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FDR vs. Obama: Who Handled Economic Crisis Best? An Excerpt from 'Hall of Mirrors'

By    |   Monday, 23 Feb 2015 11:32 PM

Excerpt from the book Hall of Mirrors: The Great Depression, The Great Recession, and the Uses -- and Misuses -- of History

In 1936 Franklin Roosevelt grew anxious about a budget deficit that had ballooned to an unprecedented $4.3 billion. With pressure from his administration, Congress agreed to raise taxes on households with income above $100,000 and on corporations with undistributed profits. In 2011 Barack Obama grew concerned about a budget deficit that topped $1.2 trillion for a third successive year. In response Obama negotiated an agreement with Congress to raise taxes on the 1 percent of earners with incomes above
$400,000, in early 2013. The agreement also allowed earlier cuts in payroll taxes to expire, causing the rate paid by workers to jump from 4.2 to 6.2 percent and reducing take-home pay by $1,000 for a US family earning $50,000 a year. These steps were coupled with “sequestration,” under which the defense budget and nondefense discretionary spending were cut by 8.5 percent.

Roosevelt’s tax increases were not the only, or even the most important, reason for the economic slowdown that blossomed into a recession in the final months of 1937. More important was the failure of monetary policy makers to offset the contractionary effects. Nor were the budget measures of the Obama administration and Congress, even conjoined with the slowdown in federal spending as the 2009–2011 stimulus drew to a close, the entire explanation for the disappointing recovery from the Great Recession. Also important was the failure of the Federal Reserve to do more to offset the negative impulse and instead start talking about tightening monetary policy.

But in both cases the desire to restore normal fiscal and monetary policies before normal economic conditions had returned was heavily responsible for the disappointing state of the economy. US unemployment still exceeded 17 percent when World War II erupted in Europe. Without the double-dip recession of 1937–38, it would have been 5 percentage points less.

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Unemployment in 2013, at 7.4 percent, was lower, reflecting the policy initiatives taken in 2009–2011. Even so, on almost any measure the recovery continued to disappoint. Growth averaged barely 2 percent per annum between 2011 and 2013, less than half the pace of the typical post–World War II expansion. The fall in the unemployment rate was driven less by improved labor market conditions than by a falling participation rate, as discouraged workers with- drew from the labor force.

There are good reasons for recovery from a slump caused by a financial crisis to be slower than a normal recovery. Financial crises follow periods when households, in their exuberance, incur heavy debts. The subsequent process of deleveraging, in which those same households, now face-to-face with reality, seek to work down those debts, persists into the recovery, limiting their spending. Banks, still in the process of rebuilding their capital and repairing their balance sheets, are meanwhile limiting their lending.

But the implication is not that the disappointing recovery following the 2008–09 financial crisis was inevitable. If the private sector, intent on deleveraging, spends less, then the public sector can spend more. If commercial banks lend less, then the central bank can lend more. The authorities can continue until the private sector is ready to take up the slack. The presence of unemployed resources in the wake of a crisis means there is space for the economy to bounce back even more vigorously than from the typical recession.

The Roosevelt recovery illustrates the point. Between 1933 and 1937 real GDP rose at an annual average rate of more than 8 percent despite household balance sheets and the financial system being seriously impaired. This is not to suggest that the United States could have matched this impressive rate of economic growth starting in 2009. But it could have done better.


FDR understood the need for additional government spending to replace the private spending that had dried up. As he put it with directness in 1936, “No one lightly lays a burden on the income of a Nation. But this vicious tightening circle of our declining national income simply had to be broken. . . . We accepted the final responsibility of Government, after all else had failed, to spend money when no one else had money left to spend.”

At the same time, Roosevelt never entirely relinquished his preoccupation with fiscal soundness or his embrace of the analogy between the household
budget and the government budget. The Federal debt-to-GDP ratio was only 40 percent in 1936, less than half the 90 percent scaled in 2010, but the size of the government and its tax take, out of which debt service had to be paid, were also less. Failing to address the problem would have jeopardized confidence, in the view of the president and advisors.

Then there were arguments for raising taxes on equity grounds. The rich had not suffered the same excruciating pain as the common man in the Depression. It was only just, as Roosevelt and his fellow Democrats saw it, for the wealthy to now pay their fair share to finance New Deal programs designed to right these wrongs.

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Not least, there were political considerations. Roosevelt had campaigned in 1932 on a promise to balance the budget. With the approach of another election, he worried that failure to carry it out might be turned into a political liability by his opponents.

Barack Obama, on assuming the presidency, shared all three motivations. The moral argument was that the top 1 percent had greatly increased their share of the national income in the fifteen years leading up to the Great Recession. The wealthy may have suffered capital losses in the downturn, but in the 2009–2011 recovery the incomes of the top 1 percent again grew faster than incomes overall. In the two decades ending in 2011, the real incomes of the top 1 percent rose by more than 57 percent, those of the bottom 99 percent by less than 6 percent. The top 1 percent effectively captured nearly two-thirds of all income gains. It was only fair and just that they should pay their commensurate share in taxes.

There was also a sense among Obama’s advisors that the budget had become a political liability. The midterm gains of the Tea Party underscored the danger. In the view of Rahm Emanuel, Obama’s chief of staff, and David Axelrod, his senior political advisor, the president had to be seen as addressing the deficit. Their position played into Obama’s own cautious fiscal instincts and his belief that government was bloated and inefficient. It encouraged his inclination to accept cuts in spending if the Republicans in turn agreed to increases in taxes. Unfortunately, the president did not anticipate the Republicans’ readiness to accept his offer while refusing to give anything in return, or their willingness, when push came to shove, to allow the economy to fall off the cliff.

Last, there were economic arguments. Large deficits leading to unsustainable debts could undermine business confidence. The June 2010 projection of the studiously nonpartisan Congressional Budget Office showed the deficit widening after 2014 as a result of mounting entitlement spending. It showed publicly held debt as a share of GDP rising sharply. Something had to be done now to address these problems looming in the not-too-distant future. Or so it was argued by the Concord Coalition, the Committee for a Responsible Federal Budget, and the Fiscal Times, all founded by Peter G. Peterson, commerce secretary under Richard Nixon, onetime head of Lehman Brothers, and co-founder of the Blackstone private equity group. A durable solution to these problems required bipartisan support. And getting Republican agreement on a medium-term plan, the president’s political advisors argued, would entail addressing the opposition’s concerns over the immediate deficit.

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But abdicating government’s responsibility to “spend money when no one else had money left to spend” risked aborting the recovery and plunging the economy back into recession. Here, however, the possibility of health care and entitlement reform held out hope of squaring the circle. Less public spending and smaller deficits starting in, say, 2014 would mean less government borrowing and lower interest rates at that future date. And downward pressure on interest rates in the future would put downward pressure on interest rates now, insofar as investors look forward. Investors anticipating higher treasury bond prices would start buying today, reducing current yields. Hence any negative impact on the recovery from current spending cuts would be offset, in part, by the positive impact of future spending cuts operating through lower interest rates.

This mechanism was a key factor back in the recovery from the 1991–92 recession. President Clinton’s 1993 conversion to fiscal consolidation under the tutelage of his National Economic Council director Robert Rubin unleashed just such a low-interest-rate-led recovery. Consolidation that put downward pressure on interest rates helped to stimulate investment and growth. The Clinton administration alumni who now populated the Obama White House looked back nostalgically on this episode.

The flaw in their logic, it should have been clear, was that interest rates had already been pushed as low as they could go. The recession associated with the 2008–09 crisis was fundamentally different from the recession from which the United States recovered in 1993. The economy had now fallen into a liquidity trap. Interest rates couldn’t be depressed further by promises of lower deficits down the road. Even if coupled with a credible commitment to future deficit reduction, deficit reduction now could only hinder recovery.

With hindsight, this fly in the ointment is blindingly clear. The question is why it wasn’t discerned at the time.

Reprinted from the book Hall of Mirrors: The Great Depression, The Great Recession, and the Uses -- and Misuses -- of History by Barry Eichengreen with permission from Oxford University Press. Copyright © 2015 by Barry Eichengreen.

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In 1936 franklin Roosevelt grew anxious about a budget deficit that had ballooned to an unprecedented $4.3 billion.
hall of mirrors, great depression, great recession, fdr, obama, barry eichengreen
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2015-32-23
Monday, 23 Feb 2015 11:32 PM
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