I was witness to a puzzling exchange between Joe Stiglitz and a number of other people at a Roosevelt Institution forum on monetary policy several weeks ago, and after reading his longish take on monetary policy, the Great Depression, and our current woes I'm more puzzled than ever. What's puzzling about it, in particular, is that so much of it seems correct and persuasive. A completely absurd, yet now widely accepted for political reasons, narrative has grown up that somehow Herbert Hoover's tiny deviations from classical liberal orthodox caused an unprecedented worldwide economic calamity. Stiglitz, by contrast, quite correctly argues that it was the deflation, stupid. He argues that rising agricultural productivity meant falling farm incomes and increasing indebtedness:
The cities weren’t spared—far from it. As rural incomes fell, farmers had less and less money to buy goods produced in factories. Manufacturers had to lay off workers, which further diminished demand for agricultural produce, driving down prices even more. Before long, this vicious circle affected the entire national economy.
The value of assets (such as homes) often declines when incomes do. Farmers got trapped in their declining sector and in their depressed locales. Diminished income and wealth made migration to the cities more difficult; high urban unemployment made migration less attractive. Throughout the 1930s, in spite of the massive drop in farm income, there was little overall out-migration. Meanwhile, the farmers continued to produce, sometimes working even harder to make up for lower prices. Individually, that made sense; collectively, it didn’t, as any increased output kept forcing prices down.
Stiglitz goes on to further argue (like Keynes and Fischer and modern-day thinkers like Krugman and Eggertson) that under the circumstances downward nominal wage flexibility was counterproductive, further entrenching expectations of deflation. This basic analysis is why most researcher believe that monetary policy was key to alleviating the Great Depression. By taking the US dollar off the gold standard, FDR raised expectations about the future nominal price of commodities and broke the back of the deflationary spiral. This led to rapid growth until 1937 when a combination of fiscal and monetary tightening created a new recession that, in turn, ended when policymakers reversed course. Finally, full employment was achieved via wartime mobilization to beat Nazi Germany.
Puzzlingly, however, Stiglitz seems to simply deny that the initial Roosevelt recovery happened, arguing that "it was not until government spending soared in preparation for global war that America started to emerge from the Depression" and that "it was government spending—a Keynesian stimulus, not any correction of monetary policy or any revival of the banking system—that brought about recovery." A common sense check should be to ask yourself how it is that Roosevelt scored a landslide re-election victory in the fall of 1936 if America didn't start to emerge from the Depression until years later. The answer is that Roosevelt was re-elected on the back of strong growth:
It's quite true that we didn't finish recovering from the Depression until World War II mobilization was under way, but we clearly began to emerge from the Depression as soon as Roosevelt's monetary policy broke the cycle of deflation that Stiglitz identifies.
What's more, elsewhere in the article Stiglitz gestures at a rationale for the kind of public spending commitments he favors that's much sounder than this argument about the Depression. With regard to wartime mobilization he observes that "the long-run prospects for the economy would, of course, have been even better if more of the money had been spent on investments in education, technology, and infrastructure rather than munitions." This is precisely to the point. Stiglitz is saying that when an economy is severely depressed, it doesn't really matter what you increase spending on -- output goes up as long as you spend on something. But over the long-term, what you spend money on matters a great deal. Building lots of bombs and tanks and guns is a very smart thing to do if you happen to be in a war with Adolf Hitler, but it's not much of a long-term growth strategy. By the same token, if you think (as Stiglitz and I do) that America is more in need of improved infrastructure and early childhood education than it is of more private consumer goods then you'll agree that boosting spending in these categories would be a better long-term growth strategy that simply boosting private consumption spending. But in terms of ending the depression, tanks were just as good as transit and if tanks worked then so would toasters.