause of the depression of 1937-38, you are treating these actions as exogenous to the New Deal. That view of the matter makes little sense because the Fed’s statutory authority to change required reserve ratios as it did came from the Banking Act of 1935, a major New Deal enactment.
Moreover, Marriner Eccles, the chairman of the Board of Governors at the time of these actions, was appointed by President Franklin D. Roosevelt in 1934 and was highly sympathetic to New Deal-type policies. All of the other board members were also Roosevelt appointees, because the board had been reorganized after passage of the 1935 act, at which time Roosevelt named new members, except for Eccles and M. S. Szymczak, earlier Roosevelt appointees to the Federal Reserve Board whom he carried over to the new board.
The Fed did not act independently, but developed its plan of action in close cooperation with the Treasury as part of a broader government program to restrain the buildup of excess reserves in the commercial banks. The Treasury, for its part, announced that after December 22, 1936, it would sterilize all future monetary gold inflows from abroad, and by August 1937, it had sterilized more than $1.3 billion of such inflows, which otherwise would have caused bank reserves to increase.
So, if you want to blame the Fed’s ill-advised actions of August 1936 to May 1937 for the Great Duration, go ahead (although I insist that various other things also helped to bring on the 1937-38 depression, and even more things contributed to the Great Duration in its entirety), but don’t assume that these actions had nothing to do with the New Deal. They were, from the statutory and personnel ground up, simply another aspect of the New Deal. If you claim that these Fed actions caused the Great Duration, you are ipso facto claiming that the New Deal caused it.