[Senate Hearing 111-140]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 111-140

 
                       LESSONS FROM THE NEW DEAL

=======================================================================

                                HEARING

                               before the

                            SUBCOMMITTEE ON
                            ECONOMIC POLICY

                                 of the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                                   ON

 WHAT LESSONS CAN CONGRESS LEARN FROM THE NEW DEAL THAT CAN HELP DRIVE 
                           OUR ECONOMY TODAY

                               __________

                             MARCH 31, 2009

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

               CHRISTOPHER J. DODD, Connecticut, Chairman

TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York         JIM BUNNING, Kentucky
EVAN BAYH, Indiana                   MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          MEL MARTINEZ, Florida
DANIEL K. AKAKA, Hawaii              BOB CORKER, Tennessee
SHERROD BROWN, Ohio                  JIM DeMINT, South Carolina
JON TESTER, Montana                  DAVID VITTER, Louisiana
HERB KOHL, Wisconsin                 MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia             KAY BAILEY HUTCHISON, Texas
JEFF MERKLEY, Oregon
MICHAEL F. BENNET, Colorado

                 Colin McGinnis, Acting Staff Director

              William D. Duhnke, Republican Staff Director

                       Dawn Ratliff, Chief Clerk

                      Devin Hartley, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                 ______

                    Subcommittee on Economic Policy

                     SHERROD BROWN, Ohio, Chairman

         JIM DeMINT, South Carolina, Ranking Republican Member

JON TESTER, Montana
JEFF MERKLEY, Oregon
CHRISTOPHER J. DODD, Connecticut

                      Chris Slevin, Staff Director

                                  (ii)
?

                            C O N T E N T S

                              ----------                              

                        TUESDAY, MARCH 31, 2009

                                                                   Page

Opening statement of Senator Brown...............................     1

                               WITNESSES

    Christina D. Romer, Chair, President's Council of Economic 
      Advisers...................................................     3
        Prepared statement.......................................    33
    Allan M. Winkler, Professor of History, Miami University, 
      Oxford, Ohio...............................................    15
        Prepared statement.......................................    38
    James K. Galbraith, Lloyd M. Bentsen, Jr., Chair in Business/
      Government Relations, Lyndon B. Johnson School of Public 
      Affairs, University of Texas at Austin, and Senior Scholar, 
      Levy Economics Institute...................................    17
        Prepared statement.......................................    41
    Lee E. Ohanian, Professor of Economics, and Director, 
      Ettinger Family Program in Macroeconomic Research..........    19
        Prepared statement.......................................    46
    J. Bradford DeLong, Professor of Economics, University of 
      California at Berkeley.....................................    21
        Prepared statement.......................................    53

                                 (iii)


                       LESSONS FROM THE NEW DEAL

                              ----------                              


                        TUESDAY, MARCH 31, 2009

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
    Subcommittee on Economic Policy,
                                                    Washington, DC.
    The Subcommittee met at 2:44 p.m., in room SD-538, Dirksen 
Senate Office Building, Senator Sherrod Brown (Chairman of the 
Subcommittee) presiding.

           OPENING STATEMENT OF SENATOR SHERROD BROWN

    Senator Brown. The Subcommittee on Economic Policy will 
come to order.
    This is the first meeting of our Subcommittee. 
Unfortunately, it is being delayed. I apologize for starting 
about 10 or 12 minutes late. Dr. Romer, thank you for joining 
us, and the other panel members, who I will introduce in a 
moment.
    There are three votes. I just cast a vote. Senator Merkley 
will wait until the second vote starts, will vote, and then 
come back, and then I will go back and cast another two votes, 
and then come back. So we will keep this Committee going as Dr. 
Romer and the second panel testify.
    We are facing an economic challenge few among us have 
witnessed. Unemployment in Ohio is 9.4 percent, the highest in 
25 years. Several counties have rates in my State of more than 
15 percent. My colleague Senator DeMint's State--Senator DeMint 
is the Ranking Republican on this Subcommittee. In his State of 
South Carolina, the unemployment figure is 11 percent. With all 
respect to the economists in the room, these numbers do not 
tell the entire story. Millions of men and women, as we know, 
are struggling to make ends meet, trying to shield their 
families as best they can, wrestling with the emotional 
problems all too common to job loss.
    We are unfortunately becoming accustomed to the refrain 
``Worst since the Great Depression.'' Unemployment reached one 
in every four workers 75 years ago, and economic output fell by 
a quarter from 1929 to 1933. While not so severe, the policy 
challenges faced by President Obama and the Congress parallel 
some of those that Franklin Roosevelt confronted when he took 
office in March 1933. Financial institutions are wounded and 
hesitant to lend. Demand has fallen as consumers lose jobs and 
see their savings diminish. Businesses are cutting workers 
while scrambling for credit. We are learning to fear fear 
itself. Fear of the unknown, whether it is job security or 
health security or asset-backed Securities, is pervasive.
    We cannot draw lessons from every aspect of the Great 
Depression or from FDR's response. The one lesson we should 
draw is the United States did indeed recover from the Great 
Depression, and we will indeed recover from today's recession.
    What lessons can Congress learn from the New Deal that can 
help drive our economy today? That is the purpose of today's 
hearing. The New Deal era remains historic for its ambition, 
for its aid to the neediest, and for its lasting policies that 
helped strengthen the economy and improve the lives of three 
generations of Americans. While not all perfect, the New Deal 
kept millions out of poverty. By 1940, unemployment was down to 
12 percent, and real GDP by one estimate had grown 65 percent 
from 1933.
    Much of the New Deal's legacy remains with us today. 
Investments in infrastructure paved the way for the most 
dynamic economy the world has ever seen. The Fair Labor 
Standards Act has guaranteed decent wages and working 
conditions for millions of Americans, and Social Security has 
provided a secure retirement for generations of our senior 
citizens.
    And think where we would be today without the Securities 
and Exchange Commission and the FDIC and the Banking Act. 
Americans know that despite the troubles on Wall Street, their 
savings at the bank on Main Street are secure.
    Until recently, there was not much debate on whether the 
New Deal helped or hurt efforts to recover. But recently, some 
of my colleagues have suggested that the New Deal failed. They 
argue that it was World War II spending that pulled us out of 
the Great Depression. But this is a false choice, in my 
opinion. Nothing I have seen or heard disputes the economic 
impact of our becoming the arsenal of democracy. But this is 
not the same as saying that the New Deal was harmful or did no 
good. Discussion of the New Deal over the past several months 
has served as a proxy debate for current economic planning and 
recovery planning. It is a topic worthy of our examination 
today.
    Thomas Paine many years ago wrote, ``By comparing what is 
past with what is present, we frequently hit on the true 
character of both, and we become wise with very little 
trouble.'' Let us see if we should be so lucky today.
    We are honored to have a distinguished group of witnesses 
with us today. I look forward to their testimony.
    We will begin. When Senator DeMint comes and Senator 
Merkley comes and Senator Tester, if he can make it, they 
certainly can feel free to make opening statements when that 
happens.
    We will start with Christina Romer. She is Chair of the 
Council of Economic Advisers. She was a class of 1957 Wilson 
Professor of Economics at the University of California-
Berkeley. Before teaching at Berkeley, she taught economics and 
public affairs at Princeton from 1985 to 1988. She went to high 
school in northeast Ohio, so she is a Buckeye at heart.
    Until her nomination, she was co-director of the Program on 
Monetary Economics at the National Bureau of Economic Research 
and served as Vice President of the American Economic 
Association, where she also was a member of the executive 
committee. She is a fellow of the American Academy of Arts and 
Sciences. Dr. Romer is known for her research on the causes and 
recovery of the Great Depression and on the role that fiscal 
and monetary policy played in the country's economic recovery. 
Her most recent work, authored with her husband, David Romer, 
also an economics professor, shows the impact of tax policy on 
government and on economic growth.
    Dr. Romer, thank you for joining us.

STATEMENT OF CHRISTINA D. ROMER, CHAIR, PRESIDENT'S COUNCIL OF 
                       ECONOMIC ADVISERS

    Ms. Romer. Well, thank you, Chairman Brown. Thank you for 
inviting me to join you today. As you noted, in my previous 
life as an economic historian at Berkeley, one of the things 
that I studied was the Great Depression. And in my current 
life, as Chair of the Council of Economic Advisers, I have been 
on the front lines of the administration's efforts to end what 
is arguably the worst recession our country has experienced 
since the Great Depression. For this reason, I am delighted to 
be with you today to talk about the lessons learned from the 
Great Depression and President Roosevelt's New Deal and how 
they have helped to inform us--and I think will continue to 
help inform us--about the best way to approach dealing with 
today's crisis.
    To start out, I think the first thing to say is that it is 
very important to point out that the current recession, while 
unquestionably severe, pales in comparison with what our 
parents and grandparents experienced in the 1930s. February's 
employment report showed that unemployment in the United States 
has reached 8.1 percent, an obviously terrible number that 
signifies a devastating tragedy for millions of American 
families. But, as you noted, at its worst unemployment in the 
1930s reached nearly 25 percent. Likewise, following last 
month's revision of the GDP statistics, we know that real GDP 
has declined about 2 percent from its peak. But between the 
peak in 1929 and the trough of the great Depression in 1933, 
real GDP fell over 25 percent.
    Now, I don't give these comparisons to minimize the pain 
that the United States economy is experiencing today but, 
rather, to provide some crucial perspective. Perhaps it is the 
historian and the daughter in me that finds it important to pay 
tribute to just what truly horrific conditions the previous 
generation of Americans endured and, again, as you pointed out, 
eventually triumphed over. And it is the new policymaker in me, 
I guess, that wants to be clear that we are doing all that we 
can to make sure that the word ``great'' never applies to the 
current downturn.
    While what we are experiencing is less severe than the 
Great Depression, there are parallels that make it a useful 
point of comparison and a source for learning about policy 
responses today. Most obviously, like the Great Depression, 
today's downturn had its fundamental cause in the decline in 
asset prices and the failure or near-failure of financial 
institutions.
    Over the course of the early 1930s, nearly one-half of 
American financial institutions went out of existence. This, in 
turn, had two devastating consequences: a collapse of the money 
supply, as stressed by Milton Friedman and Anna Schwartz, and a 
collapse in lending, as stressed by the current Fed Chair Ben 
Bernanke.
    In the current episode, modern innovations such as 
derivatives led to a direct relationship between asset prices 
and severe strain in financial institutions. And over the fall, 
we saw credit dry up and learned just how crucial lending is to 
the effective functioning of American businesses and 
households.
    I think the similarity of the causes between the Depression 
and today's recession means that President Obama began his 
Presidency and his drive for recovery with many of the same 
challenges that Franklin Roosevelt faced in 1933. Our consumers 
and businesses are in no mood to spend or invest; our financial 
institutions are severely strained and hesitant to lend; short-
term interest rates are effectively zero, leaving little room 
for conventional monetary policy; and world demand provides 
little hope for lifting the economy. Yet the United States did 
recover from the Great Depression. So what lessons can modern 
policymakers learn from that episode that could help them make 
the recovery faster and stronger today?
    In my written testimony, I discuss six lessons. In my oral 
remarks, let me at least highlight three of them.
    I think one crucial lesson from the 1930s is that a small 
fiscal expansion only has small effects. I wrote a paper in 
1992 that said fiscal policy was not the key engine of recovery 
in the Great 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, in fact, paralleled E. Cary Brown's famous 
conclusion that in the Great Depression, fiscal policy failed 
to generate recovery ``not because it does not work, but 
because it was not tried.''
    The key fact is that while Roosevelt's fiscal actions 
through the New Deal were a bold break from the past, they were 
nevertheless small relative to the size of the problem. When 
Roosevelt took office in 1933, real GDP was more than 30 
percent below its normal trend level. For comparison, the U.S. 
economy is currently estimated to be somewhere between 5 and 10 
percent below its trend.
    The emergency spending that Roosevelt did was precedent 
breaking. Balanced budgets had certainly been the norm up to 
that point. But it was quite small. As a share of GDP, the 
deficit rose by about one-and-a-half percentage points in 1934. 
One reason the rise was not larger was that there had been a 
very large tax increase passed just at the end of the Hoover 
administration. Another key fact is that fiscal expansion was 
not sustained. The deficit as a share of GDP declined in fiscal 
1935 by roughly the same amount that it had risen in 1934. And 
Roosevelt also experienced the same inherently procyclical 
behavior of State and local fiscal actions that President Obama 
is facing. Because of balanced budget requirements, State and 
local governments are forced to cut spending and raise tax 
rates when economic activity declines and State tax revenues 
fall. So at the same time that Roosevelt was running 
unprecedented Federal deficits, State and local governments 
were switching to running surpluses. The result was that the 
total fiscal expansion in the 1930s was actually relatively 
small. As a result, it could only have a modest direct impact 
on the state of the economy.
    I think this is a lesson the Obama administration has taken 
to heart. The American Recovery and Reinvestment Act, passed by 
Congress less than 30 days after the inauguration, is simply 
the biggest and boldest countercyclical fiscal action in 
American history. The nearly $800 billion of fiscal stimulus is 
roughly equally divided between tax cuts, direct government 
investment spending, and aid to the States and people directly 
hurt by the recession. And the fiscal stimulus is close to 3 
percent of GDP in each of the next 2 years. We firmly expect 
this fiscal expansion to be extremely important to countering 
the terrible job loss that last month's numbers show now totals 
4.4 million since the recession began 14 months ago.
    A second lesson that we can draw from the recovery of the 
1930s I think is that financial recovery and real recovery go 
together. When Roosevelt took office, his immediate actions 
were largely focused on stabilizing a collapsing financial 
system. He declared a national bank holiday 2 days after his 
inauguration, effectively shutting every bank in the country 
for a week while the books were checked. This 1930s version of 
a ``stress test'' led to the permanent closure of more than 10 
percent of the Nation's banks, but improved confidence in the 
ones that remained. Roosevelt also temporarily suspended the 
gold standard, paving the way for increases in the money 
supply. And in June 1933, Congress passed legislation helping 
homeowners through the Home Owners Loan Corporation.
    Now, the actual rehabilitation of the financial 
institutions actually, obviously, took much longer. Indeed, 
much of the hard work of recapitalizing banks and dealing with 
distressed homeowners and farmers was actually spread out over 
1934 and 1935.
    Nevertheless, the immediate actions to stabilize the 
financial system had dramatic short-run effects on financial 
markets. Real stock prices rose about 40 percent from March 
until May 1933, commodity prices soared, and interest rate 
spreads shrank. And the actions surely contributed to the 
economy's rapid growth after 1933.
    But I would also point out that it was only after the real 
recovery was well established that the financial recovery took 
firm hold. The strengthening of the real economy improved the 
health of the financial system. Bank profits moved from large 
and negative in 1933 to large and positive in 1935. Real stock 
prices rose; business failures fell; and this virtuous cycle I 
think continued as the financial recovery led to further 
narrowing of interest rate spreads and increased willingness of 
banks to lend.
    I would say that this lesson is another one that has been 
prominent in the minds of policymakers today. The 
administration has from the beginning sought to create a 
comprehensive financial sector recovery program. The Financial 
Stabilization Plan was announced on February 10th and has been 
steadily put into operation since then. It includes a program 
to help stabilize house prices and save responsible homeowners 
from foreclosure; a partnership with the Federal Reserve to 
help restart the secondary credit market; a program to directly 
increase lending to small businesses; the capital assistance 
program to review the balance sheets of the largest banks and 
ensure that they are adequately capitalized; and the program we 
announced just last week to partner with the FDIC, the Federal 
Reserve, and private investors to help move legacy or ``toxic'' 
assets off banks' balance sheets. This sweeping financial 
rescue program is central to putting the financial system back 
to work for American industry and households and should provide 
the lending and stability needed for economic growth. At the 
same time, the fiscal stimulus package enacted on February 17th 
was designed to create jobs quickly. And in doing so, it should 
lower defaults and improve balance sheets so that our financial 
system can continue to strengthen.
    The third lesson that I would highlight from the Great 
Depression is that it is important not only to deal with the 
immediate economic crisis, but to put in place reforms that 
help prevent future crises. Bank runs, as you surely know, were 
one of the key factors in the downturn of the 1930s. In June 
1933, President Roosevelt worked with Congress to establish the 
Federal Deposit Insurance Corporation. That act, together with 
subsequent legislation, established the insurance of bank 
deposits that we still depend on today.
    The FDIC, I think, has been one of the most enduring 
legacies of the Great Depression. Financial panics largely 
disappeared in the 1930s and have never truly reappeared. The 
academic literature certainly suggests that deposit insurance 
played a crucial role in this development. One simple but 
powerful piece of evidence of the importance of Federal deposit 
insurance is that among the few bank runs that we have actually 
seen since the Depression were ones on non-federally insured 
savings and loans in Ohio and Maryland in the 1985. And a 
striking feature of the current crisis has been the continued 
faith of the American people in the safety of their bank 
deposits. I think in this way, the reforms instituted in 
response to the Great Depression almost surely helped prevent 
the current crisis from reaching Great Depression proportions.
    I think the importance of putting in place more fundamental 
reforms is another lesson of the New Deal that the 
administration is following. The current crisis has revealed 
weaknesses in the regulatory framework. Most obviously, we have 
discovered that financial institutions have evolved in ways 
that left systemically important institutions inadequately 
capitalized and monitored. We have also found that the 
government lacks the tools necessary to resolve complex 
financial institutions that have become insolvent in a way that 
protects both the financial system and American taxpayers. We 
look forward to working with Congress to remedy these and other 
regulatory shortfalls. By doing so, we can make the U.S. 
economy more stable and secure for the next generation.
    The very final lesson that I want to draw from the 1930s is 
perhaps the most crucial and it is one that Senator Brown 
already touched on, and that is that a key feature of the Great 
Depression is that it did eventually end. Despite the 
devastating loss of wealth, the chaos in our financial markets, 
and a loss of confidence so great that it nearly destroyed 
Americans' fundamental faith in capitalism, the economy came 
back. Indeed, the growth between 1933 and 1937 was the highest 
we have ever experienced outside of wartime.
    This fact should give Americans hope. We are starting from 
a position far stronger than our parents and grandparents were 
in back in 1933. And the policy response has been fast, bold, 
and well conceived. If we continue to heed the lessons of the 
Great Depression, there is every reason to believe that we will 
weather this trial and come through to the other side even 
stronger than before.
    Thank you.
    Senator Brown. Thank you for a very conclusive and 
comprehensive assessment and observation of that period.
    Dr. Romer, you just mentioned that we had that high growth 
rate from 1933 to 1937. Critics of the New Deal will say that 
the recession within the Depression or the second big downturn 
in that decade that happened in 1937 illustrates that 
Roosevelt's New Deal did not work, that unemployment went back 
up--not as high as it was at the beginning of the decade.
    What in your mind--answer those critics, if you will, and 
specifically what in your mind caused that downturn in 1937-38 
that led the critics to make those observations?
    Ms. Romer. You actually bring up two very important points. 
One is when people talk about the Depression being slow or 
certainly the recovery from the Depression being slow, I think 
that is really a mischaracterization of the facts. And 
precisely as you pointed out, in the mid-1930s, we just grew 
incredibly quickly. We were growing. Real GDP went up at about 
10 percent a year for those 3 years, sort of the first 3 years 
of the recovery. But part of what happened is then we do 
obviously have that second recession in 1938.
    In my mind, it is caused by two fundamental things. I think 
here I listened very strongly to Milton Friedman and Anna 
Schwartz, who say it was a monetary contraction. And, actually, 
in my written testimony, it is one of the other lessons that I 
draw from the New Deal, is the importance of not cutting back 
on stimulus too soon, because I think one of the things that 
happened in 1937 is the Federal Reserve got nervous. They said, 
you know, they were worried that should they need to tighten 
the economy, there were so many excess reserves in the economy, 
they thought, well, gee, maybe we cannot do this. So what they 
did was to just raise reserve requirements, thinking it would 
not have any effect, they had just changed excess reserves to 
required reserves. What they did not count on was that banks 
were nervous. They had just been through the Great Depression 
and all of these banking panics, and so they scrambled to get 
more excess reserves over the new higher level.
    And so we absolutely have a pretty severe monetary 
contraction in 1937 that pushes up interest rates, reduces 
lending, and I think that is an important part of it.
    The other is you do get some fiscal contraction as well. In 
1936, we had a big veterans bonus, so kind of a big sort of 
chunk of government spending that then disappeared in 1937. 
Nineteen-thirty-seven is when we first collect Social Security 
taxes, and so we do have a certain fiscal contraction, and I 
think that also played a role.
    But I think neither of those would you say are in any way 
an indictment of the New Deal policies. I think they are an 
indictment of using those tools of monetary and fiscal policy 
not very well and sort of inadvertently doing monetary and 
fiscal contraction.
    Senator Brown. Some critics will argue then that the 
recession of 1937-38 was in part a response to wage hikes; 
minimum wage had been implemented; a 40-hour work week, I 
believe, was beginning; that there was collective bargaining; 
that wages were going up; that some critics will say that that 
was a distortion, sort of an artificial distortion of the 
marketplace.
    Weigh in on that, if you would. In other words, do higher 
wages in effect cause less employment and, therefore, a 
contraction in the economy?
    Ms. Romer. So, you know, I think that was a story that was 
out there. The way it is usually described was that firms, in 
anticipation, say, of labor strife that might be coming because 
of the new collective bargaining rules, sort of produced a lot 
in 1936 and 1937, kind of got a big run-up in inventories, and 
then cut back in 1938.
    My own read of the evidence is that there is just not much 
sign that that was really the key thing going on, and I guess 
here I would invoke Milton Friedman. If there was ever a person 
that would tend to think that unionization or high wages or 
things might cause a recession, he would be one of them. And 
yet he is probably the--he and Anna Schwartz are the strongest 
proponents of the monetary explanation for what happened in 
1937 and 1938.
    So I certainly think that the evidence is much more 
strongly on the side of--that it was an aggregate demand 
contraction that was the main reason for that downturn.
    Senator Brown. And fiscal stimulus, my understanding--you 
touched on this--is Roosevelt in 1937, 1938, pulled back on--
well, one, with the tax increase in Social Security. That was 
the only tax increase?
    Ms. Romer. That was----
    Senator Brown. That was relatively significant in that 
day's economy.
    Ms. Romer. It was not very large. I think, again, if you 
are doing the weighing of these things, I would say the 
monetary contraction was more important. I would say the tax 
increase at the time--I mean, it was significant, but it was 
not large. I do not think it was certainly large enough to 
cause the kind of downturn we saw by any means.
    Senator Brown. But he also pulled back on government 
expenditures.
    Ms. Romer. Absolutely. And, again, it is almost a little 
bit of an accidental thing in the sense that we had had a big 
surge in expenditures in 1936. There was a veterans bonus, a 
bonus to World War I veterans.
    Senator Brown. But not in 1937-38. That did not----
    Ms. Romer. Right, so it was 1936 and then it disappeared in 
1937. So if you look at the path of government spending, it 
goes way up and then back down.
    Senator Brown. As an economist, teach me something from 
sort of a bird's-eye view here. Many of my colleagues are 
concerned about the level of spending and borrowing. That same 
group was not all that concerned a year or two ago with 
spending and borrowing, but that is more of a political point 
that I do not want to get into.
    Can we do this through the--well, why can't we do this 
through the Federal Reserve rather than fiscal stimulus? Talk 
me through what the difference is and why we need both in the 
economy rather than just the Fed--rather than pursuing monetary 
policy?
    Ms. Romer. Gladly. So I would have said, you know, sort of 
again if you look at my sort of life's research, a big part of 
it has been pointing out that monetary policy is very 
effective. And I think if you had asked me 5 years ago, in 
response to a recession, sort of what is the main tool that one 
uses, it is monetary policy. And the usual reason for that is 
to say that it, one, is very effective; and, second, it is 
something that can be changed pretty quickly. And certainly the 
usual view, if you do sort of the history of post-war policy, 
you know, the record on using fiscal policy well had not been 
very strong, that, you know, the times we had tried to do 
fiscal expansion, we often did it too late, and so it tended to 
come after the recession was already over and things like that.
    So that is all kind of a way of background of saying I 
think this time is different. The first is, you know, a typical 
post-war recession, quite honestly, was caused by monetary 
policy. A typical recession is the Fed would have tightened 
because they were concerned about inflation. The economy would 
go into a recession, and then it was pretty obvious how you got 
out of it. They just loosened again.
    What was very striking in this recession is very different 
in that, you know, the interest rates were already quite low 
when the trouble in our financial markets, the collapse of 
housing prices started. And so sort of the amount of room that 
we had to expand monetary policy, bring interest rates down, 
was not particularly large.
    The other thing to say is we used the tools that we had. 
Very quickly, the Federal Reserve did do a big monetary 
expansion, and I would certainly say the Fed has been quite 
creative in trying to restart lending markets and trying to do 
expansionary--their usual expansionary policy. The problem that 
we faced is it was not enough, and I think that is the key 
reason why we need the second tool now, why we need fiscal 
policy.
    The other thing--and here I mainly want to compliment 
Congress in the sense that I think this really is a triumph 
that we passed such a big, bold fiscal stimulus act at the time 
before we even hit bottom of the recession. That is very 
unusual to get our act together and get the aid that the 
economy needed through the fiscal side as quickly as we did. 
But I think the main answer to your question is: In a recession 
this big, you needed both of them.
    Senator Brown. Thank you, Dr. Romer.
    Senator Merkley.
    Senator Merkley [presiding]. Thank you very much, Doctor, 
for coming to testify. We appreciate the work you are doing. I 
am just going to continue with some of the questions that folks 
were interested in.
    When you were studying writing on the New Deal in the 
1990s, did you ever imagine you might someday put that 
knowledge to use outside an academic setting?
    Ms. Romer. I have to tell you I didn't, and when I think 
back of the number of times that I would tell my introductory 
economics classes that, well, the one thing I was sure of was 
we would never face bank runs again, and so the first time that 
I saw people lining up outside a bank out in California last 
summer, it just--or last fall, I guess, I never dreamt that 
those kind of things would ever happen again.
    So I do want to come back to the point that even though I 
think the research is quite useful now, I do want to make it 
clear conditions are quite different, that as bad as things 
are, what our parents and grandparents went through were 
certainly much worse. And I like to think it is because we have 
learned a great deal. I do think that we have spent the last 6 
years getting a much better handle on the economy.
    I would say that the shocks the economy has faced in this 
downturn are probably almost as big as what we saw in the Great 
Depression, the disruptions in our financial institutions, the 
collapse of asset prices. All of those have been just huge 
macroeconomic shocks, and I think the very fact that we are 
where we are today and not somewhere much worse is at some 
level because we have had a much better policy response.
    Senator Merkley. Thank you. Your predecessor as Chair under 
President Bush, now Fed Chairman Ben Bernanke, endorsed fiscal 
action a little over a year ago. This suggests a pretty broad 
consensus among economists. As he put it, quote, ``Fiscal 
monetary stimulus may provide broader support for the economy 
than monetary policy alone.''
    Is there a fairly broad consensus among economists for the 
need for such stimulus?
    Ms. Romer. I feel there is. I mean, certainly, there is 
always a certain amount of disagreement among economists, but I 
think one of the things that has been striking in this downturn 
is the degree to which there has been a professional consensus.
    I know back in December when we were thinking about 
designing a fiscal stimulus and how big it should be, one of 
the jobs that I took on was just calling a wide range of 
economists from both ends of the ideological spectrum and there 
was just, you know, you got a few people that would say, no, I 
don't think we need any, and there were a number that would 
say, I think it should all be in the form of tax cuts. What was 
really striking is the consensus that we needed something, that 
it needed to be big, that we had tried monetary policy, we had 
done a lot there, but we needed more. So I do think there is a 
strong professional consensus.
    Senator Merkley. You know, one of the things that I am 
interested in getting your perspective on is that we not only 
have substantial national governmental debt, but we also have 
sizable consumer debt. When those are taken together, consumer 
and government debt, is there any parallel to the Great 
Depression in terms of percent of GDP, or are we way beyond the 
level of debt that was carried even at the height of the Great 
Depression?
    Ms. Romer. I would say we--I mean, I should check the 
numbers, but I would say we certainly are higher. I mean, one 
of the things that is important to realize is right before the 
Depression started, very much the norm had been a balanced 
budget and so the debt-to-GDP ratio, we had made a lot of 
progress coming out of World War I and had retired a lot of it.
    Likewise, in the 1920s, there had been sort of the 
beginning of the consumer durables revolution. People started 
to buy cars and appliances and things. But even so, consumers 
were certainly much less in debt than now. So that certainly, I 
think, is a change between the 1930s and today.
    Senator Merkley. I saw a chart in a magazine article a year 
or so ago that seemed a little surreal to me. I believe that 
what it showed, and it was combining consumer debt and 
governmental debt, was that during the height of the Great 
Depression, the debt-to-GDP, the combined debt, reached about 
two-and-three-quarters times the GDP, not so much because the 
debt surged in the Depression, but because of the economy 
tanking, and then the chart showed this combined debt now, and 
now being about a year ago, had exceeded that height at the 
Great Depression and was still headed straight up.
    Those numbers are not--I don't normally hear those numbers 
in the debate because we don't normally talk about the 
combination of consumer and governmental debt, but let us say 
this is--is it in the ballpark that we may be well over three 
times the GDP with the combination, and if so, how does that 
really constrain our ability to recover in this economic 
downturn?
    Ms. Romer. I think on the numbers, I just have to go back 
and check them. It is not one that I have on the top of my 
head.
    I think the place where economists are thinking certainly 
about the consumer debt is both consumer debt--I guess the 
other thing we talk about a lot is consumers have seen their 
wealth decline. At the same time they add a certain amount of 
debt, they have also seen their 401(k)s and the value of their 
house go down, and so how that kind of change in the household 
balance sheet is going to affect what they do going forward, I 
think is an important question.
    Certainly, I think most economists predict that we are 
going to see consumers having a higher savings rate. We are 
already seeing that, and my prediction is that is what is going 
to be true as we go forward, even once we are out of this 
particular downturn. And so that is going to be an adjustment 
for the American economy. To the degree that we have been sort 
of living on a consumer that was going into debt and sort of 
spending beyond their means, it is going to mean a 
readjustment, and I think it could be a very healthy 
readjustment in the sense that what would normally happen in an 
economy, if consumers start to save more, that tends to bring 
down interest rates in the economy. That tends to encourage 
investment. And certainly from an economic perspective, I think 
that would be good for the economy and would put us on a path 
to a more sustainable future and a higher growth future.
    Senator Merkley. You know, so much of our effort now 
involves generating dollars through the Fed as well as 
appropriated response in terms of creating a stimulus, do we 
have a very good way of judging the tipping point at which the 
international community becomes concerned about the long-term 
health of the dollar?
    Ms. Romer. I think what I would say is we probably don't 
have a good way of judging it other than to say, I am virtually 
certain we are not anywhere close to being at a tipping point. 
So I think what we have seen in this particular downturn, 
especially with the uproar in financial markets, what I have 
found very striking is the degree to which in times of crisis 
everybody wants to invest in the United States. We have seen a 
lot of our interest rates, in fact, come down because 
foreigners want to hold American assets and the dollar.
    So you raise, I think, a legitimate point. You know, the 
way I think about it is sort of going forward, we do know that 
our budget deficit is very large, mainly because, one, we 
inherited a large deficit. The economy is in a terrible way and 
we are having to spend a lot to get out of this.
    But it is certainly something that I don't feel can or 
should be sustained, that it is something--you know, the 
President has certainly said he wants to get this down, is 
committed to bringing it down, and I think that is ultimately 
going to be important for everyone maintaining faith in the 
U.S. Government, that we need to show signs that we are going 
to get this deficit under control, make real progress, and I 
think that is something that the world will be looking at.
    Senator Merkley. You know, within the stimulus plan, there 
are three major emphases in terms of restructuring our economy, 
and so I wanted to ask you about each of those, starting first 
with the energy side. And I apologize if I am repeating any 
questions that the Chair had before he left. But specifically, 
the argument that we need to insulate ourselves from foreign 
energy price spikes such as we had last year driving $4 a 
gallon gas and just kind of the vulnerability, perhaps the 
national security vulnerability as well as economic security 
issue. How important is it to use this opportunity to 
restructure our energy consumption, and are the strategies that 
are in the stimulus the right ways to do that?
    Ms. Romer. I think you raise a great point. I mean, there 
are a couple of things. One is your mention of the stimulus 
package. One of the things that the President, working with 
Congress, felt was important is that if we need to be spending 
money to get the economy out of recession, we ought to spend it 
wisely, and so one of the things that I think we all tried to 
do is to do things that we thought would benefit the American 
economy going forward, and I think you are absolutely right. 
Anything that helps to wean us off foreign oil, we think is 
going to be good for the economy.
    We certainly think that in the Recovery Act, we had various 
incentives for alternative fuels, incentives for increased 
efficiency, like weatherization, Federal buildings, low-income 
housing. I think all of that are incredibly important and 
things that we probably should be doing more as we go forward, 
and that has certainly been one of the key areas that the 
President has identified, that even as tough as times are now, 
energy independence, weaning us off foreign oil, dealing with 
the long-run effects of climate change, are things that he very 
much thinks warrant important investments.
    Senator Merkley. So one side of the energy puzzle is 
certainly using less energy, using less oil. Another side is 
putting the United States in a position of manufacturing 
products, both intellectual property products--patents, et 
cetera--and actual physical products--wind turbines, solar 
panels, et cetera--to sell to the world. How important is 
positioning ourselves in terms of the manufacturing side of the 
energy puzzle?
    Ms. Romer. Certainly, the President has identified that as 
sort of the alternative energies and the manufacturing that 
goes with wind turbines and solar panels as a win-win, right, 
so it is something that strengthens our economy, creates jobs 
here, and makes us be more efficient and able to use the kinds 
of energy that we have here that are renewable and aren't 
coming from abroad.
    Senator Merkley. I heard a statistic today, I am not sure 
if this is accurate or not, that for every month of the last 8 
years, for every single month, we have lost manufacturing jobs 
in this country. Is that accurate, every single month?
    Ms. Romer. I would have to check every single month. I 
certainly know it has actually been very striking. The Council 
of Economic Advisors--this has been an issue that we are very 
interested in. It is certainly a priority for the President. 
And so we have been doing some work looking at the decline in 
manufacturing. It is very striking. You go back to, say, the 
1982 recession. What has really been true after sort of each 
recession is you never quite come back to where you were 
before, and that we do see this long-run decline in 
manufacturing.
    So part of what we are experiencing now in Michigan, Ohio, 
Indiana, where we see not only the effects of the very severe 
recession that we are in, but this long-run decline in the 
manufacturing base, especially sort of the Midwestern heavy 
industrial manufacturing base, is absolutely a trend that is 
there.
    Senator Merkley. Does the preservation and expansion of the 
middle class in our country depend upon the expansion of 
manufacturing, or are there alternative strategies to have a 
large percentage of Americans in the middle class?
    Ms. Romer. That is again a terrific question. What I would 
say, there is a sense that somehow there is something special 
about manufacturing, and for an economist, I think that is--we 
have less trouble, maybe, than most in saying, even if you 
can't see it, a service like providing a mammogram for someone, 
well, that is as much a good thing as if you make a motor or 
something.
    So I wouldn't draw that kind of a distinction. But what has 
been true is that manufacturing jobs tended to be good, high-
wage kinds of jobs, and so certainly one way to sort of 
maintain the middle class or grow the middle class is to grow 
that sector of the economy. If that doesn't work, what you 
absolutely need to do is to create other kinds of jobs that 
have those same characteristics. So whether they are, you know, 
services that require a certain amount of training, but 
whatever is the case, you certainly need to be creating the 
good jobs at good wages. That is what is fundamentally good for 
making a big, strong middle class.
    Senator Merkley. Let me turn to the area of education. I 
have often said that the success of our economy a generation 
from now depends on our investment in education today, but that 
is--I am a layman. I am not an economist. Do we see a 
correlation as we look at economies around the world in terms 
of their investment in education paying off in terms of the 
strength of their economy years down the road? And what can we 
take from our observation of statistics around the world, 
performance of economies around the world, to help guide us in 
terms of our investment in education?
    Ms. Romer. This may be a very good question to ask Brad 
DeLong when he is on the next panel. Certainly, when you do the 
growth accounting, I think, across countries, what we call 
human capital formation, where there is mainly education, I 
think the evidence is that it is quite important to the 
development of countries and to their ultimate economic 
success.
    Certainly the empirical literature on sort of the returns 
to education and how important it is, it is inherently hard 
precisely because rich countries tend to invest more in 
education and so disentangling the causation. But certainly my 
own read of the literature is that there is a strong 
correlation and I think the correlation runs from investments 
in education to indeed make you a stronger economy, able to 
produce more, able to command higher wages.
    Senator Merkley. Are there kind of distinctions between the 
types of investment in education that we should be aware of as 
we think about this issue of strengthening our economy, getting 
the most bang for the buck for our investment in education?
    Ms. Romer. Certainly, I think if you had my colleague on 
the Council of Economic Advisors Cecilia Rouse, I think one of 
the things she would tell you is junior colleges are one of the 
places where you get some of the highest returns, sort of 
those--those, I think, have certainly shown to be a very good 
investment in terms of both how much costs to provide that 
education and the kind of jobs that you are able to get with an 
associate's degree.
    In general, I think all types of education are good and 
certainly more is better. I think there is a certain amount of 
evidence that job training is very good.
    Senator Merkley. Doctor, thank you. I have just one more 
question for you and that is turning to the health care side. 
We invest about a sixth of our economy, about 18 percent, a 
little more than a sixth, in health care, and yet Europe and 
Canada, many other modern manufacturing economies are spending 
a great deal less. Is our health care structure a competitive 
disadvantage and do we have to overhaul health care, not only 
for the quality of life of our citizens, but in order to be 
competitive internationally?
    Ms. Romer. I have to say it is. I think that is exactly 
why, again, even as tough as economic conditions are now, the 
President has identified reforming our health care system as 
just a priority that can't wait. I think he would have exactly 
the point of view that you just mentioned, that this fact that 
the cost of health care is rising so rapidly in the United 
States, faster than GDP and other costs, has been certainly 
something that is bankrupting businesses. It is hard on 
households. And it is ultimately very hard on the Federal 
Government. So I think it is crucial.
    Senator Merkley. Thank you very much, Doctor. It is my turn 
to dash to the floor to vote. Thank you.
    Ms. Romer. Thank you.
    Senator Brown [presiding]. Thank you, Senator Merkley, and 
Dr. Romer, thank you for your time. Thank you for your 
testimony, and especially thank you for your public service.
    Ms. Romer. It has been lovely to be here. Thank you for 
having me.
    Senator Brown. The Chair will call up the next panel, Allan 
Winkler, James Galbraith, Lee Ohanian, and Brad DeLong, if the 
four of you would join us, please. We will take a moment's 
break until they come forward.
    [Pause.]
    Senator Brown. We will come to order again. Thank you all 
for joining us.
    Dr. Allan Winkler is--I will introduce all four panelists. 
I very much appreciate your coming and joining us today and 
sharing your wisdom and your thoughts and ideas with us. I will 
introduce all four panelists and then we will begin the 
testimony, Dr. Winkler, with you, from left to right.
    Dr. Winkler is distinguished Professor of History at Miami 
University in the great State of Ohio. Thank you for joining 
us. He has taught at Yale University, the University of Oregon, 
and for 1 year each at the University of Helsinki in Finland, 
the University of Amsterdam in the Netherlands, and the 
University of Nairobi in Kenya. A prize-winning teacher, he is 
the author of ten books, including Franklin Roosevelt and the 
Making of Modern America.
    Dr. James Galbraith, who I met in 1972 for the first time, 
teaches at the LBJ School. He holds degrees from Harvard and 
Yale, a Ph.D. in economics in 1981. He served in several 
positions on the staff of the U.S. Congress, including 
Executive Director of the Joint Economic Committee. Dr. 
Galbraith is a Senior Scholar of the Levy Economics Institute 
and Chair of the Board of Economists for Peace and Security, a 
global professional network. He writes a column for Mother 
Jones and occasional commentary in other publications, 
including the Texas Observer, the American Prospect, Washington 
Monthly, and The Nation.
    Lee Ohanian has been a Professor of Economics and Director 
of the Ettinger Family Program in Macroeconomic Research at the 
University of California-Los Angeles since 1999. Thank you for 
joining us, Dr. Ohanian. He also taught at the University of 
Minnesota and the University of Pennsylvania. He is a Research 
Associate at the National Bureau of Economic Research and has 
consulted in various capacities for the Federal Reserve. He has 
published numerous studies on the New Deal. I read one of his 
recent articles in the Wall Street Journal, so welcome.
    Brad DeLong is Professor of Economics at UC-Berkeley, Chair 
of the Political Economy of Industrial Societies Major and a 
Research Associate of the National Bureau of Economic Research. 
He was educated at Harvard. He received his Ph.D. from that 
institution in 1987. He joined Berkeley as an Associate 
Professor 6 years later and became a full professor in 1997. He 
has been a fellow of the National Bureau of Economic Research 
and Assistant Professor of Economics at Boston University and a 
lecturer at the Department of Economics at MIT. Professor 
DeLong also served in the U.S. Government as Deputy Assistant 
Secretary of the Treasury for Economic Policy from 1993 to 
1995.
    Dr. Winkler, let us begin with you. Thank you.

  STATEMENT OF ALLAN M. WINKLER, PROFESSOR OF HISTORY, MIAMI 
                    UNIVERSITY, OXFORD, OHIO

    Mr. Winkler. Thank you very much. It is a pleasure to be 
here for two reasons. First of all, as an historian, I have 
spent a lot of time reading hearings and transcripts and to be 
here is something I appreciate very much. Second, my father was 
a beneficiary of the National Youth Administration during the 
Depression. That allowed him to continue his education at the 
University of Cincinnati and that made a huge difference in his 
life.
    The New Deal basically was a response to the worst crisis 
in American history. It involved efforts to promote relief, to 
deal with the ravages of the Depression and create recovery, to 
reform elements of the American system, and it worked in all 
three different areas. And yet it wasn't a planned operation. 
It was haphazard. It was often contradictory, and elements in 
one area worked against the grain in terms of elements in 
another, and that is a large part of how we have to view it 
these days.
    As Christina Romer indicated earlier, monetary policy 
played an important role. Fiscal policy, likewise, could have, 
but was not really tried, in part because the conventional 
wisdom of the day didn't really understand where things were at 
that point.
    The New Deal revolved around Franklin Roosevelt, who was an 
extraordinary leader. In his inaugural address, when he talked 
about the need for action and action now, he sounded just the 
right note. His comment that the only thing we have to fear is 
fear itself was something that really created a sense of 
confidence in the American people, and that was hugely 
important in what followed.
    In the first 100 days, launched almost immediately after 
the inauguration, the important element here is that there was 
no complete, coherent plan of what was going to happen. The 
banking crisis then, as now, was a major issue that had to be 
dealt with. The Emergency Banking Act was pushed through almost 
without having printed it and by a voice vote. And with that 
kind of momentum, Roosevelt proceeded from one thing to another 
and it went on from there.
    Overall, the New Deal did a range of different things. In 
the relief sphere, there were a series of early initiatives 
that culminated in 1935 with the Works Progress Administration 
that put all kinds of people, ranging from artists and authors 
and the like, as well as laborers, back to work, and that was 
hugely important. Recovery was something the New Deal 
recognized it had to deal with, and the National Industrial 
Recovery Act creating the NRA was again important in that area, 
even though it never worked particularly well, as I will come 
back to.
    Reform elements were hugely important in the New Deal, 
ranging from creation of the Securities and Exchange Commission 
to Social Security in 1935 to the Wagner Act to deal with 
collective bargaining and the like.
    The New Deal was important. It made some huge 
contributions. It put people back to work. It saved capitalism. 
It restored faith in the American system and revived a sense of 
hope in the American people. And yet economically, it never 
worked as well as it could have.
    As Christina Romer pointed out, monetary policy did lead to 
an expansion in the economy, and yet because we were starting 
at such a rock bottom low level, those elements were not as 
important as otherwise they might have been.
    But fiscal policy was the real question. In 1936, John 
Maynard Keynes published his major work, The General Theory of 
Employment, Interest and Money in which he argued that 
Depression was not automatically going to disappear if you 
simply waited it out, that what was necessary to make that 
happen, in his phrase, was deliberate sustained countercyclical 
spending. It was necessary for private spending to occur, if 
that could happen. If not, the government needed to step in.
    And yet Keynesian analysis never really caught hold during 
the Great Depression. Keynes and Roosevelt met one another on a 
couple of brief occasions. Neither man understood the other. 
Keynes understood the New Deal was not proceeding in the 
directions that he would have counseled, and that was 
important.
    And the contradictions in economic policy, according to 
Keynesian analysis, really give us some perspective on what was 
happening. Acts like the Agricultural Adjustment Administration 
called for a processing tax that cut into the money that was 
being spent to pay farmers not to produce. Social Security, as 
was pointed out, was taking money out of people's pockets in 
1937, with pensions not to begin until 1942. The cities and 
States trying to run surpluses or at least balance their budget 
worked against the grain of what was happening with regard to 
larger government spending.
    When the economy tanked in 1937, when Roosevelt cut WPA 
rolls significantly, when he cut back on the budget so that it 
was about a third of what it had been before, the economy went 
into recession. The lesson learned then was that if you began 
to spend, you could bring it back, and that was what happened 
in the next couple of years.
    What do we take from all of this? I would suggest the 
lessons are very clear. Government can make a difference. A 
major stimulus, according to Keynesian analysis, is necessary 
and essential and can promote recovery. It is above all 
important for us to ensure that measures do not work in 
contradictory ways and to allow the stimulus to take the effect 
that it can have.
    Thank you very much.
    Senator Brown. Thank you, Dr. Winkler.
    Dr. Galbraith.

 STATEMENT OF JAMES K. GALBRAITH, LLOYD M. BENTSEN, JR., CHAIR 
 IN BUSINESS/GOVERNMENT RELATIONS, LYNDON B. JOHNSON SCHOOL OF 
   PUBLIC AFFAIRS, UNIVERSITY OF TEXAS AT AUSTIN, AND SENIOR 
               SCHOLAR, LEVY ECONOMICS INSTITUTE

    Mr. Galbraith. Thank you very much, Chairman Brown. It is a 
privilege to be here to discuss the New Deal and its relevance 
to our present troubles.
    In my view, we can distill three main principles for 
economic policy from the Great Depression, the New Deal, and 
ultimately from the Second World War.
    The first is that unregulated capitalism is not necessarily 
self-correcting; mass unemployment, which a previous generation 
of economists thought was always going to be a temporary 
aberration, can, in fact, occur and it can persist with no 
automatic tendency for it to disappear.
    The second is that economic intervention by public policy 
works best when it is targeted directly to the broad population 
rather than filtered through those at the top, and, of course, 
when it is implemented on a sufficiently large scale. Now, we 
can come back to the discussion of whether the New Deal 
operated on a sufficiently large scale. Certainly in the Second 
World War we did.
    Third--and Professor Winkler has already alluded to this--
the fiscal cutbacks which produced the recession of 1937-38 
showed that backtracking is disastrous. There will come a time 
when the private economy is sufficiently robust and resilient 
to launch and sustain economic growth on its own, but that time 
need not come particularly soon. And to anticipate it 
prematurely can lead to a severe interruption of the progress 
toward recovery.
    In my brief remarks to follow, I shall summarize points 
that are made in great detail in my written testimony in four 
areas.
    The first is that, like our present troubles, the Great 
Depression flowed from a collapse of the banking system and of 
asset values--the Great Crash of October 1929 and subsequent 
events. This was a fundamental and unprecedented development in 
the American economy in the depth and extent of the financial 
calamity, and it eliminated the possibility that recovery could 
be led by a revival of the financial system. The result of this 
was that Roosevelt effectively bypassed the financial system 
via public spending and also through direct lending to the 
private sector using the Reconstruction Finance Corporation and 
other vehicles.
    I do not subscribe to the view that monetary policy caused 
the Depression--I think that view was and is advanced by those 
who seek to minimize the inherent instability of the financial 
sector in those days. Nor do I subscribe to the view that 
monetary policy played the principal role in getting us out.
    The second point: Much of the New Deal was not, in fact, 
about fiscal expansion but about the creation of a 
comprehensive network of social insurance and social 
protections, and the construction of institutions for 
collective action inside the population, including trade 
unions. This was true, for example, of the philosophy behind 
deposit insurance, behind the creation of the Social Security 
system to protect the elderly, behind the Agricultural 
Adjustment Administration, and also the much maligned National 
Industrial Recovery Act, certainly true of the philosophy 
behind the National Labor Relations Act and the creation of the 
minimum wage.
    Each of these institutions played an important role in 
reducing the amount of instability, insecurity, and privation 
in the broad population. Each played an important role in the 
moral and psychological recovery from the Great Depression, 
even if their contributions to aggregate effective demand and 
economic growth may appear in retrospect to be relatively 
modest. Strengthening social insurance is, therefore, extremely 
important.
    Third, there were, of course, massive employment programs. 
From the beginning of the New Deal, 3.5 million or so people 
were employed in jobs directly in the public sector, and this 
had a very important effect.
    It is important to say that the principle behind these 
programs was not a short-run Keynesian stimulus. It was not 
designed to return the economy quickly back to the allegedly 
normal condition of the 1920s but, rather, to provide immediate 
and necessary relief to legions of people who would otherwise 
not have been able to eat.
    And it is important also to note that in terms of the 
effects on unemployment, the impact of these programs has been 
largely misstated in the literature, in a great deal of the 
literature, because economists in subsequent years have adopted 
the habit of not counting people who worked for the New Deal as 
employed, although, in fact, they were fully employed, working 
every day and being paid for their labors.
    Finally, in addition to its employment programs, the New 
Deal embarked on a massive program of public investment, which 
was strongly oriented toward the long term, toward the benefits 
of education, transportation, art, culture, and conservation. 
Those programs also had macroeconomic effects, but the 
important thing about them is that they, in fact, rebuilt the 
country.
    I just want to close with a brief quotation from a recent 
paper by an economist named Marshall Auerback, which I think 
captures the flavor of this particular aspect of the New Deal 
in a very effective way. He writes, ``The government hired 
about 60 percent of the unemployed in public works and 
conservation projects that planted a billion trees, saved the 
whooping crane, modernized rural America, and built such 
diverse projects as the Cathedral of Learning in Pittsburgh, 
the Montana State capitol, much of the Chicago lakefront, New 
York's Lincoln Tunnel and Triborough Bridge complex, the 
Tennessee Valley Authority and the aircraft carriers Enterprise 
and Yorktown. It also built or renovated 2,500 hospitals, 
45,000 schools, 13,000 parks and playgrounds, 7,800 bridges, 
700,000 miles of roads, and a thousand airfields. And it 
employed 50,000 teachers, rebuilt the country's entire rural 
school system, and hired 3,000 writers, musicians, sculptors 
and painters, including Willem de Kooning and Jackson 
Pollock.''
    The point, I think, is that the New Deal was not an effort 
to return the country to the prosperity of the 1920s. Rather, 
it recognized that the conditions of that period could not be 
re-created, set out to do something quite different, and did so 
with very considerable success.
    Senator Brown. Thank you, Dr. Galbraith.
    Dr. Ohanian, welcome. Thank you for coming all the way from 
California. Welcome.

   STATEMENT OF LEE E. OHANIAN, PROFESSOR OF ECONOMICS, AND 
              DIRECTOR, ETTINGER FAMILY PROGRAM IN
                     MACROECONOMIC RESEARCH

    Mr. Ohanian. Thank you, Mr. Chairman.
    Over the decade, much of my research has focused in the 
area of economic crises, including work on the Great Depression 
and the New Deal. My findings indicate that some New Deal 
policies, those that impacted industrial product and labor 
markets, delayed recovery by impeding the normal competitive 
forces of supply and demand from operating. My research also 
indicates similar policies put in place by President Hoover 
also had a significant contributing effect during the early 
1930s.
    In terms of the policies that I have studied, one stands 
out, which is the National Industrial Recovery Act. The NIRA 
was collusive. It permitted firms within industries to 
cooperate, coordinate on setting minimum prices, restricting 
expansion of plant and capacity, provided that they paid wages 
that were well above trend.
    Expanding monopoly depresses output employment, and setting 
wages above trend or above levels consistent with market 
clearing makes labor expensive and leaves employers to scale 
back on employment.
    The NIRA was declared unconstitutional in 1935, but my 
research indicates that New Deal-type policies continued after 
that through lax prosecution of antitrust and on the labor side 
through the National Labor Relations Act, which substantially 
increased labor bargaining power. During a short period of 
time, unions and workers used the sit-down strike in which 
workers occupied factories to prevent production, with great 
success against companies including GM and U.S. Steel.
    Immediately after the Supreme Court upheld the 
constitutionality of the Wagner Act, wages in a number of 
industries considered by the FTC to be collusive jumped 
significantly. This was in, I believe, May 1937, right at the 
start of the 1937-38 contraction.
    There is significant evidence that these specific New Deal 
policies impeded recovery. Some evidence is that the recovery 
was delayed. Figures 1 and 2 in my testimony show per capita 
output, consumption, and investment, and hours worked. Per 
capita consumption, relative to its normal 2-percent trend, 
recovers hardly at all. Per capita investment does recover, 
rising from about 80 percent below trend to this trough in 
1933, but still remained more than 50 percent below trend by 
the end of the decade.
    Other evidence in what I can point out is that the recovery 
failure seems particularly striking in that the economic 
fundamentals that were in place at the time seemed--a number of 
them seemed to be very healthy. Productivity growth grew very 
rapidly after 1933. As mentioned earlier, the banking system 
had been stabilized. Liquidity was plentiful. Deflation had 
been eliminated. And a number of economists ranging from Milton 
Friedman to Nobel Laureates Robert Lucas and Edward Prescott 
have pointed to the weak recovery and thought about whether the 
Government policies were important here.
    Other evidence is that in the sectors that were covered by 
these New Deal policies, in particular much of major 
manufacturing, wages and prices did indeed jump after NIRA 
Codes of Fair Competition were adopted. Moreover, not only were 
prices and wages higher in these sectors, but employment was 
low. In sectors that were not impacted by the NIRA, for 
example, the agricultural sector, employment remained high and 
wages were below trend.
    Perhaps the most compelling evidence about the failure of 
the market economy at that time, that it was distorted, comes 
from the fact that hours worked is low, consumption is low, but 
the real manufacturing wage is well above trend--10 to 15 
percent above trend. The coincidence of such a high wage in 
conjunction with the Depression is puzzling because we would 
usually think competitive forces would push down that wage and 
raise employment, consumption, and output.
    The main lesson, I believe, to be learned from the New Deal 
is that while a number of New Deal policies were really quite 
useful, some, those that distorted product and labor markets 
and impeded the normal forces of competition, delayed recovery 
and that when we consider policy in future crises and we adopt 
what I might call crisis management policies to cushion the 
impact of a crisis on the economy, that those policies be 
consistent with good, long-run economic incentives.
    Thank you very much.
    Senator Brown. Thank you, Dr. Ohanian.
    Dr. DeLong, thank you for coming all this distance to be 
with us.

   STATEMENT OF J. BRADFORD DELONG, PROFESSOR OF ECONOMICS, 
              UNIVERSITY OF CALIFORNIA AT BERKELEY

    Mr. DeLong. Thank you, Chairman Brown, Senator Merkley.
    Drawing lessons from the New Deal requires, first, 
understanding what the New Deal was. Franklin Delano Roosevelt 
took everything that was on the kitchen shelf and threw it into 
the pot on March 4, 1933, and then began stirring, fishing 
things out that seemed not to be so tasty and having the 
Supreme Court fish a good deal of it out as well; adding 
spices, adding new ingredients, all the while watching the 
thing cook.
    Now, the aspect of the New Deal we focus on today is the 
expansionary monetary policy aspect. The conventional interest 
rate reductions, the quantitative easing by the Federal Reserve 
in the late 1930s, banking sector nationalization and 
recapitalization, and fiscal policy expansion--how effective 
were these?
    Well, I think there is a broad, near-consensus that the 
expansionary macroeconomic policies of the New Deal era were 
effective. Had Senator McCain won the Presidential election 
last November, the first panel here would not have had 
Christina Romer. She would be back at Berkeley, and I would not 
be having to teach her course this semester. Instead, it would 
have someone like Douglas Holtz-Eakin or Kevin Hassett or Mark 
Zandi, one of John McCain's senior economic advisers, all of 
whom would be arguing that New Deal-like monetary and fiscal 
stimulus programs were effective as part of arguing for the 
McCain fiscal stimulus program that would in all likelihood--or 
the McCain banking recapitalization program that would in all 
likelihood be proceeding through the Congress.
    Now, back at the start of the Great Depression, none of the 
major industrial powers of the world pursued these expansionary 
macroeconomic policies. They held instead that the government 
is best which governs least as far as interventionist policy is 
concerned, and they bound themselves with the golden fetters of 
the gold standard. Only when these were broken could a New Deal 
begin in any of the major industrial countries, and we know 
when each of the five major industrial countries of the world 
back during the Depression case off its golden fetters and 
began its New Deal, we know also how quickly each of them 
recovered from the Great Depression. That is the chart up there 
on your right.
    There is a very strong correlation between how early a 
country abandoned gold and began its own individual New Deal on 
the one hand and how rapid and complete its recovery was on the 
other, as this chart I have reproduced from Barry Eichengreen's 
1992 article and then scribbled on myself shows. Those 
economies that abandoned the gold standard and started 
expansionary monetary and, to a lesser extent, fiscal policies 
in 1931 did best; those that abandoned the gold standard in 
1933 did second best; France, which waited until the very end 
of the 1930s to start its New Deal, did worse.
    Statisticians will tell you that if you thought before 
looking at this chart that it really did not matter what a New 
Deal did, that the pluses and the minuses of New Deal policies 
largely offset each other, that if you thought there was only 
50-50 chance that New Deals mattered before looking at this 
chart, then after looking at this evidence you would be 95 
percent sure that New Deals mattered.
    Which part of the fiscal and monetary expansion of the New 
Deals in all the different countries mattered? Probably all of 
them. It is difficult to write down a model of the economy in 
which some tools work and others do not. All four of the 
aspects operate through boosting spending, either through 
boosting the money stock and hoping the velocity of money will 
remain unchanged, or through boosting the velocity of money and 
hoping that the money stock will remain unchanged. And any 
model of the economy in which increases in spending cause not 
just inflation but also boost employment and output will see 
that all four of these policy tools are likely to be effective.
    Which of the four components of macroeconomic policy helped 
the most in the New Deal's aiding of recovery? That is a much 
more difficult question. Christina Romer, who was here before, 
places enormous stress on the quantitative easing policies of 
the late 1930s, the mammoth expansions of the money supply even 
after interest rates on Treasury securities had already been 
reduced to effectively zero, and says it played the most major 
role. Professor Galbraith earlier dissented from that.
    Did the fiscal policy expansions help? Well, as Christina 
Romer said earlier, there were so little of them that it was 
hard to say. The gap between the size of the Great Depression 
in the United States and the magnitude of the extra-direct 
government spending was so large that it is truly hard to see 
whether fiscal policy might have mattered.
    But as Professor Galbraith said, for evidence of the 
ability of fiscal policy to boost employment and production if 
used on a sufficiently large scale, we have to wait until World 
War II.
    Monetary policy contraction, banking sector collapse, and 
the transformation of irrational exuberance into unwarranted 
pessimism carried the U.S. unemployment rate up from 3 percent 
to 29 percent--or to 23 percent from 1929 to 1932. Monetary 
expansion, banking reform, and small deficits then drove the 
unemployment rate down to 9.5 percent by the start of large-
scale mobilization in 1940. And wartime government expenditures 
and deficits drove the unemployment rate down to 1.2 percent by 
1944.
    Thank you.
    Senator Brown. Thank you, Dr. DeLong.
    I will sort of go left to right and ask each of you about 5 
minutes' worth of questions if no other Senator shows up, and 
then certainly feel free to weigh in on any question I ask any 
of the other three.
    Dr. Winkler, starting with you, first, tell me about the 
National Youth Administration and what it did for your Dad?
    Mr. Winkler. He was employed. He ended up working in the 
Federal Writers Project for a chunk of time as part of his 
responsibilities there. He worked with, oh, Harriet Arnow and a 
number of other people writing the Cincinnati and Ohio Guides.
    Senator Brown. You cautioned near the end of your testimony 
against measures--you cautioned that measures not work in 
contradictory ways. What is the potentially biggest damage that 
we can do in the way that we have pursued, President Obama and 
the House and Senate are pursuing our counterattack, if you 
will, on this terrible recession?
    Mr. Winkler. The biggest difference between then and now, 
in my estimation, is that then they did not really understand 
the impact that fiscal policy could have and now we do 
understand it. They were not aware of the processing tax in the 
AAA and the effect that it was going to have on larger fiscal 
policy. They did not really understand what the Social Security 
tax was going to do before you are beginning to pay out the 
pensions and the like.
    We do understand those things now, but the debate about how 
much money you should spend and how extensive the spending 
should be is one that is comparable to this at this point in 
time as well.
    It seems to me that with the awareness that we now have to 
back off of the kind of spending that we have begun to do would 
be a serious mistake in light of what happened during the 
Depression and particularly in the 1937 recession period.
    Senator Brown. So you are advocating depending on economic 
growth in the next 12 months, whether we do additional stimulus 
packages of some sort?
    Mr. Winkler. I think it is clear that the growth will come, 
whether it is in the next 12 months or thereafter, and I think 
that one has to basically have faith and confidence that that 
will happen and that the deficits will be retired in time. I 
think that was something that was not understood at the time of 
the Great Depression and during the New Deal, but that I think 
we do understand that now.
    We had the huge deficits of World War II, and in time, with 
the prosperity that followed the war, we were able to get the 
country back on a very sound economic footing before long.
    Senator Brown. What did you mean when you said Keynes and 
FDR did not understand one another? And more importantly than 
personal issue is what did that mean to Roosevelt's pursuing 
Keynesian economics in any way or Keynes trying to advise 
Roosevelt from afar with that letter that was sent December 31, 
1933, that open letter to FDR?
    Mr. Winkler. It meant that Keynesian economics at that 
time, when it perhaps could have had an impact or even a couple 
of years later, simply was not tried. It took time until people 
began to understand what Keynes was doing and saying. Mariner 
Eccles, who was head of the Federal Reserve Board during the 
1930s, did understand by the end of the decade what was going 
on. Other people began to promote Keynesian theories, Alvin 
Hansen and others, and it began to catch on in ways that had 
not been the case in the 1930s.
    But the fact that the two men basically were talking at 
cross purposes in the meeting that they initially had is simply 
reflective of the fact that Keynes was not going to be listened 
to very coherently at that time.
    Senator Brown. What do you make of Hoover's differences 
with Andrew Mellon in the last couple of years of his 
Presidency when Mellon wanted no government intervention and 
Hoover presumably did?
    Mr. Winkler. I wished that Hoover had responded, as he did 
in his memoirs, the same way much earlier, and I think it could 
have made a difference. I think the fact that he did listen to 
Mellon during the years after 1929 was catastrophic, and that I 
think Mellon's advice was all wrong, and that Hoover would have 
been far better off if he had taken advantage of the awareness 
that he later had.
    Senator Brown. Thank you.
    Dr. Galbraith, you spoke of the much maligned NIRA. Dr. 
Ohanian pretty much maligned it. Talk to me about that.
    Mr. Galbraith. Well, the NIRA was never popular with----
    Senator Brown. Your microphone, please.
    Mr. Galbraith. The NIRA was never popular with the 
economics profession. The Act essentially authorized the 
creation of cartels and deflated the Antitrust Act. And it has 
been largely dismissed in the historical treatment of the New 
Deal, so I do not want to overemphasize my point. Let me simply 
say that I think we should be agnostic in retrospect about a 
program that was in effect during a 4-year period when 
industrial production, in fact, doubled. It would be very hard 
to argue that the NIRA impeded industrial recovery, because 
industrial recovery was proceeding between 1933 and 1936 at a 
very rapid rate.
    Senator Brown. There has been discussion from both the two 
of you, Dr. Ohanian and you, but really all four of the 
panelists, and certainly by critics of the New Deal and 
supporters of the New Deal, about the Wagner Act, about, if you 
will, the artificial market and intervention that increased 
wages, whether it was the sit-down strikes that Dr. Ohanian had 
mentioned, the minimum wage, the Wagner Act overall collective 
bargaining.
    Talk to me, if you would, about--sort of answer his views 
that that, in fact, did cost jobs. I believe Dr. Ohanian--and I 
certainly want you involved in this discussion, Dr. Ohanian, 
what it meant that the lowest growth sectors in terms of jobs 
seemed to be the highest wage sectors. I think that is pretty 
much what you said. And talk about it in some immediate terms, 
Dr. Galbraith, if you would, and then its impact on economic 
growth in the 1950s and 1960s, the foundations of the New Deal, 
the Wagner Act, as wages were increasing what that did to 
employment. Dr. Galbraith, and then I would like to hear your 
thoughts, Dr. Ohanian.
    Mr. Galbraith. Yes, it is, again, a commonly held view in 
the economics profession that high wages cause unemployment, 
but the evidence for that proposition has always been extremely 
weak. If one believes that the measures that supported trade 
unions in the middle 1930s produced unemployment, you have to 
then explain why unemployment reached 25 percent in the early 
1930s before those measures took effect. And you have to 
explain why in the 1950s, very extensive trade union 
membership, which had reached 30 percent or more of the labor 
force, did not cause a reversion to high unemployment.
    One can look at this question also in a comparative context 
in the modern world, and a very interesting way of doing that 
is to examine the European experience, where we find that quite 
systematically across a wide range of countries those which 
have more egalitarian wage structures--the Scandinavian 
countries and the Northern European countries--as a result of 
very long traditions of very high levels of trade union 
membership--tend to have systematically lower unemployment 
rates, better and more efficiently operating labor markets, 
than countries which tolerate very high degrees of inequality. 
And there are very good and very conventional theoretical 
economic reasons why that would be expected to be the case.
    Senator Brown. So why would some critical New Deal policies 
emphasize the total hours worked per adult in 1939 were 20 
percent or more below their 1929 level? Isn't that an accurate 
indicator of what higher wages meant in terms of people with--
--
    Mr. Galbraith. Well, no; 1929 was the peak of an enormous 
speculative boom, and one cannot, I think, argue fairly that 
the experience of the late 1920s was sustainable. It was not. 
It led to a collapse of the financial sector just as the 
speculative boom in housing in the middle part of this decade, 
toward the end of this decade, led to a collapse of the 
financial sector that we are just experiencing. So to draw a 
trend line through that period and then say that in 1939 we 
were far below the trend is intrinsically questionable.
    Beyond that, there is the problem of counting unemployment, 
and Brad DeLong I think gave the accurate figures just now. The 
unemployment rate in the New Deal period fell from 25 percent 
to just under 10 percent by 1936. It then jumped back up again 
in the recession of 1937 and was brought down again, as 
Roosevelt relaunched the New Deal, back down below 10 percent, 
again, before the start of the war.
    That is a dramatic accomplishment in the face of the 
extremely serious situation that he started with.
    Senator Brown. Dr. Ohanian, talk to me about distorted 
labor markets and the Wagner Act and minimum wage and what that 
did to employment.
    Mr. Ohanian. My pleasure. Can I respond to a couple of 
points that Mr. Galbraith made?
    Senator Brown. Of course, yes, as any of you can. Feel free 
in jumping in.
    Mr. Ohanian. OK. So I believe Professor Galbraith made 
three or four points I would like to respond to. One is the 
idea about benchmarking comparisons to the year 1929, and it 
actually does turn out that, statistically speaking, a 2-
percent trend literally goes through the year 1929 and captures 
the rest of the economy going forward very closely. So a 
statistical procedure known as least squares drives that trend 
line on, going through 1929 and fitting the remainder of the 
economy really quite well.
    Another point Dr. Galbraith made was how can it be that 
with a higher rate of unionization in the 1950s, that the 
economy improved so much compared to the New Deal period. In 
terms of how much employment loss is going to be sustained on 
the basis of unions or other types of institutions that raise 
wages, what is relevant is how high the wage is above this 
market-clearing level. The estimates I have produced indicate 
that the wage was much higher above this market-clearing level 
in the late 1930s than it was immediately after the war.
    And, in fact, to get to your question about the Wagner Act, 
the Wagner Act, National Labor Relations Act, was significantly 
modified by the Taft-Hartley Act in 1947, which provided for 
States to have right-to-work States. It gave States the right 
to outlaw the closed shop. So what is really central for 
understanding how much work was lost is how high the wage is 
relative to trend or this market-clearing level rather than the 
actual amount of individuals and unions.
    Another point Dr. Galbraith made was about unemployment 
versus hours worked. I use hours worked as a measure of labor, 
as do other macroeconomists, because that is the measure that 
we use for trying to understand how much production is 
occurring. Unemployment rates are tricky because for long-term 
issues, such as we are talking about in the Great Depression, 
you know, 9, 10 years, there is something called the 
discouraged worker effect in which individuals leave the labor 
force, which reduces unemployment.
    The final point Dr. Galbraith made was about whether high 
wages do cause job loss. Most economists, in my view, do 
subscribe to the view that if wages are boosted above the 
market-clearing level, that will reduce jobs. The economic 
reasoning is well accepted among economists and there is 
significant evidence for that.
    I am not sure if I covered your initial question about the 
Wagner Act, but I would be happy to----
    Senator Brown. You did. You did. You did. Thank you.
    You acknowledged, Dr. Ohanian, that there are New Deal 
policies that were useful, as you said, Social Security, bank 
stabilization policies. What is the line between a useful 
social safety net and policies that are meddlesome to 
interventionist to distorting of the market? Can you share how 
you come to those conclusions, or do you just look at each one 
individually and make an educated sort of estimate?
    Mr. Ohanian. Sure. Well, in my view, among the most useful 
policies in the New Deal did establish the basic social safety 
net. So unemployment benefits, for example, in my opinion, were 
one of the most important parts of the New Deal. Establishing 
Social Security----
    Senator Brown. I am sorry. So you reject the view that 
unemployment extensions would cause some people to not seek 
work, therefore distorting the labor market? You don't buy 
those sort of conservative arguments that the unemployment 
system really causes fewer people to want to work?
    Mr. Ohanian. A number of economists have been working on 
the difficult issue of how to design unemployment insurance, 
disability insurance, other types of social insurance to try to 
get incentives right, which is, I believe, what you are talking 
about, and at the same time trying to provide enough insurance, 
and that is a difficult, difficult question.
    What I can tell you is that current research indicates that 
the incentive issues become less problematic during periods 
when the chances of finding work are extremely low. So, for 
example, during the Great Depression when labor markets are 
quite distorted, you know, expanding unemployment benefits--
well, they were adopted at that time. But that might have been 
a good idea.
    In terms of trying to figure out which policies are useful 
and which aren't, good policymaking really needs to be 
consistent with getting economic incentives right. I believe 
there is a large level of agreement among economists about what 
constitutes guides for good long-run policy, increasing the 
incentives to work, save, and invest, increasing the incentives 
and maintaining incentives for financial intermediaries to 
intermediate capital efficiently. These are all good guides for 
policy.
    When we see policies that sharply deviate from those good 
long-range goals, that is when I say these are policies that 
are going to have a negative impact on the economy.
    Senator Brown. Thank you.
    Dr. DeLong, would you weigh in on the 1929-1939, 20 percent 
hours worked for adults, 20 percent lower? Do you think that is 
an accurate indicator of----
    Mr. DeLong. It is a puzzling question that--and it is 
indeed the case that unemployment declined, the unemployment 
rate declined extremely sharply from 1932 to 1939, from 23 
percent down to 11.3 percent, according to the Weir measure, 
and practically all of this is indeed an increase in the 
fraction of the labor force that has jobs and very little of it 
being a discouraged worker effect because that discouraged 
worker effect is not present, at least I at least can't see it 
in David Weir's Labor Force series.
    But nevertheless, it is certainly true that hours of work 
per employed person were 13 percent lower in 1939 than in 1929, 
and Lee Ohanian wants to conclude that a substantial chunk of 
this decline is due to deficient demand, that the economy was 
getting better at sharing the available work hours among the 
workers but was not producing nearly as much demand for labor 
as we would want to see.
    This is debatable. In 1949, hours worked per adult were 18 
percent. In 1959, they were 17 percent below their 1929 level. 
But do we want to conclude that the economy was even more 
depressed in the 1950s than it was in 1939? No. The decline in 
hours worked tells us a lot about the cycle and the trend, that 
the decline in hours worked from 1914 to 1952 does not mean 
that the economy was performing much worse in 1952 than it was 
in 1914.
    The Great Depression comes in the middle of the last sharp 
decline in the American work week we have seen and shows us 
that Americans back then were deciding collectively to take a 
substantial part of their increased technological wealth and 
use it to buy increased leisure. And for that reason, I am more 
skeptical of the work hours comparison of 1939 to 1932 and 1929 
and I tend to think that it makes more sense to take the 
unemployment rate as an indicator of how complete recovery is.
    Senator Brown. Interesting answer. Thank you.
    What role did the Fed play in reversing the Great 
Depression? What policies, in particular, should it have 
pursued?
    Mr. DeLong. Well, this is--I think when you, in fact, talk 
about the Federal Reserve and the Great Depression, there 
really are three questions. The first is did the Federal 
Reserve cause the Depression? Was the economy going along doing 
its normal thing and then the Federal Reserve all of a sudden 
decided to do something bad, and as a result we fell into the 
Great Depression? And I think the answer to that is clearly no, 
that the Great Depression started for other reasons. The 
Federal Reserve was simply a bystander, that, as Professor 
Galbraith said earlier, there are signs of substantial natural 
instability, right, in the economy, at least as it stood in the 
interwar period. Then it starts down and it keeps going down.
    The second question is, could the Federal Reserve have 
interrupted the Great Depression? Milton Friedman and Anna 
Jacobson Schwartz's Monetary History of the United States is a 
very large and very impressive book. I think Professor 
Galbraith calls it magisterial at some point in his written 
testimony. It argues the Federal Reserve could by itself have 
stopped the Great Depression in its tracks had it done enough 
to print up bank reserves, to encourage the Bureau of Engraving 
and Printing to print up currency, had it rescued threatened 
banks. But the Federal Reserve did not do so.
    And this thesis of the Monetary History of the United 
States has, I think, taken profound damage over the last 2 
years, for Chairman Bernanke of the Federal Reserve and his 
team have, via open market operations and now quantitative 
easing, they have done exactly what Friedman-Schwartz 
recommended and claimed would have stopped the Great Depression 
in its tracks. They have expanded bank reserves, the monetary 
base, and the money supply to an extent I would not have 
believed possible 3 years ago. Yet we all think that this was 
not enough, that we need banking policy and probably fiscal 
policy, as well, in order to keep the Great Depression 
currently the last depression that America has suffered.
    I think this is a substantial intellectual loss for 
Friedman-Schwartz and an intellectual victory for Bernanke-
Keynes, who argued that all the conventional interest rate and 
quantitative easing monetary policy in the world might not be 
enough if the capitalization of the banking sector vanished and 
the credit channel got itself well and truly clogged, which is 
where we seem to be.
    The third question is what role did the Federal Reserve 
play in spurring recovery, and here we have the debate, and we 
have seen a piece of it in the debate between Chairman Romer 
and Professor Galbraith earlier, Christina Romer placing a very 
heavy weight on the quantitative easing policies of the Federal 
Reserve and of the gold inflow during the 1930s, arguing that 
even after the Federal Reserve has done everything it can to 
lower interest rates on Treasury securities to zero, if it 
continues to expand the money supply, well, that money burns a 
hole in people's pockets and they spend it and that boosts 
spending, and Professor Galbraith placing more stress on what 
fiscal expansion there was and on the recovery of the banking 
system.
    Here, well, my office and Professor Galbraith's office is 
1,000 miles away, but in her previous life, Christina Romer's 
office is only 50 steps down the hall and she is very, very 
impressive and very convincing, so I tend to side with 
Christina on that one.
    Senator Brown. Fair enough.
    I will close with one question, particularly in light of 
his last comments about fiscal and monetary policy. I want to 
ask the same question of all four of you, and let us close with 
that. The question is, expand on whether it is fiscal policy or 
monetary policy that was primarily responsible for economic 
growth during the Depression in the 1930s and your views of 
what that means for today, if you would just take that 
question, Dr. Winkler, and each of you work through your 
thoughts on that sort of central question.
    Mr. Winkler. I have been thinking about fiscal policy and 
particularly with regard to the NIRA that came up earlier in 
this conversation. There is no question that the NIRA did not 
work very well. It was trying to stabilize prices and wages and 
hours and the like. In so doing, it probably reversed the 
deflationary cycle, but it also discouraged investment. 
Business people who were not making profits were not likely to 
invest. The point, though, is that they weren't going to invest 
anyway. Keynes was absolutely right. This was not working. 
Something else needed to be done.
    My whole point, I think, has been that fiscal policy could 
have made a difference as we look at this in retrospect but did 
not because enough was not being spent, at least in the 
aggregate. I tend to side with Professor DeLong that monetary 
policy did make a difference. Would that fiscal policy have 
been permitted to be used in the ways that might have made a 
greater difference and ended the Depression sooner.
    Senator Brown. Thank you.
    Dr. Galbraith.
    Mr. Galbraith. The judgment of contemporaries was that 
monetary policy played a very minor role in the recovery from 
the Great Depression, and I tend to share that judgment. The 
Federal Reserve at the time was regarded as something of a 
backwater and I wonder to what extent the present emphasis on 
monetary policy in those years may be picking up the work of 
other agencies and in particular the Reconstruction Finance 
Corporation and the institutions that were set up to help 
recapitalize housing and to reconstruct the mortgage business.
    But leaving that aside, public spending in the national 
income and product accounts increased over 50 percent between 
1932 and 1936, and as a share of GDP, federal spending rose 
from 10 percent to around 17 percent. That is a substantial 
increase both in absolute numbers and in proportions. The 
argument that this is an insignificant factor, it seems to me, 
is deeply questionable. To establish it, we would need to know 
what the multipliers--what the multiplier effects, the knock-on 
effects, actually were at that time.
    Earlier, you asked a question of Professor Winkler that I 
think is very pertinent to this issue, and that was ``What are 
the biggest differences between the approach taken in the New 
Deal and the approach that we are taking today?'' I would like 
just to close by coming back to two differences that I think 
are very instructive and important for the design of policy 
going forward.
    I think in our present environment, in our present 
situation, we are placing much more reliance on policies 
intended to resurrect the existing structure of banking and to 
get credit flowing again than was true in the early and middle 
1930s, and we are likely to fail at this. The present approach 
to the banking crisis is actually somewhat more reminiscent of 
the early 1930s than it is of the Roosevelt period and likely 
to meet the same disappointment as in those early years, 
insofar as the problem is not one of a blockage in the pipes of 
credit but rather a collapse of asset values and therefore of 
the collateral on which credit rests, the demand for credit as 
much as of the supply.
    That problem can only be solved by reconstructing the 
financial position of America's households and businesses. In 
the Great Depression, that did not happen, and it didn't really 
happen until the Second World War completely recapitalized the 
private sector by giving them a vast stock of government bonds, 
which became the basis of their financial wealth, of middle-
class prosperity in the post-war period.
    The second point is that we are placing too much emphasis 
on the idea that by using the short-term Keynesian stimulus, we 
can bring ourselves out of this problem in a short period of 
time. I think if we do that, we are going to be prone to a 
policy reversal with the same danger that Roosevelt experienced 
in 1937, that is to say, when you reverse policy, the economy 
then punishes you by going back into the tank.
    It would be appropriate to take a lesson from the early New 
Deal. What is needed here is a comprehensive set of measures 
that will build an economy for the future, an economy which, in 
particular, deals with two vital, very closely related 
challenges. One of them is energy security, because if we don't 
deal with our energy security problems, we are going to be at 
the mercy of rising oil prices just as soon as aggregate demand 
starts expanding aggressively. And second there is climate 
change, a problem which we have an opportunity now to deal with 
and which if we do not take that opportunity, we will both miss 
our chance to put the overall working of the American economy 
on an environmentally sustainable basis, and also an 
opportunity to take many millions of people and give them 
useful employment for many years to come.
    Senator Brown. Thank you, Dr. Galbraith.
    Dr. Ohanian.
    Mr. Ohanian. If I might just briefly respond to one of the 
points Professor DeLong made about how much hours worked were 
depressed at the end of the 1930s, so one point I just want to 
make is that per capita hours in the 1950s are indeed higher 
than they are in the 1930s, just as they were in the 1920s.
    The second point, Professor DeLong indicated that as people 
become wealthier, they increase their demand for leisure and 
hours worked falls. There is not a conclusion about this force 
within the Depression. It is an area of active research. But if 
that force was operative, the Depression is a period of 
declining wealth and income, which would suggest people would 
be demanding less leisure rather than more leisure.
    Regarding your question about recovery and fiscal versus 
monetary policy, expansion output is necessarily due to 
expansion either in hours or output per hour. The numbers 
indicate there is not much expansion in hours in the 1930s, so 
the growth we do see in the 1930s is--most of it is coming from 
output per hour or productivity.
    Economists don't have a good understanding about cyclical 
changes in productivity. Our basic economic reasoning doesn't 
point to a substantial link between either fiscal policy or 
monetary policy and expansions in productivity. Economic 
historian Alexander Field has indicated that the 1930s were a 
really remarkable period for productivity growth, true 
productivity growth in terms of efficiency gains. I don't see 
necessarily either monetary or fiscal policy playing a major 
role there.
    In terms of today's economy, we face, as other panel 
members indicated, a different set of problems, in some sense 
related but in some sense really quite different. Re-regulating 
the financial system is a tall order to fill. It is not an easy 
question. There are a number of complicated issues. Currently, 
we have a system that has stocked a lot of risk onto the backs 
of taxpayers and incentives were in place to make that happen 
at some level. So in my view, the major challenge we face is 
re-regulating that financial system that became much more 
sophisticated and much faster than the current regulatory 
framework could deal with. That won't be an easy issue to make 
progress on, but in my view, that is the main challenge we 
face.
    Senator Brown. Thank you.
    The last word, Dr. DeLong.
    Mr. DeLong. I think that the lesson from viewing fiscal and 
monetary policy and government attempts to use them to serve as 
balance wheels of the economy since the Great Depression, of 
the abandonment of Herbert Hoover Treasury Secretary Andrew 
Mellon's dictum that liquidation is actually a healthy process, 
part of what economist Joseph Schumpeter called the natural 
breathing of the economic organism, that we have abandoned that 
and we think we have these policy tools and have been trying to 
use them and the question is how effective they are.
    And I think the conclusion from 70 years of economists 
arguing and watching economies and watching the success of 
these tools is that almost all of the time monetary policy is 
more effective, and almost all of the time monetary policy is 
easier to implement and easier to change when conditions 
change, that it moves faster and it also is more flexible.
    But then there come times like today, all right, times when 
the interest rate on safe short- and medium-term Treasury 
securities has been pushed all the way down to zero and in 
which you have to ask, if you undertake further expansionary 
monetary policy, well, whose incentives are you changing? We 
are economists. We believe that people respond to incentives, 
that government policies worked by changing the incentives that 
people face, but by the time you have pushed interest rates 
down to zero and can't push them any further, whose incentives 
are you changing by continuing to rely on monetary policy?
    And it is in that situation that we are now, and that is 
when you start dragging out the other tools of trying to keep 
spending in the economy at a normal pace. You know, the 
quantitative easing part of monetary policy, that maybe you can 
give people so much money it burns a hole in their pocket and 
they spend it, that the aggressive banking sector 
recapitalizations and government loan guarantee programs that 
we see the Treasury trying to roll out now that have their 
parallel in operations conducted by the Reconstruction Finance 
Corporation during the Great Depression, which had, if I may 
say so, an easier time. The RFC had powers to bring banks into 
conservatorship without declaring that they were insolvent.
    And so to the extent that there is a fear that declaring 
that banks are, in the view of the government, insolvent will 
cause some kind of crisis of confidence and a shrinkage of the 
money stock as people pull their money out of banks, well, the 
RFC had tools that would avoid this, and perhaps Tim Geithner's 
life would be a little bit easier at the Treasury if he had 
them now.
    And last, there is the fiscal policy, that government 
spending, government tax cuts, with the idea that if the 
private sector is spending and is not staying stable, well, 
maybe the government can add to it and so keep things on an 
even keel. And I think the prudent thing is, when asked which 
of these should we be doing, is to say yes, all right, that 
when there is great uncertainty and when you have a number of 
tools for all of which there is some reason to believe they are 
at least somewhat effective, we will do what Roosevelt did, 
experimentation. Try them all and reinforce the ones that seem 
to be working.
    Senator Brown. Thank you, Dr. DeLong.
    Thank you all for joining us. This is the first of several 
hearings that will help Congress shape our response and our 
reaction to this economic crisis. I appreciate all of the 
service all of you have given by being here today and the good 
work you do, each in your institutions.
    The record will be open for 7 days for Senator DeMint and 
the two other Members of the Subcommittee, and if you want to 
revise your remarks or add anything or respond to any of the 
questions that you didn't feel that you got to respond to 
completely enough, certainly you are free to be in touch with 
the Subcommittee to do that, also.
    The Committee is adjourned. Thank you very much.
    [Whereupon, at 4:34 p.m., the hearing was adjourned.]
    [Prepared statements supplied for the record follow:]
                PREPARED STATEMENT OF CHRISTINA D. ROMER
                                 Chair,
                President's Council of Economic Advisers
                             March 31, 2009
    Chairman Brown, Ranking Member DeMint, and Members of the 
Subcommittee, thank you for inviting me to join you today. In my 
previous life, as an economic historian at Berkeley, one of the things 
I studied was the Great Depression. And in my current life, as Chair of 
the Council of Economic Advisers, I have been on the front lines of the 
Administration's policies to help us to end what is arguably the worst 
recession our country has experienced since the 1930s. For this reason, 
I am delighted to talk with you today about the lessons learned from 
the Great Depression and President Roosevelt's New Deal that have 
helped inform us--and will continue to help inform us--about the right 
approach to dealing with today's economic crisis.
    To start, let me point out that though the current recession is 
unquestionably severe, it pales in comparison with what our parents and 
grandparents experienced in the 1930s. February's employment report 
showed that unemployment in the United States has reached 8.1 percent--
a terrible number that signifies a devastating tragedy for millions of 
American families. But, at its worst, unemployment in the 1930s reached 
nearly 25 percent. \1\ And, that quarter of American workers had 
painfully few of the social safety nets that today help families 
maintain at least the essentials of life during unemployment. Likewise, 
following last month's revision of the GDP statistics, we know that 
real GDP has declined almost 2 percent from its peak. But, between the 
peak in 1929 and the trough of the great Depression in 1933, real GDP 
fell over 25 percent. \2\
---------------------------------------------------------------------------
     \1\ Unemployment data for the 1930s are from Historical Statistics 
of the United States: Colonial Times to 1970 (Washington, DC: 
Government Printing Office, 1975), Part 1, p. 135, series D86.
     \2\ Real GDP data are from the Bureau of Economic Analysis, http:/
/www.bea.gov/national/nipaweb/SelectTable.asp?Selected=Y, Table 1.1.3.
---------------------------------------------------------------------------
    I don't give these comparisons to minimize the pain the United 
States economy is experiencing today, but to provide some crucial 
perspective. Perhaps it is the historian and the daughter in me that 
finds it important to pay tribute to just what truly horrific 
conditions the previous generation of Americans endured and eventually 
triumphed over. And, it is the new policymaker in me that wants to be 
very clear that we are doing all that we can to make sure that the word 
``great'' never applies to the current downturn.
    While what we are experiencing is less severe than the Great 
Depression, there are parallels that make it a useful point of 
comparison and a source for learning about policy responses today. Most 
obviously, like the Great Depression, today's downturn had its 
fundamental cause in the decline in asset prices and the failure or 
near-failure of financial institutions. In 1929, the collapse and 
extreme volatility of stock prices led consumers and firms to simply 
stop spending. \3\ In the recent episode, the collapse of housing 
prices and stock prices has reduced wealth and shaken confidence, and 
led to sharp rises in the saving rate as consumers have hunkered down 
in the face of greatly reduced and much more uncertain wealth.
---------------------------------------------------------------------------
     \3\ Christina D. Romer, ``The Great Crash and the Onset of the 
Great Depression,'' Quarterly Journal of Economics 105 (August 1990): 
597-624.
---------------------------------------------------------------------------
    In the 1930s, the collapse of production and wealth led to 
bankruptcies and the disappearance of nearly half of American financial 
institutions. \4\ This, in turn, had two devastating consequences: a 
collapse of the money supply, as stressed by Milton Friedman and Anna 
Schwartz, and a collapse in lending, as stressed by Ben Bernanke. \5\ 
In the current episode, modern innovations such as derivatives led to a 
direct relationship between asset prices and severe stress in financial 
institutions. Over the fall, we saw credit dry up and learned just how 
crucial lending is to the effective functioning of American businesses 
and households.
---------------------------------------------------------------------------
     \4\ Data on the number of banks is from Banking and Monetary 
Statistics (Washington, DC: Board of Governors of the Federal Reserve 
System, 1943), Table 1.
     \5\ Milton Friedman and Anna Jacobson Schwartz, A Monetary History 
of the United States: 1867-1960 (Princeton, NJ: Princeton University 
Press for NBER, 1963), and Ben S. Bernanke, ``Nonmonetary Effects of 
the Financial Crisis in the Propagation of the Great Depression,'' 
American Economic Review 73 (June 1983): 257-276.
---------------------------------------------------------------------------
    Another parallel is the worldwide nature of the decline. A key 
feature of the Great Depression was that virtually every industrial 
country experienced a severe contraction in production and a terrible 
rise in unemployment. \6\ 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, 
during the past few months, we have realized that this hope was a false 
one. As statistics have poured in, we have learned that Europe, Asia, 
and many other areas are facing declines as large as, if not larger 
than, our own. Indeed, rather than world demand helping to hold us up, 
the fall in U.S. demand has had a devastating impact on export 
economies such as Taiwan, China, and South Korea.
---------------------------------------------------------------------------
     \6\ Christina D. Romer, ``The Nation in Depression,'' Journal of 
Economic Perspectives 7 (Spring 1993): 19-39.
---------------------------------------------------------------------------
    This similarity of causes between the Depression and today's 
recession means that President Obama began his presidency and his drive 
for recovery with many of the same challenges that Franklin Roosevelt 
faced in 1933. Our consumers and businesses are in no mood to spend or 
invest; our financial institutions are severely strained and hesitant 
to lend; short-term interest rates are effectively zero, leaving little 
room for conventional monetary policy; and world demand provides little 
hope for lifting the economy. Yet, the United States did recover from 
the Great Depression. What lessons can modern policymakers learn from 
that episode that could help them make the recovery faster and stronger 
today?
    One crucial lesson from the 1930s is that a small fiscal expansion 
has only small effects. I wrote a paper in 1992 that said that fiscal 
policy was not the key engine of recovery in the Depression. \7\ 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 conclusion 
that in the Great Depression, fiscal policy failed to generate recovery 
``not because it does not work, but because it was not tried.'' \8\
---------------------------------------------------------------------------
     \7\ Christina D. Romer, ``What Ended the Great Depression?'' 
Journal of Economic History 52 (December 1992): 757-784.
     \8\ E. Cary Brown, ``Fiscal Policy in the Thirties: A 
Reappraisal,'' American Economic Review 46 (December): 857-879.
---------------------------------------------------------------------------
    The key fact is that while Roosevelt's fiscal actions through the 
New Deal were a bold break from the past, they were nevertheless small 
relative to the size of the problem. When Roosevelt took office in 
1933, real GDP was more than 30 percent below its normal trend level. 
(For comparison, the U.S. economy is currently estimated to be between 
5 and 10 percent below trend.) \9\ The emergency spending that 
Roosevelt did was precedent-breaking--balanced budgets had certainly 
been the norm up to that point. But, it was quite small. As a share of 
GDP, the deficit rose by about one and a half percentage points in 
1934. \10\ One reason the rise wasn't larger was that a large tax 
increase had been passed at the end of the Hoover administration. 
Another key fact is that fiscal expansion was not sustained. The 
deficit as a share of GDP declined in fiscal 1935 by roughly the same 
amount that it had risen in 1934. Roosevelt also experienced the same 
inherently procyclical behavior of state and local fiscal actions that 
President Obama is facing. Because of balanced budget requirements, 
state and local governments are forced to cut spending and raise tax 
rates when economic activity declines and state tax revenues fall. At 
the same time that Roosevelt was running unprecedented federal 
deficits, state and local governments were switching to running 
surpluses. \11\ The result was that the total fiscal expansion in the 
1930s was very small indeed. As a result, it could only have a modest 
direct impact on the state of the economy.
---------------------------------------------------------------------------
     \9\ The 2009 figure is an extrapolation to the current quarter 
based on estimates of potential output by the Congressional Budget 
Office, http://www.cbo.gov/ftpdocs/99xx/doc9957/Background_Table2-
2_090107.xls. For 1933, the estimate is based on the facts that the 
economy does not appear to have been substantially above trend in 1929 
and that real GDP fell 25 percent from 1929 to 1933. Normal growth 
would have added at least 10 percent to GDP over this period.
     \10\ The deficit figures are from Historical Statistics of the 
United States: Colonial Times to 1970, Part 2, p. 1194, series Y337. 
Nominal GDP data are from the Bureau of Economic Analysis, http://
www.bea.gov/national/nipaweb/SelectTable.asp?Selected=Y, Table 1.1.5. I 
average calendar year figures to estimate fiscal year values.
     \11\ The data on state and local fiscal stance are from the Bureau 
of Economic Analysis, http://www.bea.gov/national/nipaweb/
SelectTable.asp?Selected=Y, Table 3.3.
---------------------------------------------------------------------------
    This is a lesson the Obama Administration has taken to heart. The 
American Recovery and Reinvestment Act, passed by Congress less than 30 
days after the Inauguration, is simply the biggest and boldest 
countercyclical fiscal action in history. The nearly $800 billion 
fiscal stimulus is roughly equally divided between tax cuts, direct 
government investment spending, and aid to the states and people 
directly hurt by the recession. The fiscal stimulus is close to 3 
percent of GDP in each of the next 2 years. And, as I mentioned, a good 
chunk of this stimulus takes the form of fiscal relief to state 
governments, so that they do not have to balance their budgets only by 
such measures as raising taxes and cutting the employment of nurses, 
teachers, and first responders. We expect this fiscal expansion to be 
extremely important to countering the terrible job loss that last 
month's numbers show now totals 4.4 million since the recession began 
14 months ago.
    While the direct effects of fiscal stimulus were small in the Great 
Depression, I think it is important to acknowledge that there may have 
been an indirect effect. Roosevelt's very act of doing something must 
have come as a great relief to a country that had been suffering 
depression for more than 3 years. To have a President step up to the 
challenge and say the country would attack the Depression with the same 
fervor and strength it would an invading army surely lessened 
uncertainty and calmed fears. Also, signature programs such as the WPA 
that directly hired millions of workers no doubt contributed to a sense 
of progress and control. In this way, Roosevelt's actions may have been 
more beneficial than the usual estimates of fiscal policy suggest. If 
the actions President Obama is taking in the current downturn can 
generate the same kind of confidence effects, they may also be more 
effective than estimates based on conventional multipliers would lead 
one to believe.
    A second key lesson from the 1930s is that monetary expansion can 
help to heal an economy even when interest rates are near zero. In the 
same paper where I said fiscal policy was not key in the recovery from 
the Great Depression, I argued that monetary expansion was very useful. 
But, the monetary expansion took a surprising form: it was essentially 
a policy of quantitative easing conducted by the U.S. Treasury. \12\
---------------------------------------------------------------------------
     \12\ Romer, ``What Ended the Great Depression?''
---------------------------------------------------------------------------
    The United States was on a gold standard throughout the Depression. 
Part of the explanation for why the Federal Reserve did so little to 
counter the financial panics and economic decline was that it was 
fighting to defend the gold standard and maintain the prevailing fixed 
exchange rate. \13\ In April 1933, Roosevelt temporarily suspended the 
convertibility to gold and let the dollar depreciate substantially. 
When we went back on gold at the new higher price, large quantities of 
gold flowed into the U.S. Treasury from abroad. These gold inflows 
serendipitously continued throughout the mid-1930s, as political 
tensions mounted in Europe and investors sought the safety of U.S. 
assets.
---------------------------------------------------------------------------
     \13\ For a comprehensive history of the role of the gold standard 
in the Great Depression, see Barry Eichengreen, Golden Fetters: The 
Gold Standard and the Great Depression, 1919-1939 (New York: Oxford 
University Press, 1992).
---------------------------------------------------------------------------
    Under a gold standard, the Treasury could increase the money supply 
without going through the Federal Reserve. It was allowed to issue gold 
certificates, which were interchangeable with Federal Reserve notes, on 
the basis of the gold it held. When gold flowed in, the Treasury issued 
more notes. The result was that the money supply, defined narrowly as 
currency and reserves, grew by nearly 17 percent per year between 1933 
and 1936. \14\
---------------------------------------------------------------------------
     \14\ Friedman and Schwartz, A Monetary History of the United 
States, Table A-1, column 1 and Table A-2, column 3. The growth rate 
refers to the period December 1933 to December 1936.
---------------------------------------------------------------------------
    This monetary expansion couldn't lower nominal interest rates 
because they were already near zero. What it could do was break 
expectations of deflation. Prices had fallen 25 percent between 1929 
and 1933. \15\ People throughout the economy expected this deflation to 
continue. As a result, the real cost of borrowing and investing was 
exceedingly high. Consumers and businesses wanted to sit on any cash 
they had because they expected its real purchasing power to increase as 
prices fell. Devaluation followed by rapid monetary expansion broke 
this deflationary spiral. Expectations of rapid deflation were replaced 
by expectations of price stability or even some inflation. This change 
in expectations brought real interest rates down dramatically. \16\
---------------------------------------------------------------------------
     \15\ The GDP price index data are from the Bureau of Economic 
Analysis, http://www.bea.gov/national/nipaweb/
SelectTable.asp?Selected=Y, Table 1.1.4.
     \16\ Romer, ``What Ended the Great Depression?''
---------------------------------------------------------------------------
    The change in the real cost of borrowing and investing appears to 
have had a beneficial impact on consumer and firm behavior. The first 
thing that turned around was interest-sensitive spending. For example, 
car sales surged in the summer of 1933. \17\ One sign that lower real 
interest rates were crucial is that real fixed investment and consumer 
spending on durables both rose dramatically between 1933 and 1934, 
while consumer spending on services barely budged. \18\
---------------------------------------------------------------------------
     \17\ Peter Temin and Barrie A. Wigmore, ``The End of One Big 
Deflation,'' Explorations in Economic History 27 (October 1990): 483-
502.
     \18\ Data on the components of spending are from the Bureau of 
Economic Analysis, http://www.bea.gov/national/nipaweb/
SelectTable.asp?Selected=Y, Table 1.1.3.
---------------------------------------------------------------------------
    In thinking about the lessons from the Great Depression for today, 
I want to tread very carefully. A key rule of my current job is that I 
do not comment on Federal Reserve policy. So, let me be very clear--I 
am not advocating going on a gold standard just so we can go off it 
again, or that Secretary Geithner should start conducting monetary 
policy. But the experience of the 1930s does suggest that monetary 
policy can continue to have an important role to play even when 
interest rates are low by affecting expectations, and in particular, by 
preventing expectations of deflation.
    This discussion of fiscal and monetary policy in the 1930s leads me 
to a third lesson from the 1930s: beware of cutting back on stimulus 
too soon.
    As I have just described, monetary policy was very expansionary in 
the mid-1930s. Fiscal policy, though less expansionary, was also 
helpful. Indeed, in 1936 it was inadvertently stimulatory. Largely 
because of political pressures, Congress overrode Roosevelt's veto and 
gave World War I veterans a large bonus. This caused another one-time 
rise in the deficit as a share of GDP of more than 1\1/2\ percentage 
points.
    And, the economy responded. Growth was very rapid in the mid-1930s. 
Real GDP increased 11 percent in 1934, 9 percent in 1935, and 13 
percent in 1936. Because the economy was beginning at such a low level, 
even these growth rates were not enough to bring it all the way back to 
normal. Industrial production finally surpassed its July 1929 peak in 
December 1936, but was still well below the level predicted by the pre-
Depression trend. \19\ Unemployment had fallen by close to 10 
percentage points--but was still over 15 percent. The economy was on 
the road to recovery, but still precarious and not yet at a point where 
private demand was ready to carry the full load of generating growth.
---------------------------------------------------------------------------
     \19\ Industrial production data are from the Board of Governors of 
the Federal Reserve, http://www.federalreserve.gov/releases/g17/iphist/
iphist_sa.txt.
---------------------------------------------------------------------------
    In this fragile environment, fiscal policy turned sharply 
contractionary. The one-time veterans' bonus ended, and Social Security 
taxes were collected for the first time in 1937. As a result, the 
deficit-to-GDP ratio was reduced by roughly 2= percentage points.
    Monetary policy also turned inadvertently contractionary. The 
Federal Reserve was becoming increasingly concerned about inflation in 
1936. It was also concerned that, because banks were holding such large 
quantities of excess reserves, open-market operations would merely 
cause banks to substitute government bonds for excess reserves and 
would have no impact on lending. In an effort to put themselves in a 
position where they could tighten if they needed to, the Federal 
Reserve doubled reserve requirements in three steps in 1936 and 1937. 
Unfortunately, banks, shaken by the bank runs of just a few years 
before, scrambled to build reserves above the new higher required 
levels. As a result, interest rates rose and lending plummeted. \20\
---------------------------------------------------------------------------
     \20\ The data on interest rates are from Banking and Monetary 
Statistics, Table 120; the data on lending are from the same source, 
Table 2.
---------------------------------------------------------------------------
    The results of the fiscal and monetary double whammy in the 
precarious environment were disastrous. GDP rose by only 5 percent in 
1937 and then fell by 3 percent in 1938, and unemployment rose 
dramatically, reaching 19 percent in 1938. Policymakers soon reversed 
course and the strong recovery resumed, but taking the wrong turn in 
1937 effectively added 2 years to the Depression.
    The 1937 episode is an important cautionary tale for modern 
policymakers. At some point, recovery will take on a life of its own, 
as rising output generates rising investment and inventory demand 
through accelerator effects, and confidence and optimism replace 
caution and pessimism. But, we will need to monitor the economy closely 
to be sure that the private sector is back in the saddle before 
government takes away its crucial lifeline. \21\
---------------------------------------------------------------------------
     \21\ Of course, every episode is different, and the Federal 
Reserve will come to its own independent management of monetary policy.
---------------------------------------------------------------------------
    The fourth lesson we can draw from the recovery of the 1930s is 
that financial recovery and real recovery go together. When Roosevelt 
took office, his immediate actions were largely focused on stabilizing 
a collapsing financial system. He declared a national Bank Holiday 2 
days after his inauguration, effectively shutting every bank in the 
country for a week while the books were checked. This 1930s version of 
a ``stress test'' led to the permanent closure of more than 10 percent 
of the Nation's banks, but improved confidence in the ones that 
remained. \22\ As I discussed before, Roosevelt temporarily suspended 
the gold standard, before going back on gold at a lower value for the 
dollar, paving the way for increases in the money supply. In June 1933, 
Congress passed legislation helping homeowners through the Home Owners 
Loan Corporation. \23\ The actual rehabilitation of financial 
institutions, obviously took much longer. Indeed, much of the hard work 
of recapitalizing banks and dealing with distressed homeowners and 
farmers was spread out over 1934 and 1935.
---------------------------------------------------------------------------
     \22\ See Friedman and Schwartz, A Monetary History of the United 
States, pp. 328, 421-428, for more information on the 1933 Bank 
Holiday.
     \23\ For a good description of the various financial stabilization 
measures Roosevelt took, see Lester V. Chandler, America's Greatest 
Depression, 1929-1941 (New York: Harper & Row, 1970), Chapter 9.
---------------------------------------------------------------------------
    Nevertheless, the immediate actions to stabilize the financial 
system had dramatic short-run effects on financial markets. Real stock 
prices rose over 40 percent from March to May 1933, commodity prices 
soared, and interest-rate spreads shrank. \24\ And, the actions surely 
contributed to the economy's rapid growth after 1933, as wealth rose, 
confidence improved, and bank failures and home foreclosures declined.
---------------------------------------------------------------------------
     \24\ Stock price data are from Robert Shiller, http://
www.econ.yale.edu/shiller/data.htm. Temin and Wigmore, ``The End of One 
Big Deflation,'' describe the behavior of commodity prices and 
interest-rate spreads in 1933.
---------------------------------------------------------------------------
    But, it was only after the real recovery was well established that 
the financial recovery took firm hold. Real stock prices in March 1935 
were more than 10 percent lower than in May 1933; bank lending 
continued falling until mid-1935; and real house prices rose only 7 
percent from 1933 to 1935. \25\ The strengthening real economy improved 
the health of the financial system. Bank profits moved from large and 
negative in 1933 to large and positive in 1935, and remained high 
through the end of the Depression, with the result that bank 
suspensions were minimal after 1933. Real stock prices rose robustly. 
Business failures and home foreclosures fell sharply and almost without 
interruption after 1932. \26\ And, this virtuous cycle continued as the 
financial recovery led to further narrowing of interest-rate spreads 
and increased willingness of banks to lend. \27\
---------------------------------------------------------------------------
     \25\ The data on bank lending are from Banking and Monetary 
Statistics (Washington, DC: Board of Governors of the Federal reserve 
System, 1943), Table 2; the data on house prices are from Robert 
Shiller, http://www.econ.yale.edu/shiller/data.htm.
     \26\ The data on bank suspensions and profits are from Banking and 
Monetary Statistics (Section 7 and Table 56, Column 5, respectively). 
The data on business failures are from Historical Statistics of the 
United States: Colonial Times to 1970, Part 2, p. 912, series V27. The 
data on home foreclosures are from Historical Statistics of the United 
States: Colonial Times to 1970, Part 2, p. 651, series N301.
     \27\ Data on U.S. and corporate bond yields are available in 
Banking and Monetary Statistics, Table 128.
---------------------------------------------------------------------------
    This lesson is another one that has been prominent in the minds of 
policymakers today. The Administration has from the beginning sought to 
create a comprehensive financial sector recovery program. The Financial 
Stabilization Plan was announced on February 10, 2009, and has been 
steadily put into operation since then. It includes a program to help 
stabilize house prices and save responsible homeowners from 
foreclosure; a partnership with the Federal Reserve to help restart the 
secondary credit market; a program to directly increase lending to 
small businesses; the capital assistance program to review the balance 
sheets of the largest banks and ensure that they are adequately 
capitalized; and the program we announced just last week to partner 
with the FDIC, the Federal Reserve, and private investors to help move 
legacy or ``toxic'' assets off banks' balance sheets. This sweeping 
financial rescue program is central to putting the financial system 
back to work for American industry and households and should provide 
the lending and stability needed for economic growth. At the same time, 
the fiscal stimulus package enacted on February 17th was designed to 
create jobs quickly. In doing so, it should lower defaults and improve 
balance sheets so that our financial system can continue to strengthen.
    The fifth lesson from the 1930s is that worldwide expansionary 
policy shares the burdens and the benefits of recovery. Research by 
Barry Eichengreen and Jeffrey Sachs shows that going off the gold 
standard and increasing the domestic money supply was a key factor in 
generating recovery and growth across a wide range of countries in the 
1930s. \28\ Importantly, these actions worked to lower world interest 
rates and benefit other countries, rather than to just shift expansion 
from one country to another.
---------------------------------------------------------------------------
     \28\ Barry Eichengreen and Jeffrey Sachs, ``Exchange Rates and 
Economic Recovery in the 1930s,'' Journal of Economic History 45 
(December 1985): 925-946.
---------------------------------------------------------------------------
    The implications for today are obvious. The more that countries 
throughout the world can move toward monetary and fiscal expansion, the 
better off we all will be. In this regard, aggressive fiscal actions in 
China and other countries, and the recent reductions in interest rates 
in Europe and the U.K. are welcome news. They are paving the way for a 
worldwide end to this worldwide recession.
    A sixth lesson from the Great Depression is that it is important 
not only to deal with the immediate economic crisis, but to put in 
place reforms that help prevent future crises. Bank runs were clearly 
one of the key factors in the horrific downturn of the 1930s. The 
United States suffered four waves of banking panics between the fall of 
1930 and the spring of 1933. \29\ In June 1933, President Roosevelt 
worked with Congress to establish the Federal Deposit Insurance 
Corporation (FDIC). This act, together with subsequent legislation, 
established the insurance of bank deposits that we still depend on 
today.
---------------------------------------------------------------------------
     \29\ See Friedman and Schwartz, A Monetary History of the United 
States, Chapter 7, for a description of the four waves of panics.
---------------------------------------------------------------------------
    The FDIC has been one of the most enduring legacies of the Great 
Depression. Financial panics largely disappeared in the 1930s and have 
never truly reappeared. The academic literature suggests that deposit 
insurance has played a crucial role in this welcome development. \30\ 
One simple but powerful piece of evidence of the importance of Federal 
deposit insurance is that among the very few runs we have seen since 
the Depression were ones on non-federally insured savings and loans in 
Ohio and Maryland in the 1985. \31\ And, a striking feature of the 
current crisis has been the continued faith of the American people in 
the safety of their bank deposits. Though near-runs occurred on some 
financial institutions this past fall and winter, for the most part 
Americans have remained confident that their bank deposits are secure. 
In this way, the reforms instituted in response to the Great Depression 
almost surely helped prevent the current crisis from reaching Great 
Depression proportions.
---------------------------------------------------------------------------
     \30\ See, for example, Douglas W. Diamond and Philip H. Dybvig, 
``Bank Runs, Deposit Insurance, and Liquidity,'' Journal of Political 
Economy 91 (June 1983): 401-419.
     \31\ See http://www.fdic.gov/bank/historical/s&l/.
---------------------------------------------------------------------------
    The importance of putting in place more fundamental reforms is 
another lesson of the New Deal that the Administration is following. 
The current crisis has revealed weaknesses in the regulatory framework. 
Most obviously, we have discovered that financial institutions have 
evolved in ways that left systemically important institutions 
inadequately capitalized and monitored. We have also found that the 
government lacks the tools necessary to resolve complex financial 
institutions that become insolvent in a way that protects both the 
financial system and American taxpayers. We look forward to working 
with Congress to remedy these and other regulatory shortfalls. By doing 
so, we can make the U.S. economy more stable and secure for the next 
generation.
    The final lesson that I want to draw from the 1930s is perhaps the 
most crucial. A key feature of the Great Depression is that it did 
eventually end. Despite the devastating loss of wealth, chaos in our 
financial markets, and a loss of confidence so great that it nearly 
destroyed Americans' fundamental faith in capitalism, the economy came 
back. Indeed, the growth between 1933 and 1937 was the highest we have 
ever experienced outside of wartime. Had the U.S. not had the terrible 
policy-induced setback in 1937, we, like most other countries in the 
world, would probably have been fully recovered before the outbreak of 
World War II.
    This fact should give Americans hope. We are starting from a 
position far stronger than our parents and grandparents were in during 
1933. And, the policy response has been fast, bold, and well-conceived. 
If we continue to heed the lessons of the Great Depression, there is 
every reason to believe that we will weather this trial and come 
through to the other side even stronger than before.
                                 ______
                                 

                 PREPARED STATEMENT OF ALLAN M. WINKLER
                         Professor of History,
                     Miami University, Oxford, Ohio
                             March 31, 2009

    The New Deal was a response to the worst economic crisis in 
American history. As the United States suffered from the ravages of the 
Great Depression, the administration of Franklin D. Roosevelt, which 
took office in March 1933, tried a host of different, often 
contradictory measures in an aggressive effort to provide relief for 
the unemployed, to prompt the recovery of the faltering economic 
system, and to propose the kind of structural reform that could protect 
people in future crises. But the New Deal was never a coherent, 
interconnected effort to deal with the various dimensions of the 
Depression in a systematic way. Rather it was a multi-faceted attempt 
to deal with different elements of the catastrophe in ways that 
sometimes seemed haphazard and occasionally were contradictory. On 
balance, though, the New Deal enjoyed some notable accomplishments, 
even if it failed to promote full-scale economic recovery.
    The Great Depression was an economic disaster. While the stock 
market crash of 1929 need not have precipitated a depression, 
structural weaknesses in the economy, unbridled speculation in 
financial markets, and lack of regulation on Wall Street led to an 
unprecedented economic calamity that soon affected the entire world 
economy. In the United States, unemployment was the chief symptom of 
the depression, and by the time FDR took office there were 
approximately 13 million people unemployed--fully one quarter of the 
working population--with another quarter underemployed. In some cities, 
unemployment reached 75 percent.
    The response of President Herbert Hoover did little to alleviate 
distress. Though he took a more activist role that many of his 
predecessors, his own commitment to individualism and belief that 
government should not play an aggressive role in an economic bailout 
impeded action, and the few measures he did take had little impact. 
Even the Reconstruction Finance Corporation, established as a result of 
Democratic pressure, proved unable to reduce unemployment in the Hoover 
years.
    Franklin D. Roosevelt, elected in 1932, had no clear sense of what 
he might do when he assumed office. Some people viewed him as something 
of a lightweight. Journalist Walter Lippmann called him an ``amiable 
boy scout,'' and on another occasion said, ``He is a pleasant man who, 
without any important qualifications for the office, would like very 
much to be president. But Roosevelt's experience as Governor of New 
York for two terms taught him how he might respond to the economic 
crisis.
    FDR struck just the right note in his inaugural address. At a time 
when bank failures across the country swept away the savings of 
millions of small investors, he promised ``action, and action now,'' 
and he boosted spirits with his stunning assertion that ``the only 
thing we have to fear is fear itself.'' It was clear evidence of a 
sense of self-confidence and self-assurance that played a powerful part 
in helping Americans feel better in the midst of hard times. Just as 
the presidency had been a ``bully pulpit'' for Theodore Roosevelt, it 
was ``preeminently a place of moral leadership'' for FDR.
    Then he embarked on what came to be called the First Hundred Days. 
There was no blueprint. Roosevelt needed to do something about the 
banks, and so, working with officials left over from the Hoover 
administration, he proposed a bank holiday. The Emergency Banking Act 
authorized the Federal Reserve Board to issue new bank notes, allowed 
the reopening of banks that had adequate assets, and arranged for the 
reorganization of those that did not.
    With that somewhat surprising success, he pushed ahead with a 
measure to cut the budget, for the conventional wisdom held that a 
balanced budget was necessary for economic health, and then a bill to 
legalize 3.2 beer, to help make people happy as Prohibition came to an 
end. By the time the First Hundred Days came to an end, he had made 10 
major speeches, sent 15 messages to Congress, and helped push through 
the passage of 15 major pieces of legislation. It was, in short, the 
most extraordinary period of legislative activity in American history. 
And it set the tone and template for the rest of the New Deal.
    Overall, what did the New Deal do?
    First, it addressed the unemployed. A Federal Emergency Relief 
Administration provided direct assistance to the states, to pass it on 
to those out of work. The next winter, a work-relief program provided 
jobs in the brief period it existed. Then, in 1935, FDR created the 
Works Progress Administration, which paid all kinds of people, 
including artists, actors, and authors, to work and built new schools, 
bridges, and other structures around the country. It was expensive, to 
be sure, but it made a huge economic and emotional difference to the 
people it assisted.
    Second, the New Deal sought to do something to promote recovery. 
The National Recovery Administration attempted to check unbridled 
competition which was driving prices down and contributing to a 
deflationary spiral. It tried to stabilize wages, prices, and working 
hours through detailed codes of fair competition. Meanwhile, the 
Agricultural Adjustment Administration sought to stabilize prices in 
the farm sector by paying farmers to produce less.
    Finally, over the course of the New Deal, the administration 
addressed questions of structural reform. The Wagner Act, which created 
the National Labor Relations Board in 1935, was a monumental step 
forward in giving workers the right to bargain collectively and to 
arrange for fair and open elections to determine a bargain agent, if 
laborers so chose. The Social Security Act the same year was in many 
ways one of the most important New Deal measures, in providing security 
for those reaching old age with a self-supporting plan for retirement 
pensions. But there were other reform measures as well. The Securities 
and Exchange Commission and Federal Deposit Insurance Corporation were 
new. And the Glass-Steagall Act, only recently repealed with frightful 
consequences, separated commercial and investment banking.
    The New Deal was responsible for some powerful and important 
accomplishments. It put people back to work. It saved capitalism. It 
restored faith in the American economic system, while at the same time 
it revived a sense of hope in the American people. But economically, it 
was less successful. Monetary policy, as Christina Romer has suggested, 
made the most difference. Fiscal policy didn't really work because it 
wasn't really tried.
    Why, then did the New Deal fail to achieve economic recovery? The 
answer rests with the theoretical speculations of English economist 
John Maynard Keynes. In 1936, he published his powerfully important 
book The General Theory of Employment, Interest and Money, but he had 
been lecturing about the concepts for several years to his Cambridge 
University students. Basically, Keynes argued that depressions would 
not disappear of their own accord. It was rather necessary to take 
aggressive action to jump start the economy. Ideally, such action 
should come from the private sector. But if such a response was not 
forthcoming, the government could act instead. It could spend massive 
amounts of money on public works or other projects, or cut taxes, or 
both. What was necessary, in Keynes's phrase, was deliberate, sustained 
countercyclical spending.
    Keynes came to the United States and had one ill-fated meeting with 
FDR. Neither man understood the other. Keynes remarked that he had 
``supposed that the President was more literate, economically 
speaking.'' FDR simply commented that Keynes ``left a whole rigamarole 
of figures. He must be a mathematician rather than a political 
economist.'' And that was that.
    Furthermore, the New Deal often worked in counterproductive ways, 
at least economically. Whereas Keynes demanded what we would today call 
a major stimulus package, and while the New Deal did spend more than 
ever before, it also embarked on contradictory initiatives. For 
example, the Agricultural Adjustment Administration spent large amounts 
of money to take land out of circulation, to cut down on production and 
thereby raise prices. But it diminished the effect of that spending by 
paying for it with a sizeable processing tax. Likewise, Social 
Security, which aimed to plow a huge amount of money into pensions, was 
not slated to make payments until 1942, but began taking money out of 
circulation through a withholding tax long before then.
    The New Deal also alienated businessmen, something Keynes counseled 
against. ``Businessmen have a different sense of delusions from 
politicians,'' he once said. ``You could do anything you liked with 
them, if you would treat them (even the big ones) not as wolves and 
tigers but as domestic animals by nature, even though they have been 
badly brought up and not trained as you would wish.'' The NRA alienated 
business, and never did encourage private expansion or investment. It 
may have halted the deflationary spiral, but it failed to create new 
jobs. And it contributed to a measure of ill will. As Roosevelt got 
frustrated, his rhetoric marginalized business interests. Speaking of 
business interests in the reelection campaign of 1936, he proclaimed, 
``They are unanimous in their hate for me--and I welcome their 
hatred.'' That may have helped politically, but it hurt economically.
    Fiscal policy, in short, along the lines Keynes counseled, did not 
work because it was never really tried. The unemployment rate never 
dropped below 14 percent, and for the entire decade of the 1930s, it 
averaged 17 percent.
    Slowly, however, the New Deal learned fiscal lessons In 1937, 
assuming that the economy was improving and could manage without 
assistance, Roosevelt slashed half of all WPA jobs and cut the 
allocation to less than a third of what it had been. At the same time, 
workers were just beginning to contribute to Social Security, though 
payout were still in the future. Industrial production fell 
precipitously. The stock market plunged. Unemployment soared back to 19 
percent. A quick restoration of spending brought matters under control.
    But spending for World War II really vindicated Keynes and his 
theories. With the onset of the war, even before American entrance, 
defense spending quadrupled, and unemployment vanished virtually 
overnight. The lesson was clear. There was no need to suffer the 
ravages of depression any longer. We now had the tools to help the 
economy revive.
    Some parts of the New Deal worked; some did not. The New Deal 
restored a sense of security as it put people back to work. It created 
the framework for a regulatory state that could protect the interests 
of all Americans, rich and poor, and thereby help the business system 
work in more productive ways. It rebuilt the infrastructure of the 
United States, providing a network of schools, hospitals, and roads 
that served us well for the next 70 years.
    Did the New Deal, as has sometimes been charged, exacerbate and 
extend the Great Depression? Hardly. The regulatory state provided 
protections that benefited all Americans. The administration could have 
treated business interests better, but they were often responsible 
themselves for the antagonism that persisted throughout the 1930s. 
Fiscal policy would certainly have worked better had it been better 
understood. The fact that we were slow to embrace Keynesian theory is 
one of the disappointments of the decade.
    Today, the lessons are clear. Government can make a difference. A 
major stimulus is essential and can promote recovery. We need to ensure 
that measures do not work in contradictory ways against the stimulus. 
We can do something about unemployment. It is as important today as it 
was in the 1930s to bolster security, as we turn our attention to 
health care reform just as the New Deal crafted a program, pathbreaking 
for us, for retirement assistance. The New Deal made a profound 
difference in people's lives and in the lives of our Nation. Now it 
behooves us to learn from the lessons of the 1930s and take the actions 
necessary to promote a return to prosperity.
                                 ______
                                 

                PREPARED STATEMENT OF JAMES K. GALBRAITH
     Lloyd M. Bentsen, Jr., Chair in Business/Government Relations,
              Lyndon B. Johnson School of Public Affairs,
                   University of Texas at Austin, and
                Senior Scholar, Levy Economics Institute
                             March 31, 2009

    Chairman Brown, Ranking Member DeMint, and Members of the 
Subcommittee, it is a privilege to appear today to discuss the New Deal 
and its relevance to our present troubles.
    In my view three main principles for economic policy emerged from 
the Great Depression, the New Deal, and ultimately from World War II. 
The first is that unregulated capitalism is not necessarily self-
correcting; mass unemployment can occur and persist. The second is that 
direct economic intervention works best when it is targeted directly to 
the broad population--not filtered through those at the top--and when 
it is implemented on a sufficiently large scale. Third, the fiscal 
cutbacks which produced the recession of 1937-38 showed that 
backtracking is disastrous. Once embarked on a policy of expansion and 
economic growth, it is essential to see it through to the end.
    In what follows, I shall emphasize four points:

    Like our present troubles, the Great Depression flowed from 
        a collapse of the banking system and of asset values--the Great 
        Crash. This eliminated the possibility that recovery could be 
        led by a revival of the financial system.

    Much of the New Deal involved the creation of comprehensive 
        social insurance and the construction of institutions for 
        collective action, including trade unions.

    The employment effects of New Deal policies have been 
        under-rated and misstated in much recent work, in part because 
        of a widespread misreading of the statistics.

    The early New Deal's employment policies were not conceived 
        as ``fiscal stimulus'' but rather as programs to create jobs 
        and for public investment. The investment programs were 
        strongly oriented toward the long-term benefits of education, 
        transportation, art and culture, and conservation. These 
        programs had important macroeconomic effects but they also 
        rebuilt the country.

    1. The New Deal emerged from the Great Depression, and the 
Roosevelt administration understood very well that the Depression 
originated in the Great Crash of 1929 and in the collapse of the 
banking system in 1930. At the heart of the problem, as the Pecora 
investigations revealed, lay a culture of corruption, speculation, and 
self-dealing on Wall Street, and a well-justified loss of confidence by 
the public in the captains of finance.
    Virtually every bank in America was shut when Roosevelt took 
office. His first act, the bank holiday, permitted them to be inspected 
and reopened; the public understood that those that reopened could be 
relied on. Other early actions were to institute federal deposit 
insurance so as to put an end to panics and runs, the passage of the 
Glass-Steagall Act separating commercial from investment banking, and 
the creation of the Securities and Exchange Commission, and the end of 
the gold standard. Taken together, these measures amounted to a 
comprehensive assertion of state power over finance. This power was 
reinforced in 1944 by the creation of the Bretton Woods system of 
fixed-but-adjustable exchange rates along with capital controls, and 
was largely maintained until that system was abandoned by Richard Nixon 
in 1971. The principal result was that economic growth was 
comparatively strong, stable and free of financial crises for a 
generation following the war, and with stable growth came a slow but 
steady decline in the inequality of income and wealth.
    The early New Deal marked a fundamental break with the previous 
role of the banks. In the Hoover administration and also in England in 
the early 1930s, a reflexive concern of financial policy was to 
reassure the markets--hence the phrase ``prosperity is just around the 
corner''--and to support the major banks by staying on the gold 
standard. This was the natural viewpoint of men who had spent their 
lives at the center of the New York and London financial worlds. But 
banks did not resume lending, in the depths of the depression, simply 
because they had gold in their vaults. There was no one to lend to, 
nothing to lend against. A first lesson of the Depression is that 
stuffing the banks with money does not solve a credit freeze.
    The New Deal dealt with this problem bypassing the banks, or in 
some cases running them directly, through the Reconstruction Finance 
Corporation. Roosevelt also created new institutions, new public 
agencies to provide jobs and stabilize prices, wages and purchasing 
power. Thus the initial and indeed the later phases of the New Deal had 
three especially important elements beyond the regulation of finance: 
the introduction of comprehensive social insurance, the use of public 
spending to create jobs, and vast programs of conservation and public 
investment, effectively rebuilding the entire country from one end to 
the other.
    2. Social insurance addressed a fundamental problem of capitalism: 
unregulated private markets are unstable. They cannot be relied on to 
provide an adequate minimum living standard for the working population. 
They cannot be relied on to provide a secure repository for savings. 
They cannot be relied upon to provide decent incomes in retirement. The 
problem of the Depression was perhaps above all a problem of 
insecurity, or as Roosevelt put it, of ``fear itself.'' For most 
Americans, what was ``just around the corner'' was not prosperity but 
destitution.
    Social innovation under the New Deal was motivated by a desire to 
deal with this fact. Deposit insurance, Social Security, farm price 
supports, the National Industrial Recovery Act, the minimum wage and 
the National Labor Relations Act were all, in different ways, aimed at 
establishing stability and decent minima. Some of this horrified the 
economists of that day and ours, particularly where the push for 
stability contradicted their deep philosophical and even emotional 
commitment to competition and antitrust. The NIRA was ruled 
unconstitutional by the Supreme Court. And some economists have ever 
since labored mightily to demonstrate that unions and minimum wages 
increased unemployment, that farm price supports were wasteful and 
inefficient, that Social Security discouraged savings. New Dealers 
would counter, very simply, that the proven alternatives to these 
things were poverty, migration and early death.
    3. When Roosevelt took office in March, 1933 the macroeconomic 
tools and understanding we have today did not fully exist. \1\ Mass 
unemployment had not been persuasively explained by the economics 
profession, and was variously blamed in academic circles on trade 
unions, on technological change, and on ``events beyond our control.'' 
Then as now, a large body of academic opinion sought the remedy in 
lower wages. Then as now, a fair number of economists understood and 
favored the use of public works projects to keep people from starving 
or revolution. But the idea that public works could be run on a scale 
sufficient to end the Depression was not yet fully worked out. Nor did 
the country have the national income statistics or the unemployment 
statistics we presently use to analyze these problems: from a 
macroeconometric perspective, the government was flying blind.
---------------------------------------------------------------------------
     \1\ Simon Kuznets published the first national income statistics 
in 1934.
---------------------------------------------------------------------------
    The New Deal's approach to employment policy was direct and open-
ended. Under Harry Hopkins, jobs were created, as quickly as possible, 
to help millions get through the year. The budget was, essentially, an 
afterthought. There was no particular emphasis on achieving a high 
economic growth rate, for the concept of economic growth (as we know 
it) did not yet exist. Nevertheless, the public spending initiatives of 
the New Deal did have powerful macroeconomic effects. Industrial 
production doubled between December 1932 and December, 1936. This is 
worth mentioning because it is sometimes denied: for example, in her 
recent book, The Forgotten Man, the journalist Amity Shlaes writes that 
industrial production did not rise in the United States after 1932. In 
point of fact, it rose very rapidly.
    The New Deal's effects on unemployment are behind a widely stated 
belief that ``only the war ended the Depression.'' But as the economist 
Marshall Auerback has pointed out in a recent paper, widely used 
unemployment figures (constructed after the fact) treat the 3.5 million 
workers who at the peak were employed by New Deal agencies as though 
they were unemployed. The original rationale for this was essentially 
ideological, insofar as recovery was defined as recovery of the private 
sector. But in practical terms the distinction is absurd. It supposes 
that someone building a private house on a temporary construction 
project in 1928 is employed, but that the same worker working on the 
Lincoln Tunnel in 1935 is not.
    I take the liberty here of quoting from Auerback at length:

        Even pro-Roosevelt historians such as William Leuchtenburg and 
        Doris Kearns Goodwin have meekly accepted that the millions of 
        people in the New Deal workfare programs were unemployed, while 
        comparable millions of Germans and Japanese, and eventually 
        French and British, who were dragooned into the armed forces 
        and defense production industries in the mid- and late 1930s, 
        were considered to be employed.

        This made the Roosevelt administration's economic performance 
        appear uncompetitive, but it is fairer to argue that the people 
        employed in government public works and conservation programs 
        were just as authentically (and much more usefully) employed as 
        draftees in what became garrison states, while Roosevelt was 
        rebuilding America at a historic bargain cost.

        If these workfare Americans are considered to be unemployed, 
        the Roosevelt administration reduced unemployment from 25 per 
        cent in 1933 to 9 per cent in 1936, up to 13 per cent in 1938 
        (due largely to a reversal of the fiscal activism which had 
        characterized FDR's first term in office), back to less than 10 
        per cent at the end of 1940, to less than 1 per cent a year 
        later when the U.S. was plunged into the Second World War at 
        the end of 1941. The reasons for the discrepancies in the 
        unemployment data that have historically arisen out of the New 
        Deal are that the current sampling method of estimation for 
        unemployment by the BLS was not developed until 1940, thus 
        unemployment rates prior to this time have to be estimated and 
        this leads to some judgment calls. The primary judgment call is 
        what do about people on work relief. The official series counts 
        these people as unemployed. . . . A lot of people looked at 
        these numbers without reading the notes . . . and concluded 
        just that.

        Then in 1976, an economist named Michael R. Darby wrote an 
        article with the delightfully self-explanatory title, ``Three-
        and-a-Half Million U.S. Employees Have Been Mislaid.'' What 
        Darby did was read the notes. Here is what Lebergott had to say 
        about counting unemployment in the 1930s:

        ``These estimates for the years prior to 1940 are intended to 
        measure the number of persons who are totally unemployed, 
        having no work at all. For the 1930's this concept, however, 
        does include one large group of persons who had both work and 
        income from work-those on emergency work. . . . This contrasts 
        sharply, for example, with the German practice during the 
        1930's when persons in the labor-force camps were classed as 
        employed, and Soviet practice which includes employment in 
        labor camps, if it includes it at all, as employment.''

        We would normally not consider people who painted murals for 
        the WPA to be deemed worse off than those who ``worked'' in 
        Mauthausen or the Soviet gulag. And yet, until we adjust the 
        ``workfare'' discrepancy, incredibly we count such individuals 
        as unemployed, even though their position was considerably 
        better someone generating no income, or working in abysmal 
        conditions in a slave labor camp. \2\
---------------------------------------------------------------------------
     \2\ Marshall Auerback, ``Time for a New New Deal,'' mimeo, 2009.

    To give a sense of the actual reduction in unemployment under the 
New Deal, I borrow a chart from Auerback, showing the official series 
with (dashed line) and without (solid line) counting those working for 
New Deal programs as employed. The chart illustrates that New Deal 
policies in fact brought unemployment down from 25 to below 10 percent 
before the policy reversal and recession of 1937, and again by 1940--
still before the war.



    The New Deal validated the ideas of the economist Richard Kahn, a 
close associate of Keynes, who had worked out the ``employment 
multiplier'' in the early 1930s; the idea that an increase of 
governmental expenditure on public improvements would create jobs both 
directly and indirectly: directly in the public service and indirectly 
in the private sector. In 1936, Keynes's General Theory translated this 
insight from employment to output, giving us the now-familiar concept 
of the multiplier effect of increased government spending on national 
income. And then, of course, the vast scale of new spending during the 
war not only eliminated unemployment but stopped the discussion: the 
case that public spending could cure unemployment had, for that 
generation, been proved.
    By the same token, domestic monetary policy in this period played a 
very minor role, to the point where economists of that generation 
tended to feel that the Federal Reserve was a backwater. I do not buy 
for a single minute the currently fashionable view that ``quantitative 
easing'' was primarily responsible for the economic expansion that 
occurred after 1933, unless one counts federal loan guarantees and 
direct lending as monetary policy. \3\ If somehow the 1930s were a new 
golden age of private bank lending (at zero interest rates!) and of new 
business fixed investment, that fact completely escaped contemporary 
notice. Indeed the phrase ``pushing on a string'' was invented to 
describe the impotence of monetary policy at that time.
---------------------------------------------------------------------------
     \3\ The work of Professor Thomas Ferguson on the early New Deal 
covers these issues well, especially ``Monetary policy, loan 
liquidation and industrial conflict: The Federal Reserve and open 
market operations of 1932'' Journal of Economic History, 1984 and 
``From Normalcy to New Deal'', International Organization 1984.
---------------------------------------------------------------------------
    Finally, my difference with Professor DeLong on the role of fiscal 
policy is that it is by ex ante public spending, not ex post deficits, 
that one must measure the strength of fiscal expansion. Public 
expenditures rose 55 percent between 1932 and 1934; as a share of 
(collapsing) GDP they rose from 10.2 percent in 1932 to 17.4 percent in 
1934. I have also never understood how the gold inflow in advance of 
WWII was supposed to have been a stimulus, insofar as gold at that time 
had been stripped of its monetary role. What stimulated the economy in 
1939-1940, of course, was still more public spending, now motivated for 
the first time by Keynesian ideas, and export orders.
    4. A fourth great area of New Deal achievement lay in the physical, 
moral and artistic reconstruction of the Nation. In 1932 the country 
was underdeveloped--to take one example, in 1930 my father drove a 
Model T Ford from his home in Ontario to Berkeley California, and noted 
that from Lincoln, Nebraska to the California line the roads were 
unpaved. Auerback has an elegant description of what happened during 
the following decade:

        The government hired about 60 percent of the unemployed in 
        public works and conservation projects that planted a billion 
        trees, saved the whooping crane, modernized rural America, and 
        built such diverse projects as the Cathedral of Learning in 
        Pittsburgh, the Montana State capitol, much of the Chicago 
        lakefront, New York's Lincoln Tunnel and Triborough Bridge 
        complex, the Tennessee Valley Authority and the aircraft 
        carriers Enterprise and Yorktown. It also built or renovated 
        2,500 hospitals, 45,000 schools, 13,000 parks and playgrounds, 
        7,800 bridges, 700,000 miles of roads, and a thousand 
        airfields. And it employed 50,000 teachers, rebuilt the 
        country's entire rural school system, and hired 3,000 writers, 
        musicians, sculptors and painters, including Willem de Kooning 
        and Jackson Pollock. \4\
---------------------------------------------------------------------------
     \4\ Auerback, op. cit.

    These accomplishments had important Keynesian effects, but they 
were not incidental to a short-term Keynesian expansion policy, and 
would not have been possible if they were. Major construction projects 
require advance planning and they take time to complete. But FDR did 
not limit himself to the ``shovel ready'' projects on the ground that 
the economy needed only a ``stimulus'' in order to ``get credit flowing 
again'' and to return to the happy days of the 1920s. He had no 
interest in ever returning to those days. The money-changers had fled 
the temple, and he was not about to let them come back. The New Deal 
built for the ages, as shown by the fact that its greatest 
achievements--from the TVA to Social Security--are still in use.
    It is true that there was tension with Roosevelt's team between 
Hopkins, head of short term employment at the WPA, and Harold Ickes, 
head of the major investment projects of the PWA. My father liked to 
tell of a morning when FDR met both men in sequence, heard Hopkins' 
case for immediate jobs programs and then Ickes' for worthwhile capital 
projects. He told each man, ``You're exactly right!'' After the 
meetings, Mrs. Roosevelt remonstrated with her husband: hadn't he 
contradicted himself by supporting these two precisely opposed 
opinions? The President's response was, ``Eleanor, you're exactly 
right.''
    5. Let me round out this brief overview by noting something the New 
Deal did not achieve: it never resurrected the commercial banking 
system. The New Deal renegotiated short-term mortgages that could not 
be refinanced, creating the 30-year, fixed-rate mortgage that was the 
staple of housing finance for the next half-century. It fostered 
savings-and-loans through strict regulation of interest rates, and 
began the secondary markets for prime mortgages. It ran many failed or 
otherwise-failed banks. The Reconstruction Finance Corporation provided 
a lending lifeline to private businesses. But private commercial bank 
lending remained a minor feature of the recovery picture. By and large, 
the collapse of asset values meant that very few people or businesses 
could qualify for private commercial bank loans, and the flight to cash 
insured that despite low interest rates very few would have wanted them 
anyway.
    What eventually began the resurrection of private banking was the 
creation of net financial wealth during World War II. In this period, 
national income doubled, while output available for civilian use was 
held roughly constant. Thus working families had roughly twice the 
income they could spend, and rigorous price controls prevented 
inflation that would have absorbed the nominal incomes. Americans were 
therefore willing to lend their excess incomes back to the government 
to finance the war effort, and the resulting war bonds, amounting to 
125 percent of GDP by the war's end, formed the foundation of the 
financial position of the post-war middle class. It was only then (and 
following the further contributions to private wealth of the Korean War 
in 1950), that the American public became once more a profitable 
clientele for private banks. And it was not until considerably later 
yet, that the public began to rediscover the stock market.
    My final argument is therefore that a banking calamity of the type 
experienced in the 1930 and, I would argue, repeated for the first time 
beginning in August, 2007, has very long-term effects on the resilience 
of the banking system no matter what steps the government may take to 
restore output, employment and total capital formation, and no matter 
how effective those steps are. There is no easy or swift way back to 
rapid credit expansion. And the path is slower and more difficult, if 
policy energies are devoted to futile attempts to revive a Paradise 
Lost, an economy led and directed by private commercial banking 
interests. Even if it were desirable, it probably cannot be done.
    6. As part of an exercise yesterday at the Council on Foreign 
Relations, I reviewed some of the recent academic literature which 
alleges that the New Deal prolonged or even deepened the Great 
Depression. The central logic of this argument is the following. In 
normal times, it is alleged, without government interference, falling 
real wages rapidly restore the conditions for full employment. Since 
this did not happen in the 1930s, the argument goes, wages must not 
have fallen enough. If one asks why not, the answer is close at hand: 
the New Deal's efforts to raise prices and wages, to promote unions, 
and to impose a minimum wage were all counterproductive from the 
standpoint of maintaining employment. The New Deal is then faulted for 
the failure of total output to return to the trend line of the 1920s 
until after the start of the Second World War.
    In the opening chapters of The General Theory, Keynes specifically 
showed that the cuts in money-wages then (as now) being demanded of 
workers would not produce the cuts in real wages that were required by 
theory, since prices would also fall. Correspondingly, raising both 
prices and wages does not raise real wages as the argument claims.
    But the argument has other flaws as well. First, it ignores the 
depth of the Great Depression, and begs the question of how and why 
unemployment rose to 25 percent by the end of 1932--before Roosevelt 
took office and therefore before any of the alleged mistakes of the 
early New Deal had been made. Second, it ignores the extremely rapid 
recovery of 1933-36, or rather simply demands to know why that recovery 
wasn't more rapid still, asserting in effect that it would have been 
still more rapid if nothing by way of policy had been done. This 
assertion is simply an act of faith. Third, it assumes that the 
speculative bubble of the late 1920s was not unsustainable, and that in 
principle growth of the same type could have continued for another 
decade (or even indefinitely). This is tantamount to asserting that the 
Great Crash had no roots in the unsafe banking practices of that 
earlier time, and no implications for the ensuing Depression.
    Suffice to say, I don't think so.
    Thank you very much again for your attention.
                                 ______
                                 

                  PREPARED STATEMENT OF LEE E. OHANIAN
                 Professor of Economics, and Director,
           Ettinger Family Program in Macroeconomic Research
                             March 31, 2009

    Chairman Brown, it is a pleasure to have the opportunity to speak 
with you about economic policy and lessons from the New Deal. The New 
Deal was a collection of policies adopted in response to the Great 
Depression that were designed to alleviate economic hardship and 
promote economic recovery. Today's economic crisis has prompted many 
comparisons to the Great Depression, and has led many to ask whether a 
``New'' New Deal is warranted. My research shows that some New Deal 
policies significantly delayed economic recovery by impeding the normal 
forces of supply and demand, and that the economy would have 
experienced a robust recovery in the absence of these policies.
    One implication of my research, and other recent research on 
protracted economic crises, is that short-run policies designed to 
moderate the effects of a crisis--crisis management policies--can 
prolong the crisis if those policies impede competitive market forces. 
Another implication is that the policymaking process can benefit from 
current research on economic crises. Much of the evidence that crisis 
management policies can prolong economic downturns is from research 
that utilizes recent developments in economic theory and methodologies. 
These new research developments can inform the policymaking process. 
These views are detailed below.
    The recovery from the Depression was indeed slow, and this has been 
recognized by a number of economists, including 1976 Nobel Laureate 
Milton Friedman (Friedman and Schwartz( 1963)), 1995 Nobel Laureate 
Robert Lucas, (Lucas and Rapping (1972)), and 2004 Nobel Laureate 
Edward Prescott (1999). My work with Harold Cole (2007) details this 
slow recovery. Total hours worked per adult, which is the standard 
measure of labor input used in macro-economics, was 27 percent below 
its 1929 level in 1933, and remained 21 percent below that level in 
1939. There was even less recovery in private hours worked per adult. 
Per-capita investment, which declined by nearly 80 percent relative to 
trend (2 percent annual growth), remained more than 50 percent below 
trend at the end of the 1930s. Per-capita consumption, which was about 
25 percent below trend in 1933, remained roughly at that level for the 
remainder of the 1930s. Figures 1 and 2 show these data on real output 
and its components, and hours worked. The Depression clearly continued 
throughout the 1930s.
    The failure to recover is puzzling, because economic fundamentals 
improved considerably after 1933. Productivity growth was rapid, 
liquidity was plentiful, deflation was eliminated, and the banking 
system was stabilized. With these fundamentals in place, the normal 
forces of supply, demand, and competition should have produced a robust 
recovery from the Depression. Figure 3 shows the recovery in 
productivity, real bank deposits, and the level of the GNP deflator, 
which stops falling after 1933, and rises modestly afterwards. Why 
wasn't the recovery stronger?
    My research shows that one policy that delayed recovery was the 
National Industrial Recovery Act (NIRA), which was the centerpiece of 
New Deal recovery policy. The NIRA prevented market forces from working 
by permitting industry to collude, including allowing firms within an 
industry to set minimum prices, restrict expansion of capacity, and 
adopt other collusive arrangements, provided that firms raised wages 
considerably. These policies worked. Following government approval of 
an industry's ``code of fair competition'', industry prices and wages 
rose significantly.
    Promoting collusion reduces employment and output, while setting 
the wage above its market-clearing level depresses employment by making 
labor expensive. Employers respond to high wages by reducing employment 
relative to the market-clearing level that is jointly determined by 
supply and demand. Figure 2 shows hours worked and the real 
manufacturing wage. The most striking feature of the graph is that the 
continuation of the Depression coincides with rising real wages. This 
fact stands in sharp contrast to standard economic reasoning, which 
indicates that normal competitive forces should have reduced industry 
wage levels and increased employment and output. This coincidence of 
high industry wages and low hours worked is one of the most telling 
signs that the market process was considerably distorted.
    While declared unconstitutional in 1935, the NIRA de facto 
continued, with virtually no antitrust activity despite substantial 
evidence of collusion documented by the Federal Trade Commission (Cole 
and Ohanian (2004)). Wages rose even higher following the Wagner Act in 
1935, which greatly increased union bargaining power in wage setting 
and which also facilitated unionization. The share of non-agricultural 
workers in unions rose from about 12 percent in 1934 to nearly 27 
percent in 1938 (Freeman (1998)). During the mid-1930s, the sit-down 
strike, in which workers occupied factories and prevent production, was 
used most notably against G.M. and the threat of a sit-down strike was 
successful against U.S. Steel. Wages jumped in many industries shortly 
after the NLRA was upheld by the Supreme Court in 1937, and our 
research shows that these higher wages played a significant role in the 
1937-38 economic contraction.
    By the late 1930s, these New Deal policies began to reverse. Anti-
trust activity was resumed, the Supreme Court ruled against the sit-
down strike, and the growing gap between wages and productivity began 
to narrow, particularly during the War, as the National War Labor Board 
ruled against wage increases that exceeded cost of living.
    After the war, The National Labor Relations Act was substantially 
weakened by the Taft-Hartley Act of 1947. Since then, industry wages 
have never risen so high above their normal levels.
    Despite the fact that several New Deal policies were useful, 
including those that established a basic social safety net, and those 
that stabilized the banking and financial system, Cole and I have found 
that Roosevelt's cartel-high wage policies prolonged the Depression by 
several years. In the absence of these policies, we estimate that the 
economy would have recovered back to trend quickly, with hours worked 
and investment rising well above their normal levels, rather than being 
significantly depressed.
    In addition to Friedman and Schwartz (1963), Lucas and Rapping 
(1972), and Prescott (1999), there is more research on the New Deal 
that draws similar conclusions to mine, including work by Chari, Kehoe, 
and McGrattan (2006), and Bordo, Erceg, and Evans (2000). There is also 
relevant research on the impact of nonmarket policies on recoveries 
from financial crises in other countries. This research also concludes 
that nonmarket policies deepen and prolong crises.
    Bergoeing, Kehoe, Kehoe, and Soto (2007) examined the recoveries in 
Chile and Mexico following financial crises in the early 1980s. Chile 
moved quickly to reorganize their banking system and also allowed 
inefficient banks and firms to fail. In contrast, Mexico tried to prop 
up their economy in the 1980s by maintaining incumbent banks, many of 
whom were inefficient, and by providing credit at below-market interest 
rates to large firms to keep them afloat. This impeded the necessary 
re-allocation of resources from inefficient to efficient producers.
    Chile chose to pay the price of economic reorganization and had a 
deeper downturn than Mexico during the initial stages of their 
respective crises. But since the early 1980s, Chile has grown 
substantially. In contrast, the Mexican economic crisis worsened over 
time, with per-capita real output falling until the mid-1990s, and 
growing little since then. Today, per-capita output in Chile relative 
to Mexico has doubled compared to their respective levels prior to the 
early 1980s (Fernandez de Cordoba and Kehoe (2009)).
    Japan's financial crisis of the early 1990s provides further 
evidence on the depressing effects of nonmarket policies that delay 
economic reform and prevent competition from working. Hayashi and 
Prescott (2007), and Caballero, Hoshi, and Kashyap (2005) studied the 
Japanese economy in the 1990s following their financial crisis. Both 
studies conclude that Japan's policies that kept otherwise insolvent 
banks operating, and that impeded the flow of capital to efficient 
firms, significantly prolonged the effect of Japan's crisis, resulting 
in a decade-long stagnation of the Japanese economy.
    There are two principal messages from the New Deal and these other 
economic crises for our current crisis. One is that crisis management 
policies designed to reduce the cost of a financial crisis can actually 
prolong the depressing effects of these crises by impeding the normal 
forces of supply, demand, and competition. Instead, policies should be 
consistent with the broader, long-term goals of raising the incentives 
for households to work and save, for firms to hire and invest, for the 
financial system to efficiently intermediate capital, and for promoting 
competition, in which successful businesses thrive, and inefficient 
businesses exit.
    There is relatively little debate among economists regarding the 
importance of these long-run guides for successful policy. Short-run 
policies that impede these economic forces can delay recovery and 
deepen crises, even if other aspects of the policy mix are well-
designed. This means good short-run policy is de facto good-long run 
policy.
    The second message is that policymaking can benefit considerably 
from current research on economic crises. Much of the evidence that 
short-run policies can prolong crises is from research that utilizes 
recent developments in economic theory and quantitative methods. 
Consequently, the profession's view about the costs and benefits of 
various types of polices has changed over time, including its views 
about fiscal policy, one of the key components in the response of 
policy to our current crisis.
    Many recent discussions about fiscal policy focus on measuring a 
``multiplier'', which aims to quantify how much output and employment 
will change from an increase in government spending. Much recent 
research no longer focuses on this idea, however, largely because there 
is no presumption from economic theory about how a change in government 
spending impacts employment and output. Instead, economy theory 
indicates that the impact depends critically on what the spending is 
on, and how it is financed (Baxter and King (1991)).
    In practice, research shows that observed differences in the types 
of spending and the mix of taxes, over time and across countries, have 
a big effect on economic outcomes. My research shows that the effects 
of large increases in government spending in the United States are very 
sensitive to tax policies (Ohanian (1997)). Specifically, the effect of 
government spending on output is smaller if the spending is ultimately 
financed with capital income taxes. Edward Prescott (2002) shows that 
much of the large decline in hours worked that occurred over the last 
40 years in several European countries can be accounted for by an 
expansion in government spending that substitutes closely for private 
consumption, coupled with a large increase in European tax rates. 
Prescott's work thus suggests that for these European countries, 
aggressive fiscal policy depressed their economies.
    Good economic policymaking is consistent with getting economic 
incentives right. This is perhaps the most important lesson from the 
New Deal and from other protracted economic crises.
References
Baxter, Marianne, and Robert King (1991), ``Fiscal Policy in General 
    Equilibrium'', American Economic Review
Bordo, Michael, Chris Erceg, and Charlie Evans (2000) ``Money, Sticky 
    Wages, and the Great Depression'', American Economic Review, 2000
Bergoeing, Raphael, Patrick Kehoe, Timothy Kehoe, and Raimundo Soto 
    (2007) ``A Decade Lost and Found: Mexico and Chile in the 1980s'', 
    in Timothy Kehoe and Edward C. Prescott, eds., Great Depressions of 
    the 20th Century, Federal Reserve Bank of Minneapolis
Caballero, Ricardo, Takeo Hoshi, and Anil Kashyap (2005) ``Zombie 
    Lending and Depressed Restructuring in Japan'', Annals of the 
    Inter-American Seminar on Economics, Rio de Janeiro
Cole, Harold, and Lee E. Ohanian (2004) ``New Deal Policies and the 
    Persistence of the Great Depression'', Journal of Political Economy
Cole, Harold, and Lee E. Ohanian (2007), ``A Second Look at the U.S. 
    Great Depression from a Neoclassical Perspective'', in Great 
    Depressions of the 20th Century, Timothy Kehoe and Edward Prescott, 
    eds.
Field, Alexander (2003) ``The Most Technologically Progressive Decade 
    of the Century'', American Economic Review
Fernandez de Cordoba, Gonzalo, and Timothy Kehoe (2009) ``The Current 
    Financial Crisis: What Should We Learn from Great Depressions of 
    the 20th Century'', Staff Report 421, Federal Reserve Bank of 
    Minneapolis
Friedman, Milton, and Anna Schwartz (1963) A Monetary History of the 
    United States, Princeton University Press: Princeton, NJ
Hayashi, Fumio, and Edward C. Prescott (2007) ``The 1990s in Japan: A 
    Lost Decade'', in Timothy Kehoe and Edward C. Prescott, editors, 
    Great Depressions of the 20th Century, Federal Reserve Bank of 
    Minneapolis
Lucas, Robert, and Leonard Rapping ``Unemployment in the Great 
    Depression: Is There a Full Explanation?'' Journal of Political 
    Economy, Jan. 1972
Ohanian, Lee E. (1997) ``The Macroeconomic Effects of War Finance: 
    World War II and the Korean War'', American Economic Review
Ohanian, Lee E. (2009), ``What--or Who--Started the Great 
    Depression?'', under review, Journal of Economic Theory
Mulligan, Casey (2008), ``A Depressing Scenario: When Mortgage Debt 
    Becomes Unemployment Insurance'', Discussion Paper, University of 
    Chicago
Prescott, Edward C. (1999),``Some Observations on the Great 
    Depression'', Quarterly Review, Federal Reserve Bank of Minneapolis
Prescott, Edward C. (2002), ``Prosperity and Depression'', Ely Lecture, 
    American Economic Review Papers and Proceedings
Appendix: Responses to Professor DeLong
    This addendum section responds to Professor DeLong's comments about 
my research, as presented in his March 31, 2009, testimony. [http://
banking.senate.gov/public/
index.cfm?FuseAction=Files.View&FileStore_id=06162 472-d0a4-486f-a25e-
a9a83db42eed]
    1. Professor DeLong states that Milton Friedman blamed the 1937-38 
recession in a recession on higher reserve requirements, not on New 
Deal-unionization policies.

    Friedman and Schwartz (1963) stated that New Deal policies 
        that raised wages and prices delayed recovery. Friedman 
        restated this view at his 90th birthday party conference at the 
        University of Chicago in 2002, when he commented on my research 
        about the New Deal prolonging the Depression.

    2. Professor DeLong states that Ohanian's ``impediments to 
competition'' hypothesis is not supported by data from the late 1940s, 
as Professor DeLong argues that these impediments were even stronger at 
that time than during the New Deal.

    Measuring labor bargaining power is about wage premia, and 
        wage premia data show that that bargaining power was 
        considerably weaker after World War II than during the New 
        Deal. Under the National Recovery Administration, the 
        government bargained with industry on behalf of labor. The 
        program did not rely on unionization to give labor bargaining 
        power over wages, and wages rose considerably. After 1935, the 
        Wagner Act initially increased unionized bargaining 
        substantially, and this drove wages even above their NIRA 
        levels. These wage increases, which follow the Supreme Court's 
        ruling upholding the constitutionality of the Wagner Act, 
        coincide with the 1937-38 recession. Cole and Ohanian (2004) 
        document that manufacturing wages relative to productivity were 
        exceptionally high during the New Deal, but return to their 
        1929 level after the war. They attributed this decline to the 
        National War Labor Board, the Supreme Court's ruling against 
        the use of the sit-down strike, and the Taft-Hartley Act, which 
        substantially weakened labor's position viz-a-viz the original 
        National Labor Relations Act. Labor bargaining power was lower, 
        not higher, after the New Deal.

    3. Professor DeLong states that ``the same models that tell 
Professor Ohanian that starting in 1932 the Depression should have been 
over by 1936 also tell him if you start them in 1928 that the Great 
Depression did not happen at all.''

    Professor DeLong's statement is false. As noted in my 
        testimony at the hearing on March 31, 2009, my research shows 
        that similar policies put in place by President Hoover--studied 
        in a model very similar to my work with Cole (2004)--played a 
        significant role in accounting for the depth of the Depression 
        prior to the New Deal (Ohanian (2009)). In fact, Professor 
        DeLong attended my lecture at U.C. Berkeley in April, 2008 on 
        this topic. My research concludes that nonmarket policies are a 
        critical factor in accounting for the Depression under both 
        Presidents Hoover and Roosevelt.

    4. My next response applies to Professor DeLong's statements about 
unemployment before and after the New Deal, and hours worked during the 
New Deal.

    I don't know what Professor DeLong is referring to 
        regarding unemployment, as my research uses hours worked per 
        capita, rather than unemployment, as a measure of labor market 
        performance. I do not use unemployment statistics as those data 
        do not tell us how much work was restored during the New Deal--
        they don't measure either employment or hours per worker. And 
        unemployment is a notoriously difficult concept to measure, and 
        becomes even more problematic when one takes into account 
        factors such as discouraged workers exiting the labor force 
        (see http://www.bls.gov/cps/lfcharacteristics.htm), which 
        reduces the unemployment rate, and because there was a great 
        deal of job sharing during the New Deal, which also biases 
        unemployment as a measure of labor utilization.

    Hours worked is the standard measure of labor used in 
        macroeconomics, as it is the measure that is relevant for 
        production. It certainly is the measure to use when reporting 
        how much work was restored during the New Deal. Cole and I have 
        analyzed total hours to evaluate the overall impact of the New 
        Deal, and private hours to examine how the increased market 
        activity (as opposed to government) activity. There is little 
        recovery in total hours, and even less in private hours.

    More broadly, Professor DeLong raises questions about the data of 
        the recovery in my testimony. But as my March 31, 2009, 
        testimony indicates, Figures 1 and 2 show real GDP, 
        consumption, investment, and hours worked, in each year between 
        1929-39. None of these years show a significant recovery. The 
        data are downloadable from www.greatdepressionsbook.com.

    But more important, any analysis of the New Deal must confront the 
        substantial evidence that the labor market failed to clear. My 
        research and other recent analyses of this period (e.g., Chari, 
        Kehoe, and McGrattan (2006), Mulligan (2008)) argue that the 
        New Deal is an episode with industrial wages above normal, and/
        or employment and consumption well below normal, indicating a 
        significant labor market failure. The chronic persistence of 
        industrial wages well above normal during a Depression stands 
        in sharp contrast to standard economic reasoning. Professor 
        DeLong has offered no alternative explanation for these data, 
        or why the labor market failure worsened during the New Deal. 
        The decade-long Depression indicates that the central driving 
        force behind this event was the failure supply and demand to 
        reduce the wage and increase employment and output.

    5. Professor DeLong claims that hours worked at the end of the 
1930s were less depressed than the Cole-Ohanian numbers indicate 
because the workweek was declining over time as a consequence of rising 
wealth which led Americans to consume more leisure.

    Professor DeLong's argument is about increased leisure as 
        choice of households arising from higher wealth. But the 
        Depression was a period of declining income and wealth, meaning 
        that this effect would not be operative during the 1930s. 
        Instead, declining income and wealth would motivate households 
        to choose less leisure. In any case, I am unaware of any debate 
        that hours were not significantly depressed in the 1930s. After 
        all, hours per adult were not only higher in the 1920s, but 
        also higher in the 1950s and afterwards. Professor Valerie 
        Ramey who has conducted recent research on trends in hours per 
        worker and leisure, agrees with the premise that some New Deal 
        policies delayed recovery, as indicated in Ramey's statements 
        below about the New Deal in a recent interview: ``Anytime you 
        put in price and wage controls, you are more likely than not to 
        make the economy worse off,'' says Valerie Ramey, professor of 
        economics at University of California, San Diego. ``That's the 
        lesson of all economic history . . . You don't want to say, 
        `Oh, don't do any of it,' because some aspects did work, but 
        they were impeded by other aspects that led the economy to be 
        worse,'' says Ramey. http://money.cnn.com/2009/02/10/news/
        economy/yang_newdeal.fortune/index.htm
Other Questions about the New Deal and Recovery
    The major questions that arose during the March 31, 2009, hearing 
were about the growth rate of output, and whether that data was strong 
evidence that the New Deal was successful in promoting recovery, and 
whether monetary and/or fiscal policy promoted recovery.

    Q: Isn't the fact that growth rates of real GDP or industrial 
production strong evidence that the New Deal was successful?

    A: Not in my view. Using data on output growth, or the growth of 
other economic indicators, as evidence on the speed of recovery, first 
requires a benchmark of how fast recovery should have occurred. My 
research with Cole (2004) indicates that recovery should have been much 
faster than observed. Moreover, it is striking that actual industrial 
production grew more than 60 percent between July, 1932, and July 1933. 
This indicates not only that the economy can generate remarkable growth 
rates coming out of a deep depression, but that a recovery was starting 
in the summer of 1932, despite the fact that deflation and banking 
crises were continuing. That recovery then accelerated considerably in 
the spring of 1933, which has been interpreted as business was 
producing in advance of the distortions that would be imposed by the 
NIRA. Industrial production then began to decline in the summer of 
1933, which roughly coincides with the passage of the NIRA.

    Q: Was recovery during the New Deal the result of monetary policy, 
fiscal policy, or both?

    A: In my view, neither was the central factor. Changes in output 
are necessarily due to either changes in hours worked, or output per 
hour. The data in my testimony show that hours worked recovered little. 
Thus, the recovery in output that did occur in the 1930s was by 
definition the result of output per worker, or productivity. Cyclical 
changes in productivity are still not well understood, but there is no 
presumption that either monetary or fiscal stimulus--which typically 
are viewed as influencing demand--has strong links to productivity. 
Instead, research by Professor Alexander Field (2003) suggests that 
higher output per worker was due to changes in productivity gains 
brought about by innovation. Thus, the limited recovery of the 1930s 
was unlikely driven by demand stimulus.





                                 ______
                                 

                PREPARED STATEMENT OF J. BRADFORD DELONG
                        Professor of Economics,
                  University of California at Berkeley
                             March 31, 2009

    Chairman Brown, Senator DeMint, other Members of the Committee: It 
is always an honor to be invited here to participate in a small part in 
our self-rule via representative government here in the oldest and 
strongest and most successful large Republic in the world. We today 
face an economic crisis, and a crisis that has few parallels. Thus we 
are driven back to historical analogies. It can be said that economic 
theory is always crystallized history, is always us drawing on lessons 
from the past. But usually enough of the past has gone into making the 
theory that we are happy with the crystallized version. For this 
crisis, however, there is only one even close past parallel: the Great 
Depression and the New Deal. And so this time it is, I think, best to 
drink the history raw.
    Drawing lessons from the New Deal for the Great Depression 
requires, first, understanding what the New Deal was. Franklin Delano 
Roosevelt took everything that was on the kitchen shelf and threw it 
into the pot on March 4, 1933, and then began stirring--fishing things 
out that seemed nasty (and watching the Supreme Court fish a bunch of 
stuff out too), adding spices, adding new ingredients as they came 
along, all the while watching the thing cook and trying to turn it into 
something tasty. Try everything--and then reinforce and extend the 
things that seem to be working well. Ellis Hawley's The New Deal and 
the Problem of Monopoly remains the best account of this process. As 
Franklin Delano Roosevelt said on May 23, 1932:

        The country needs and, unless I mistake its temper, the country 
        demands bold, persistent experimentation. It is common sense to 
        take a method and try it. If it fails, admit it frankly and try 
        another. But above all, try something. The millions who are in 
        want will not stand idly by silently forever while the things 
        to satisfy their needs are within easy reach.

    It is only after the fact that we can say what the New Deal was. 
And it is only after the fact that we can try to assess the parts of it 
that were worthwhile and the parts of it that were not. In the middle 
of it nobody was really sure what was going on.
    I believe that in retrospect the New Deal is best divided into four 
components: (a) income redistribution to level the gross inequalities 
and inequities that had grown so large in the Gilded Age; (b) social 
insurance programs that diminished the risks that Americans would find 
themselves destitute and totally dependent on spotty and inadequate 
individual acts of charity; (c) structural reforms of the economy; and 
(d) what we now call macroeconomic policy--the government's taking 
responsibility for and acting as the balance wheel on the aggregate 
flow of spending and thus production and employment. Of these I believe 
(a) and (b), income redistribution and social insurance, surely made 
post-New Deal America a much better place but had little if any impact 
on recovery from the Great Depression. I also believe that (c), 
structural reforms of the economy, had little or no net impact on 
recovery as well. Some of the structural reforms appear to me to have 
been well thought-out--REA, NLRA, and Thurman Arnold's drives for 
enforcement of the antitrust laws come to mind. Others appear to me to 
have been neutral or worse--the NIRA and the PUHCA come to mind.
    Indeed, last month I reread John Maynard Keynes's two substantial 
letters to Franklin Delano Roosevelt in the 1930s and found that my 
conclusions were the same as those of Keynes, who protested:

        [A] great deal of what is alleged against the wickedness of 
        [utility] holding companies is surely wide of the mark. . . . 
        No one has suggested a procedure by which the eggs can be 
        unscrambled. Why not . . . leave the existing organizations 
        undisturbed, so long as the voting power is so rearranged . . . 
        that it cannot be controlled by . . . a minority . . . ? . . . 
        Finally, the railroads. . . . Whether hereafter they are 
        publicly owned or remain in private hands, it is a matter of 
        national importance that they should be made solvent. 
        Nationalise them if the time is ripe. If not, take pity . . . 
        And here too let the dead bury their dead. \1\
---------------------------------------------------------------------------
     \1\ John Maynard Keynes (1938), ``Private Letter to Franklin 
Delano Roosevelt of February 1'' http://tinyurl.com/dl20090325a.

---------------------------------------------------------------------------
    and:

        You are engaged on a double task, Recovery and Reform . . . For 
        the first, speed and quick results are essential. The second 
        may be urgent . . . but haste will be injurious, and wisdom of 
        long-range purpose is more necessary than immediate achievement 
        . . . [T]he order of urgency between measures of Recovery and 
        measures of Reform has [not] been duly observed . . . In 
        particular, I cannot detect any material aid to recovery in 
        NIRA . . . The Act is on the Statute Book; a considerable 
        amount has been done towards implementing it; but it might be 
        better for the present to allow experience to accumulate . . . 
        NIRA, which is essentially Reform and probably impedes 
        Recovery, has been put across too hastily, in the false guise 
        of being part of the technique of Recovery. \2\
---------------------------------------------------------------------------
     \2\ John Maynard Keynes (1933), ``Open Letter to Franklin Delano 
Roosevelt of December 31'' http://tinyurl.com/dl20090325b.

    This leaves the fourth aspect of the New Deal--the recovery-
generating aspect--macroeconomic policy, which I also divide into four 
components: (a) conventional monetary expansion, (b) quantitative 
easing, (c) banking-sector recapitalization and regulation, and (d) 
fiscal policy expansion. How effective was it? Let me pause to note 
that if this were 6 years ago in 2003 or 8 years ago in 2001 we would 
all be taking it for granted that the expansionary monetary and fiscal 
policies of the types tried during the New Deal were effective. Indeed, 
had Senator McCain won the presidential election last November the 
members of this and the previous panel would include one or more senior 
McCain economic advisors like Douglas Holtz-Eakin, Kevin Hassett, or 
Mark Zandi--all of whom would be arguing that New Deal-like monetary 
and fiscal stimulus programs were effective as part of the process of 
arguing for the McCain fiscal stimulus program or the McCain banking 
recapitalization program that would, had recent history taken another 
branch, now be moving through the Congress.
    Back at the start of the Great Depression none of the major 
industrial powers of the world pursued expansionary macroeconomic 
policies. Instead, they held that that government is best which governs 
least as far as economic policy was concerned and bound themselves with 
the golden fetters of the classical gold standard. A balanced budget 
was necessary to maintain confidence that a country would maintain its 
gold parity--hence no fiscal policy expansion. Under the gold standard 
the domestic money supply was determined by the ebb and flow of gold 
reserves--hence no, or rather little, conventional monetary policy or 
quantitative easing. And under the gold standard countries except for 
Great Britain had very limited powers to support or recapitalize their 
own banks: when Austria tried in 1931 it found itself faced with an 
immediate choice of abandoning its banking policy or abandoning the 
gold standard.
    So a New Deal was simply not possible as long as countries remained 
on the gold standard during the Great Depression--only after the golden 
fetters were cast off could the government even try to use its 
monetary, fiscal, and banking policy tools to promote recovery. This 
constraint gives us as clear evidence as we want that the New Deal--or 
rather New Deals, for each major industrial country during the Great 
Depression had its own--mattered for recovery. We know when each of the 
five major industrial countries cast off the gold standard fetters and 
began its New Deal. We know how quickly each of them recovered from the 
Great Depression.
    There is a strong rank correlation between how early a country 
abandoned gold and began its New Deal on the one hand and how rapid and 
complete its recovery was on the other, as this chart that I have 
reproduced from Eichengreen (1992) and then added to shows. \3\ 
Statisticians will tell you that if you thought before looking at the 
evidence summarized in this rank correlation that there was only a 50-
50 chance that New Deals mattered for recovery, then after looking at 
this evidence you should rationally be 95.2 percent sure that New Deals 
mattered.
---------------------------------------------------------------------------
     \3\ Barry J. Eichengreen (1992), ``The Origins and Nature of the 
Great Slump Revisited,'' Economic History Review 45:2 (May), pp. 213-
39.



    We economists are pretty sure that all four components of 
macroeconomic policy helped. It is very hard to write down a model of 
the economy in which some tools work and others do not. All four 
operate through boosting spending--conventional monetary policy and 
banking-recapitalization policy by lowering the interest rates that 
businesses seeking funding to spend on expanding capacity are charged, 
quantitative easing by putting cash in people's pockets that burns a 
hole through them if not spent, fiscal policy expansion by having the 
government spend directly. Any model of the economy in which increases 
in spending boost not just prices but production and employment will 
see all four be effective. Any model of the economy in which increases 
in spending just cause inflation but don't boost employment and output 
will see none of them be effective--but we already know that the odds 
of such being the right model are only 4.8 percent at best.
    Which of the four components of macroeconomic policy helped the 
most in the New Deals' aiding of recovery? That is a much more 
difficult question. The Depression itself provides little evidence of 
the balance of power between monetary, banking, and fiscal policy.
    Christina Romer argues powerfully that quantitative easing was 
decisive--that ``nearly all the observed recovery of the U.S. economy 
[starting in 1933] prior to [the beginning of World War II] in 1942 was 
due to monetary expansion,'' and this monetary expansion was entirely 
quantitative easing because conventional interest-rate open-market 
policy had been tapped out before the recovery began. \4\ One thing 
that students of the Great Depression do agree on is that it is next to 
impossible to evaluate how powerful fiscal policy expansion was in the 
Great Depression because it simply was not tried on a sufficiently 
large scale. As Eichengreen (1992) wrote a decade and a half ago:
---------------------------------------------------------------------------
     \4\ See Christina D. Romer (1992), ``What Ended the Great 
Depression?'' Journal of Economic History 52:4 (December, pp. 757-784 
http://www.jstor.org/stable/2123226.

        In the U.S., the most important fiscal change of the period, in 
        1932, was a tax increase, not a reduction, observed budget 
        deficits were small. Cyclically-corrected deficits were smaller 
        still. This is the conclusion of Brown . . . for the U.S.; 
        Middleton . . . for Britain; and Jonung . . . for Sweden . . . 
        In contrast, in countries like the U.S. (and to a lesser extent 
        the U.K.) the [monetary] expansion of currency and bank 
        deposits was enormous. The one significant interruption to 
        monetary expansion in the U.S., in 1937, revealingly coincided 
        with the one significant interruption to economic recovery . . 
        . Even in Sweden, renowned for having developed Keynesian 
        fiscal policy before Keynes, monetary policy did most of the 
---------------------------------------------------------------------------
        work.

    For evidence of the ability of fiscal policy to boost employment 
and production--if used on a sufficiently larges scale--we have to wait 
until World War II. Monetary policy contraction, banking-sector 
collapse, and the transformation of irrational exuberance into 
unwarranted pessimism carried the U.S. unemployment rate from 2.9 
percent up to 22.9 percent from 1929 to 1932. Monetary expansion and 
banking reform then drove the unemployment rate down to 9.5 percent by 
the start of large-scale mobilization in 1940. And wartime government 
expenditure and deficits drove the unemployment rate down to 1.2 
percent by 1944.
    Thus my belief is that the principal lessons of the Great 
Depression and the World War II eras for economic recovery are twofold:

  1.  The government should not sit on its hands. The French government 
        sat on its hands, relying on its commitment to the gold 
        standard and the equilibrium-restoring forces of the market to 
        handle the Depression. As of 1937--eight years after the 
        previous business-cycle peak--it was still waiting, like Japan 
        in the 1990s, for the self-correcting forces of the marketplace 
        to come to its rescue.

  2.  All four macroeconomic policy tools are likely to have some 
        power. A prudent policy will not rely on any of conventional 
        monetary policy or quantitative easing or fiscal expansion or 
        banking policy alone, but will instead combine all four--and, 
        like Roosevelt, seek to reinforce success.

The New Deal: Lessons for Today--Questions and Answers
    Q: How much has Ben Bernanke's reputation suffered as a result of 
his failure to stop the recession?
    A: I don't think Bernanke's reputation as an economist has suffered 
at all. I think it is stronger than ever. Friedman and Schwartz's 
Monetary History of the United States argued that the Federal Reserve 
all by itself could have stopped the Great Depression in its tracks--
but did not. This thesis of The Monetary History of the United States 
has taken a profound hit over the last 2 years, for Ben Bernanke has--
via open market operations and quantitative easing--done exactly what 
Friedman-Schwartz recommended and claimed would have stopped the Great 
Depression in its tracks. Yet we all now think that that is not 
enough--that we need banking policy and fiscal policy as well. And this 
is an intellectual loss for Friedman-Schwartz. But it is an 
intellectual victory for Bernanke-Keynes, who argued that all the 
conventional interest rate and quantitative easing monetary policy in 
the world might not be enough if the capitalization of the banking 
sector vanished and the credit channel got itself well and truly 
wedged. This is where we seem to be.
    Paul Krugman wrote:

        Has anyone else noticed that the current crisis sheds light on 
        one of the great controversies of economic history? A central 
        theme of Keynes's General Theory was the impotence of monetary 
        policy in depression-type conditions. But Milton Friedman and 
        Anna Schwartz, in their magisterial monetary history of the 
        United States, claimed that the Fed could have prevented the 
        Great Depression . . . if the Fed had done more--if it had 
        expanded the monetary base faster and done more to rescue banks 
        in trouble. So here we are, facing a new crisis reminiscent of 
        the1930s. And this time the Fed has been spectacularly 
        aggressive about expanding the monetary base: And guess what--
        it doesn't seem to be working well enough.

The Federal Reserve in the Great Depression
    Q: Why do we need to do all this fiscal policy and banking policy 
stuff? Didn't Milton Friedman and Anna Schwartz prove that the Federal 
Reserve caused the Great Depression by inept and destructive policies?
    A: I think you have to be careful here. Friedman and Schwartz's 
Monetary History of the United States argued not that the Federal 
Reserve caused the Great Depression but that the Federal Reserve all by 
itself could have stopped the Great Depression--but did not.
    This thesis of The Monetary History of the United States has taken 
a profound hit over the last 2 years, for Ben Bernanke has--via open 
market operations and quantitative easing--done exactly what Friedman-
Schwartz recommended and claimed would have stopped the Great 
Depression in its tracks. Yet we all now think that that is not 
enough--that we need banking policy and fiscal policy as well.
Government Workers and Unemployment
    Q: Amity Shlaes writes that the New Deal did not diminish 
unemployment much--that unemployment was 25 percent in 1933 and still 
19 percent in 1938. Doesn't this prove that the New Deal was 
ineffective?
    A: Amity Shlaes is using the Lebergott unemployment series--and 
Christie Romer wrote the book, literally--it's her dissertation--on 
what is wrong with the Lebergott series. The Romer series or the Weir 
series paints a very different picture: a fall in unemployment from 23 
percent in 1932 to 9 percent in 1937, a jump back up to 12 percent in 
the recession of 1938, and then a fall to 11 percent in 1939.
    As Bush Administration Commerce Undersecretary Michael Darby 
pointed out, the big difference between the series that matters here 
concerns their treatment of government relief workers: is someone 
working for the WPA or the CCC employed or unemployed? From the 
perspective of ``how good a job is the private sector doing at 
generating jobs,'' there is a case for counting them as unemployed. But 
if the question is ``did the New Deal help?'' then there is absolutely 
no case at all for using the Lebergott series because WPA and CCC 
workers had jobs and were very glad to have them. Shlaes has, I think, 
simply not read the footnotes to the edition of Historical Statistics 
of the United States that she got her numbers out of.
Herbert Hoover
    Q: Wasn't the Great Depression really the fault of that dangerous 
leftist Herbert Hoover with all of his interventionist meddlings in the 
economy?
    A: Herbert Hoover is an interesting case. He wanted to meddle--he 
wanted to be an activist president--but his Treasury Secretary Andrew 
Mellon persuaded him not too. Mellon persuaded him to raise taxes 
during the Great Depression to assure investors that the U.S. would 
stay on the gold standard and not fund government spending by printing 
money. Mellon persuaded him to avoid expansionary monetary policy of 
any kind. Herbert Hoover did call business leaders into the White House 
for conferences, and did plead with them not to fire workers or cut 
wages too much, but I have never been able to find any sign that this 
had an effect--no sign that industrialists called to the White House 
for meetings changed their business practices in any way. Herbert 
Hoover did start the Reconstruction Finance Corporation, but funded it 
at a very low level. Because of Mellon's blocking position in the 
administration, the New Deal could not get under way until 1933.
    Afterwards, Herbert Hoover was very angry at himself for taking 
Mellon's counsel and at Mellon for giving it. Until George W. Bush 
unleashed his White House staff to slime Paul O'Neill, Herbert Hoover 
held the record for the most vicious attack by a President on his own 
Secretary of the Treasury, writing in his memoirs that he was very 
sorry about the influence exercised by:

        [T]he ``leave it alone liquidationists'' headed by [my] 
        Secretary of the Treasury Mellon, who felt that government must 
        keep its hands off and let the slump liquidate itself. Mr. 
        Mellon had only one formula: ``Liquidate labor, liquidate 
        stocks, liquidate the farmers, liquidate real estate.'' He 
        insisted that, when the people get an inflation brainstorm, the 
        only way to get it out of their blood is to let it collapse. He 
        held that even a panic was not altogether a bad thing. He said: 
        ``It will purge the rottenness out of the system. High costs of 
        living and high living will come down. People will work harder, 
        live a more moral life. Values will be adjusted, and 
        enterprising people will pick up the wrecks from less competent 
        people''
Fiscal Policy
    Q: Many economists say that fiscal policy does not work--that 
Roosevelt's deficit spending did not pull the U.S. out of the Great 
Depression.
    A: They are wrong. Roosevelt's deficit spending did pull the U.S. 
out of the Great Depression--but it did not do so until World War II, 
which was when the deficit spending really took place. The deficits of 
the New Deal era seemed large and shocking to people at the time, but 
they were small relative to the scale of the whole economy. Peak 
unemployment in the Great Depression hit 23 percent. To reduce that to 
5 percent would have required deficits as large as 9 percent of GDP or 
more--which we did not have until World War II. Thus it is not 
surprising that unemployment stayed above 10 percent until the eve of 
World War II.
The NIRA and NLRA as Neutral
    Q: Did structural reforms like the NIRA and the NLRA help recovery?
    A: I think there is somewhat more than a grain of truth in the 
claim that much of the New Deal, especially its structural 
interventions in the economy, was ineffective and neutral--as far as 
its impact on recovery from the Great Depression was concerned. And 
there is a grain of truth in the claim that some of it was 
counterproductive.
    John Maynard Keynes told Roosevelt so in a letter of February 1, 
1938. And Keynes went on to argue that the reason the U.S. recovery had 
stalled out in1937-1938 was that Roosevelt's policies were not 
Keynesian enough--that ``the present [renewed] slump could have been 
predicted with absolute certainty'' by anybody knowing the year before 
how Roosevelt was going to try to reduce deficit spending and tighten 
money. But that the New Deal was not Keynesian enough does not mean 
that we should be even less Keynesian now than we are being. And the 
argument that Milton Friedman and John Maynard Keynes were both wrong 
when they blamed the renewed 1938 downturn on contractionary 
macroeconomic policies--well that is an argument that Ohanian is a very 
brave man indeed to make.
The NIRA and the NLRA as Harmful
    Q: Wasn't the New Deal harmful to recovery because it introduced 
blockages into labor and product markets?
    A: I don't think anyone has argued that the NIRA and the NLRA 
boosted aggregate demand and put more people to work. That said--output 
and employment were growing very rapidly in the period when the NIRA 
was in effect, so if it was doing harm it seems likely that other 
aspects of the New Deal--abandoning the gold standard, giving up the 
target of achieving immediate budget balance, quantitative easing--were 
doing good. The years during which the NRA was in effect saw the 
unemployment rate go from 22.9 percent down to14.4 percent.
    And Milton Friedman was certain that the recession of 1937-38 was 
not due to the NLRA and to greater union power but rather to a bad 
mistake of monetary policy in raising reserve requirements. In early 
1937 the Federal Reserve doubled required reserves out of fear of 
future inflation, and the economy fell off a cliff as a result. I don't 
know anybody who hated strong unions more than Milton Friedman--yet he 
did not blame them for the recession of 1937-38.
    To step back, the ``impediments to market competition'' that 
Ohanian blames for the persistence of the Great Depression were still 
around and were stronger than ever in the late 1940s and 1950s. If they 
did not produce high structural unemployment then, what reason is there 
to think that they produced high structural unemployment in the U.S. in 
the 1930s?
The NIRA: More
    Q: What is your view of Roosevelt's signature initiative of his 
first year in office--the National Recovery Administration, the 
National Industrial Recovery Act?
    A: I believe that my view of the NRA is the same as John Maynard 
Keynes's view: that it was a mistake. When I read John Maynard Keynes's 
open letter to Franklin Delano Roosevelt of December 31, 1933, I can 
hear Keynes desperately trying not to be impolite while discouraging 
Roosevelt from any further policy moves along the lines of the NRA. 
Keynes wrote:

        I cannot detect any material aid to recovery in NIRA . . . The 
        Act is on the Statute Book; a considerable amount has been done 
        towards implementing it; but it might be better for the present 
        to allow experience to accumulate . . . NIRA, which is 
        essentially Reform and probably impedes Recovery, has been put 
        across too hastily, in the false guise of being part of the 
        technique of Recovery.

    I think the NIRA could have done significant damage to the economy 
had it not been negated by the Supreme Court. As things were, however, 
I don't think it had a material effect. Output was too depressed and 
demand too low for the NRA codes to have materially depressed it 
further during the short time it was in operation.
The NLRA: More
    Q: Some economists blame slow recovery from the Great Depression in 
the United States on the NLRA and the consequent rise to power of 
American labor unions--that they pushed up wages, and so priced workers 
out of the labor market.
    A: The NLRA came too late to be blamed for the Great Depression. 
The most you can do is blame it for the 1937-38 recession. If you are 
going to blame strong unions for high unemployment in the late 1930s, 
you then have to come up with a reason for why even stronger unions in 
the 1950s did not produce high unemployment. And you have to explain 
why Milton Friedman disagrees withyou--why Milton Friedman does not see 
union power but rather the contraction of the money stock as the cause 
of the rise of unemployment in 1937-38.
Slow Recovery From The Depression
    Q: Shouldn't the economy have recovered completely from the Great 
Depression by 1936? Doesn't the fact that the Great Depression 
continued through the 1930s suggest that the New Deal was harmful?
    A: The same models that tell Professor Ohanian, starting in 1932, 
that the Great Depression should have been over by 1936 also tell him, 
if you start them in 1928, that the Great Depression did not happen at 
all.
    The pattern across industrial economies is: the later you start 
your New Deal, the worse you do. That is a striking pattern.
Unemployment Lower Before Roosevelt
    Q: If the New Deal was such a success why was unemployment lower 
before Roosevelt, as Professor Ohanian says?
    A: This is true only for a very peculiar definition of ``before 
Roosevelt''--a normal person would think that ``before Roosevelt'' 
meant 1932 or perhaps the winter of 1932-33. But Cole and Ohanian mean, 
instead, an average of 1930-1932. Nineteen-twenty-nine was a boom year 
of extremely high unemployment. Nineteen-thirty was an average year. 
Nineteen-thirty-one was a bad year. But it was only after the financial 
crises of late 1931, say Milton Friedman and Anna Schwartz, that the 
cratering of the system of financial intermediation and the sudden rise 
in the reserve-deposit and currency-deposit ratios turned the downturn 
into the Great Depression. To compare the new deal to the average of 
1930-1932 is not just to move the goalpost--it is to pick up the 
goalposts and run as fast as you can out of the stadium.
Weekly Hours at the End of the 1930s
    Q: Total hours worked per adult in 1939 remained about 21 percent 
below their 1929 level--doesn't that prove that the New Deal was a 
failure?
    A: Cole and Ohanian work very hard to try to convince their readers 
that things got worse after Roosevelt took office. But, as they know 
well, they didn't: things got better--they just did not get enough 
better to get employment back to normal until the huge burst of federal 
deficit spending that was World War II.
    Break their claim into two parts. The first part: unemployment was 
22.9 percent in 1932 and down to 11.3 percent in 1939--yes, that tells 
us that recovery was incomplete.
    The second part: hours of work per employed person were 13 percent 
lower in 1939 than in 1929. Cole and Ohanian assume that all of this 
decline in hours of work per week per employed person is due to 
deficient demand rather than to a much-desired increase in leisure. I 
don't think that is right. In 1949 hours worked per adult were 18 
percent and in 1959, 17 percent below their 1929 level. But does that 
mean that the economy was even more depressed in the 1950s than it was 
in 1939? No. You don't want to maintain that the interwar decline in 
hours worked tells us about cycle and not trend. Is there anyone who 
will say that the decline in hours worked from 1914 to 1952 tells us 
that the economy was performing much worse along a business-cycle 
dimension in 1952 than it was in 1914? No. The 1914-1950 period saw the 
last sharp decline in the American workweek--a decline that does not 
mean that the economy was depressed and performing poorly in 1959 or 
1949 (or 1939) relative to 1914 or 1929, but instead that Americans had 
decided to take a substantial part of their increased technological 
wealth and use it to buy increased leisure.
Private Investment
    Q: Didn't Roosevelt's New Deal Policies destroy business confidence 
and deepen the Great Depression?
    A: The most aggressive claim to this effect that I have seen comes 
from Professor Bryan Caplan of George Mason, who wrote that: ``[Robert] 
Mugabe has made people afraid to invest in Zimbabwe. Why should [Brad] 
doubt that--on a smaller scale, of course--Roosevelt made people afraid 
to invest in the U.S.?''
    The answer is: no, Franklin Delano Roosevelt bears no resemblance 
to Robert Mugabe.
    And the answer is: no, Franklin Delano Roosevelt's policies did not 
depress private investment by making businessmen more scared to invest 
in America; when FDR took office, businessmen were already totally 
scared to invest in America--net investment was well below zero, and 
could hardly drop any further.
    Public confidence in markets reached a nadir in 1933, when half the 
banks in the country had closed, when Wall Street was out of business, 
when the Dow stood at its appalling lows. Before the new deal there was 
no securities industry, no banking industry, no mortgage industry, no 
capital formation or lending of any kind. Forty percent of home 
mortgages were in default. It was only with the passage of New Deal 
efforts--the SEC, the FDIC, the FSLIC--that the mechanisms of private 
capital began to kick back into gear. Don't take it from me. Take it 
from Federal Reserve Chairman Ben Bernanke, who wrote in his essays on 
the Great Depression that: ``only with the New Deal's rehabilitation of 
the financial system in 1933-35 did the economy begin its slow 
emergence from the Great Depression.''