Wednesday, April 8, 2009

Fiscal Policy and The Great Depression

Fiscal Policy and the Great Depression
Some Observations on the Great Depression
Edward C. Prescott
Research Department
Federal Reserve Bank of Minneapolis
Federal Reserve Bank of Minneapolis Quarterly Review
Winter 1999, vol. 23, no. 1, pp. 25–31
The Great Depression in the United States was largely the result of changes in economic institutions that lowered the normal or steady-state market hours per person over 16. The difference in steady-state hours in 1929 and 1939 is over 20 percent. This is a large number, but differences of this size currently exist across the rich industrial countries. The somewhat depressed Japanese economy of the 1990s could very well be the result of workweek length constraints that were adopted in the early 1990s. These constraints lowered steady-state market hours. The failure of the Japanese people to display concern with the performance of their economy
suggests that this reduction is what the Japanese people wanted. This is in sharp contrast with the United States in the 1930s when the American people wanted to work more.
FDR's policies prolonged Depression by 7 years, UCLA economists calculate (Press Release)

Also from Journal of Political Economy, 2004, vol. 112, no. 4

There are two striking aspects of the recovery from the Great Depression in the United States: the recovery was very weak, and real wages in several sectors rose significantly above trend. These data contrast sharply with neoclassical theory, which predicts a strong recovery with low real wages. We evaluate the contribution to the persistence of the Depression of New Deal cartelization policies designed to limit competition and increase labor bargaining power. We develop a model of the bargaining process between labor and firms that occurred with these policies and embed that model within a multisector dynamic general equilibrium model. We find that New Deal cartelization policies are an important factor in accounting for the failure of the economy to recover back to trend.
The Great Depression in the United States
From A Neoclassical Perspective
Federal Reserve Bank of Minneapolis Quarterly Review
Winter 1999, vol. 23, no. 1, pp. 2–24

Can neoclassical theory account for the Great Depression in the United States— both the downturn in output between 1929 and 1933 and the recovery between 1934 and 1939? Yes and no. Given the large real and monetary shocks to the U.S. economy during 1929–33, neoclassical theory does predict a long, deep downturn. However, theory predicts a much different recovery from this downturn than actually occurred. Given the period’s sharp increases in total factor productivity and the money supply and the elimination of deflation and bank failures, theory predicts an extremely rapid recovery that returns output to trend around 1936. In sharp contrast, real output remained between 25 and 30 percent below trend through the late 1930s.We conclude that a new shock is needed to account for the Depression’s weak recovery. A likely culprit is New Deal policies toward monopoly and the distribution of income.
5 Myths About the Great Depression
(Wall Street Journal)

Evidence on Tax Cuts

Lawrence Lindsey ( 1987) noted that for incomes greater than $200,000 per year, the Regan tax cuts lead to an increase in reported incomes and increased collections. For those earning > $200K per year, we saw the following increases in collections:

1982 – 3%
1983 – 9%
1984 – 23%
In his book ‘The Vision of the Annointed‘, Thomas Sowell points out the following: ( he obtained this info from ‘Budget of US Government: Historical Tables’. U.S. Government Printing Office, 1994.)

YEAR REVENUE in billions
1981 $599
82 $618
83 $601
84 $666
85 $734
86 $769
87 $854
88 $909

Each year, in the face of, and in the wake of large tax cuts, revenues increased as a result of increased economic activity.

What about the cuts in marginal taxes that George W. Bush implemented in 2003? According to a recent Wall Street Journal article, tax payments from the rich explain the very rapid reduction in the budget deficit to 1.9% of GDP in 2006 from 3.5% in 2003. Taxes paid by millionaire households more than doubled to $274 billion in 2006 from $136 billion in 2003. Accordingly "No President has ever plied more money from the rich than George W. Bush did with his 2003 tax cuts." ( see historical tables link )

Also, straight from the historical tables provided by the office of management and budget you will see that from 2004-2007 there was a 25% surge in tax revenues, ( in face of tax cuts) which was the largest 3 yr surge since 1966. ( again I checked the math)


Robert Barrow. Macroeconomics- 5th Edition MIT Press 1997

Lindsey, Lawrence B. 1987. “Individual Taxpayer Response to Taxcuts, 1982-1984.” J. of Public Economics 33 (July) 173-206

Thomas Sowell. ‘The Vision of the Anointed.’ (1995)

The Wall Street Journal ‘Their Fair Share.’ July 21,2008