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The New Deal and 'Domesticated Keynesianism' in America
The New Deal and “Domesticated Keynesianism” in America
Roger J Sandilands
University of Strathclyde
John Kenneth Galbraith has held up the “almost unique unreadability” and “fascinating obscurity” of much of John Maynard Keynes’s General Theory of Employment, Interest and Money as a major reason for its success. It created a need for translators and proselytizers to explain its deep meaning to government officials, students and the public at large; and “as with the Bible and Marx, obscurity stimulated abstract debate” (Galbraith, 1971: 44).
Unlike much of the preceding theoretical literature on depression economics, Keynes’s General Theory was not a theory of the business cycle but rather a theory of the chronic tendency of the free-enterprise economy to depart from full employment, with no automatic tendency, under realistic institutional assumptions, to return to full employment. It is a general theory of disequilibrium or, rather, explains why there is a multiplicity of possible equilibria, most of them sub-optimal, and each one prone to unpredictable shift through the vagaries of businessmen’s “animal spirits”. It called for the visible hand of government to supplement the invisible hand of the market. Though a difficult book, Keynes’s General Theory is a model of clarity compared with modern “general equilibrium theory” that purports to explain how “free”, fully flexible markets unencumbered by government may keep the economy close to a unique, optimal full-employment equilibrium. Perhaps for this reason exegesis of the latter now easily displaces Keynesian theory in prestige and classroom time.
Where does this leave Galbraith? His vision of the proper role of government is to sustain not merely high and rising levels of output and employment but a “better” composition of that output between private consumption and public investment, and to ensure that it be equitably distributed among social classes. In this sense he is an unreconstructed New Dealer Mark I and Mark II. The former embraces the Veblenian activism of the early (Mark I) New Deal, 1933-36, with its focus on the countervailing power of the state to tackle abuses of monopoly and monopsony. The latter (Mark II) New Deal followed hard on the shock of the 1937-38 recession (after several years of sustained recovery). This galvanized support for “Keynesian” fiscal activism against the orthodox view that an economy cannot be in balance unless the government’s budget is also in balance.
Galbraith’s own transparent style leaves less scope for the army of professional interpreters and obscurantists that has sustained and formalized Keynesianism and anti-Keynesianism. Furthermore, discussion of power relations, the ethics of advertising, and judgments on the respective value of bullets, butter and ballet -- other than as revealed in their market price -- smacks too much of elitism and too little of formal science to be safe subjects for economics classes or journals. But Galbraith can look back with satisfaction at the impact he has had on the economic, political, social and cultural life of our world through his fearless iconoclasm. He has stood out as an inter-disciplinarian who, in the rich American institutionalist tradition, has not shirked a duty, as scientist and citizen, to engage in the great issues of our times and expound his view of democracy and the social interest. For this his books are read with profit by a wide public audience and, somewhat furtively and uncomfortably, by many academic economists too. Few economists are entirely content with the increasing formalism and abstraction of our discipline, and a weekend with Galbraith offers escape from unreality.
Never was there a greater need to question orthodoxy than when Galbraith was starting out as a student of economics in the early 1930s. Some of Galbraith’s recollections of these years are recorded in his interview with David Colander and Harry Landreth in The Coming of Keynesianism to America (1996) and in his autobiography, A Life in Our Times (1981). As a PhD student at Berkeley, 1931-4, he was fed the mainstream view that the Depression was an exceptionally severe manifestation of the business cycle, that it would correct itself in time, and that activist government policy, especially a deliberate unbalancing of the budget, would be unsound, even immoral. But other voices did intrude. He read Veblen who held that business was chronically repressed by the type of control exercised by profit-minded managers rather than technically minded engineers. He was also introduced to pre-General Theory Keynes. And there was the view that Depression was caused by the monopolistic practices of Big Business and should be tackled through more vigorous enforcement of anti-trust laws and a restructuring of the business corporation.
Armed with his PhD and a dissertation on the economics of bee-keeping Galbraith found a summer job in Howard Tolley’s office at the Agricultural Adjustment Administration, an emergency New Deal agency within the Department of Agriculture under Henry Wallace. His work involved advice, unfortunately largely unheeded, on how tax-reverted land could usefully be kept in the public domain. In the autumn of 1934 he entered Harvard as an instructor in agricultural economics under John D Black’s direction but retained his links with the Department of Agriculture, a regular commuter between Boston and Washington.
As recounted by Galbraith, in the summer of 1936 he was hired by the unorthodox businessman, Henry Dennison, to help with the manuscript of a book on the causes of the Depression. Dennison held that depression was caused by the nonspending of income. Galbraith held that it was due to the prevalence of Chamberlinian monopolistic competition that was restricting output and raising prices. Dennison was told that his ideas were unsound. No reputable economist would endorse them. Shortly thereafter, Keynes’s General Theory fell into Galbraith’s hands. To his consternation Galbraith realized that Dennison had an ally in the greatest of modern economists. His task then was to restore Dennison’s dented self-confidence. Dennison went on to serve as an adviser to the National Resources Planning Board in 1938.
“By the autumn of 1936”, wrote Galbraith (1981: 67), “Keynes had reached Harvard with tidal force.” A majority of the prominent American Keynesians interviewed by Colander and Landreth were connected with Harvard at that time or slightly later. Three of them -- Robert Bryce, Lorie Tarshis, and Walter Salant -- had spent some time in Cambridge, England where they had attended Keynes’s lectures on a Monetary Theory of Production, which became the General Theory. On their arrival at Harvard (or, in Tarshis’s case, to nearby Tufts) in 1935 they organized an informal seminar series on Keynes’s economics for graduate students and younger faculty (including Galbraith). Paul Sweezy was a prominent member. He had taken his B.A. at Harvard (1932) and then spent a year at the LSE before returning to Harvard. Sweezy and Walter Salant had both studied Keynes, Dennis Robertson and Ralph Hawtrey’s views on money and the cycle in John Williams’s popular class in Money and Banking.
Williams’s assistant was Lauchlin Currie, and his students included Sweezy, Walter and William Salant, Emile Despres, Albert Hart, Martin Krost and Moses Abramovitz, all of whom were to play a role in New Deal and/or wartime Washington. Paul Sweezy’s older brother Alan, a history major, had been to Cambridge on a fellowship and on his return to Harvard in the early 1930s began graduate work in economics. In a paper on “The Keynesians and Government Policy, 1933-1939” Alan Sweezy (1972: 117) recalled that “Currie had already been advocating expansionary monetary and fiscal policies in his writing and teaching as an economics instructor at Harvard before coming to Washington in the summer of 1934… Like Keynes, Currie was impatient with the negative attitude of so many of his professional colleagues. Early in 1934 he persuaded five of us who were then instructors in economics at Harvard to join him in sending an open letter to President Roosevelt endorsing the main features of the New Deal recovery program.”
This letter coincided with the publication of The Economics of the Recovery Program (Brown, 1934) that several of Harvard’s senior faculty, the “Seven Wise Men”, had put together and which offered no support for Roosevelt’s policies. This may explain why Currie’s letter stated that “we wish to single out for special commendation that which has received more criticism perhaps than any other at the hands of our professional colleagues – namely, your monetary policy.” The letter praised the departure from the gold standard as essential for Roosevelt’s expansionist policies – “one of the rare occasions since the war when a government both foresaw danger and took action to avoid it” -- and warmly supported the policy of increased government expenditures. Unsurprisingly, none of the signatories received tenure. The chairman of the department, Harold Burbank, had already sharply reprimanded Currie for straying into the field of fiscal policy in his classes on money and banking. When Treasury Secretary Henry Morgenthau Jr. requested that Harvard extend Currie’s summer leave of absence to become Jacob Viner’s assistant, the request was refused.
Galbraith describes the fuss when Alan Sweezy and Raymond Walsh (both signatories of the 1934 letter to Roosevelt) were singled out for termination in 1937. One of their main rivals was Seymour Harris. Paul Samuelson recalls (Colander and Landreth, 1996: 155) that when he asked his Chicago professors in 1935 which graduate school he should attend, he was warned by Lloyd Mints that at Harvard Seymour Harris was an inflationist. “This is interesting”, said Samuelson, “because if you read The Economics of the Recovery Program, 1934, you’ll see that Harris, not yet having tenure at Harvard and still under the influence of Harold Hitchings Burbank, is a stout reactionary. Lloyd Mints must have had some keen sense of smell, because after Harris did get tenure he became a flaming Keynesian.” Currie later remarked sourly that he converted only when it was safe to do so. As Galbraith (1977: 220) put it: “In economics one should not be right too soon. The shrewd scholar always waits until the parade is passing his door and then steps bravely out in front of the band.” When Galbraith was seeking tenure in 1939 he interviewed for a post at Princeton, confident this would be a catalyst to promotion at Harvard. Instead, at dinner in the home of the chairman of the Princeton economics department he was handed a telegram from Burbank. It stated that he had just come from a meeting with president James Bryant Conant; that his Harvard prospects were very dim; and that he would be advised to take any post that was offered by Princeton.
Returning to Paul Sweezy’s role in what Galbraith has described as the coming of Keynes to America by way of Harvard (and, as we shall see, by way of the Federal Reserve Board also), it should be noted that despite his exposure to John Williams’s undergraduate class he had been more heavily influenced by Gottfreid Haberler. Thus when he arrived at the LSE in 1932 he was initially very impressed (as was his friend Abba Lerner) by the Austrian theory as expounded by Hayek and Robbins. But the LSE radicalised him. On his return to Harvard in 1933 he had Joseph Schumpeter as his supervisor and was his teaching assistant from 1935-37. Though Schumpeter was intensely jealous of Keynes and abhorred marxism, Sweezy was receptive to the activist Keynesian message that Robert Bryce brought over from Cambridge in 1935, as well as to the marxist theory for which he would later be a famous exponent. His close friend Richard Goodwin claimed (Sandilands, 1990: 26-27) that he and Sweezy (both from banking families) were the models for Schumpeter’s prognosis, in the famous “crumbling walls” chapter in Capitalism, Socialism and Democracy (1942): that capitalism was (regrettably) doomed because the sons of the bankers and entrepreneurs upon whom the system depended, would, while enjoying the comfort and security their fathers had provided, be rebels seeking different challenges. Capitalism would be a victim of its own success.
But a simpler explanation for the embrace of socialism during the 1930s, in Harvard, in Cambridge, England and elsewhere (notably at Berkeley, Galbraith’s other alma mater), was not the success but the very evident breakdown of the free enterprise capitalist system, the misery caused by that breakdown, its pervasiveness and persistence, and the absence of convincing explanations and solutions from the economics establishment.
At Harvard the Austrian School was powerfully represented by Haberler and Schumpeter. Schumpeter had been the Austrian finance minister at a time of hyperinflation. Perhaps chastened by that experience he now sided with Hayek and Robbins in the “neutral money” doctrine that welcomed declining prices as a reflection of rising productivity. The exceptional deflation of 1929-33 (when the general price index fell by around 25 percent) was held mainly to reflect and compensate for the irresponsibly inflationist policies of the “roaring” twenties. These had produced misleading price signals that encouraged excessive, speculative investments and associated “maladjustments”. Deflation was a necessary, unavoidable purgative. Some relief, however, might be afforded by greater wage flexibility.
Galbraith has remarked that Schumpeter’s “political and business misfortunes had left him with a deep distaste for practical affairs, and he condemned as intellectually debased economists who presumed to advise on practical questions”. Lauchlin Currie, who was also Schumpeter’s assistant in the early 1930s, recalls that he did once put his theories into practice: believing in wage flexibility as a cure for depression he supported Harvard’s decision to cut the wages of the support staff. Professors’ salaries were not altered and as prices fell Schumpeter enjoyed a rising real income. This accorded with his pronouncement that “a gentleman cannot live on less than $50,000 a year” (Sandilands, 1990: 25-26).
Currie was later to play a leading role in bringing Galbraith back to Washington. First, in 1938, as chief technician on the fiscal and monetary committee of the National Resources Committee under Frederic A. Delano (with Galbraith’s old friend Henry Dennison also on the board), Currie arranged for Galbraith to direct a large review (with Griff Johnson, an assistant of Currie’s at the Federal Reserve Board) of the impact of public works expenditures from the early days of the New Deal to the present (Galbraith, 1975: 230). This meant that Galbraith could again commute between Washington and Harvard where Keynes’s General Theory was now the centre of attention. In 1937 Alvin Hansen had been appointed to a chair at Harvard. Though he had previously been highly sceptical, by 1938 he had revised his opinion of the General Theory and became one of its most vigorous champions. Galbraith and a galaxy of bright students and eminent visitors from Washington attended the famous fiscal policy seminar that Hansen had organized with John Williams, and it was now in full swing (Salant, 1998). From this seminar group Currie recruited not only Galbraith but also Richard V. Gilbert, George Jaszi and Emile Despres for work in Washington.
In fact Currie was soon running a one-man recruitment agency for Keynesian economists from the White House, having been appointed as a Roosevelt aide in June 1939 after five years as assistant to Marriner Eccles at the Federal Reserve. In a session at the 1971 American Economic Association meetings organized by Galbraith (the Association’s president that year), Currie (1972: 141) recorded:
“By 1939 I had become the first economist in the White House and we were becoming a formidable group. I had recruited Dick Gilbert and his group – V.L. Bassie, Rod Riley and the rest – for Harry Hopkins at Commerce, which gave support to Bob Nathan, long a lone outpost in hostile territory. I had turned my post at the Federal Reserve over to Emile Despres. I was, I am happy to say, responsible for bringing Ken Galbraith to Washington and for getting Gerhard Colm placed in the Bureau of the Budget, now moved to the Executive Office of the President. Walter and Bill Salant, Griff Johnson, Alan Sweezy, Arthur Gayer, Malcolm Bryan, George Eddy, Albert Hart and Martin Krost were my former students or associates and were occupying key posts. Our position in the Treasury was getting stronger as Harry White [Currie’s Harvard classmate] gained influence, and we had close working relations with Gardiner Means and Tom Blaisdell in the NRPB and the members of the Board, and with [Mordecai] Ezekiel and Louis Bean in Agriculture, with Isador Lubin in Labor and, of course, with Leon Henderson and Jerome Frank in the SEC. Hansen was winning converts outside. We didn’t sleep much, but when we did, the General Theorykept working. With the Works Financing Act of 1939 and our long discussions on a major revision of the Social Security System, Roosevelt finally acquired a firm grasp of the theory. I think, therefore, that even if the war had not intervened, victory was assured.”
The second occasion on which Currie recruited Galbraith for work in Washington was in the summer of 1940, a few days after the fall of France. Leon Henderson had just been placed in charge of prices in the National Defence Advisory Commission, but was more prominent as a trust-busting (“Mark I”) than a Keynesian (“Mark II”) New Dealer. Currie wanted a reliable disciple to be on hand. Galbraith fitted the bill and went on to assume wartime responsibility for price control.
Currie had been impressed by the work of Galbraith and Griff Johnson for the National Resources Committee on the impact of public works expenditure. Their eventual report (published late 1940) conceded that “the view that depressions will correct themselves if left alone is by no means dead”. But they expressed grave doubt that this view was likely to become again the basis of public policy. The tone of the report was unmistakably Keynesian: “Unemployed men and materials are the normal or equilibrium situation in the modern economy… [T]he construction of public works, so financed as to offset otherwise idle saving, represents one of the devices for escaping a persistent low level of private investment and a persistently high level of unemployment.”
This was very much in accord with the rationale given by Currie in his draft of the 1939 Works Financing Bill, on behalf of his then boss, the activist chairman of the Federal Reserve Board, Marriner Eccles. The bill was presented to Congress in July by Senator Alben Barkley. It was framed in such a way that a major spending programme would be financed outside of the regular budget. This was intended to placate the budget balancers but also to make it possible to conduct some compensatory policy without the need for new legislation and appropriations. It was known as the “Lend-Spend Bill” and met with fierce opposition. Congress saw through the balanced budget ruse and rejected it. This showed how strong was the opposition that the Keynesians faced even at this relatively late stage. It confirms that the triumph of Keynesian ideas for policy purposes owed relatively little to the New Deal as compared to the dramatic demonstration effect of the war years: massive expenditures put idle machines and millions of men back to work. There was a huge increase in the production of military equipment without any cut in the production of consumer goods. All this was achieved with relatively modest inflation, though monetary control remained imperfect.
It was also imperfect monetary control that had precipitated the Great Contraction of 1929-33. Galbraith’s acclaimed study of The Great Crash (1972) placed the spotlight on the speculative frenzy leading up to Black Thursday, October 24, 1929, and he has regarded this as the key causal factor and more than just a mirror that provided an image of the underlying economic situation. One can, however, reconcile Galbraith’s diagnosis with the monetary diagnosis made famous by Friedman and Schwartz’s (1963) monumental study – but very similar to the thesis expounded by Currie in his Harvard classes and publications in the early 1930s – by noting how preoccupied were the monetary authorities with the movement of the stock market in 1929 – with the financial rather than the industrial circulation. So much so that as stock prices rose they took their eyes off the real economy, which had begun to turn down quite sharply in the summer of 1929. Interest rates were raised to 6 percent in August.
Despite the general stampede to buy stocks in the months up to October 24 (little deterred by the high interest rates on margin buying), there was still considerable selectivity, with the prices of more profitable sectors rising faster than others; and the price-earnings ratio (17.1 at its peak) was not exceptional by later standards, for example at the time of the stock market crash in October 1987. The great difference between 1929 and the bursting of subsequent bubbles lies in the response of the monetary and fiscal authorities. The 1929 crash led to mass liquidations and member banks were forced to borrow from the reserve banks as deposits were withdrawn. Over the next two years open market purchases by the federal authorities were far too modest to replace member banks’ lost reserves, and the banks’ repugnance to indebtedness led them to contract their own lending to the public. They simply used any new reserves to reduce their own debt.
The fiscal position “deteriorated” too, in the sense that declining business led to declining tax revenues at the same time as modest increases in federal expenditures were made -- reluctantly and as emergency humanitarian measures rather than as deliberate, intellectually respectable, counter-cyclical policy. If the authorities had acted with sufficient vigour to relieve bank indebtedness, the experience of similar episodes (such as 1987) suggests that the banks would have been able and willing to maintain their loan portfolio and so prevent the collapse of the money supply and spending. In fact the money supply did contract drastically, by about a third between late 1929 and mid-1933. At the same time the perceived loss of financial wealth, following the collapse of stock and real estate prices, had increased the propensity to save as households and businesses attempted to increase their liquid balances.
The demand for money (cash plus demand deposits) rose as a percentage of declining income. This measured decline in income velocity aggravated the impact of monetary deflation. Temin (1976) emphasized that in real terms the money supply was rising slightly because prices were falling faster than the money supply during the first two years of depression. But it makes little sense to regard monetary conditions during this period as “easy” when it was these very declines in prices that were so discouraging to business and that were persuading consumers to delay purchases. The fall in output was accompanied by a fall in incomes, and the adverse income and expectations effect on spending considerably outweighed any positive real balance effect from falling prices or stimulus to investment from the fall in interest rates (nominal terms only).
This was evident to Currie from his reading of Keynes’s Treatise on Money and Hawtrey’s monetary theory of the cycle (Hawtrey 1929, 1932), both of whom drew activist monetary conclusions from the American experience after 1929 (Laidler, 1999: 225). Hawtrey in particular believed it possible to arrest and reverse the contraction with monetary policy alone, had it been vigorous enough, but did not eschew fiscal deficits as a vehicle for achieving the requisite expansion of money. Much of this was reflected in Currie’s Harvard PhD thesis (1931) and in his classes as Williams’s assistant.
In January 1932 Lauchlin Currie, P. T. Ellsworth and Harry Dexter White wrote a 33-page memorandum from Harvard (see note 7) that began by noting that the depression had already cost the American people more than the Great War and had engendered a loss of confidence in American leadership and American institutions that was becoming more marked as the depression lengthened. They deplored the failure of the monetary authorities to provide the reserves the banks needed to get out of debt, following the loss of reserves due to a flight into cash. Furthermore, whenever individuals or corporations saved by purchasing bonds or paying off a loan to the banking system their deposits were not re-lent and spent, but were instead used to reduce member bank indebtedness (currently $800 million) to the reserve banks. Thus more and more purchasing power (means of payment in the form of demand deposits) was being wiped out and banks were closing. It was urgent that this purchasing power be put back into the system through a vigorous (billion dollar) open-market purchasing policy.
They also advocated fiscal deficits. These should be financed by borrowing not from individuals but from the reserve and other banks, in order to receive deposits that have been newly created and not diverted from individuals. In this way a net increase in spending would be achieved, both directly and through secondary and subsequent rounds of spending which “would stimulate recovery in other lines in ever widening circles”. They urged the relaxation of gold reserve requirements that were constraining such action at that time. And they urged tariff reductions and devised a plan for the relief of the reparations and inter-allied debt problem that was depressing world demand.
They addressed and dismissed various objections to activist policies: that such measures would interfere with the “natural” operation of market forces; that the depression should be permitted to run its course because it is the vehicle for the wholesome purging of inefficiency from the industrial system; that deficits would undermine business confidence (the memorandum argued the opposite, because confidence depended on the state of aggregate demand); that deficits would saddle the nation with a burdensome national debt (an argument also dismissed by pointing to the fallacy of treating the debt of a nation in the same way as a debt of an individual); and that monetary expansion and fiscal deficits would be inflationary. The memorandum answered the latter fear thus:
It is only after much of the present enormous slack in our economic system has been taken up that the danger of inflation becomes real. Before that point is reached, the production of goods and services will have greatly increased. This additional production in answer to an increased demand is just what is wanted; it is the very goal of our economic system. As Keynes has so aptly said, “To bring up the bogy of Inflation as an objection to capital expenditures at the present is like warning a patient who is wasting away from emaciation of the dangers of excessive corpulation.”
As the depression persisted and deepened Currie became more and more aware that monetary policy alone could not bring about recovery. The demand for loans by business was at a very low ebb as falling income and expenditure caused inventories of consumer goods to pile up, and as excess capacity made investment spending unnecessary and unprofitable. Banks were no longer in debt but they were now unable to find credit-worthy private sector borrowers, and the federal deficit (and associated issue of new government debt) was too small to compensate. It was imperative that the latter be boosted to get the economy moving again. These ideas later earned Currie a reputation as an early “Keynesian”, though his published writings up to 1934 stressed the “perverse elasticity” of the banking system and the pro-cyclical nature of monetary policy (Currie, 1934). As Laidler (1999: 243-44) observed:
Though Currie’s views on what had caused the depression and what might have been done to offset it during 1929-32 did not change with the passage of time, his opinion on what monetary policy was capable of achieving in dealing with contemporary circumstances did change, and radically so, as the 1930s progressed… After 1934, Currie became a vigorous proponent of income redistribution as a means for bringing about increased consumer expenditure, and of fiscal deficits as a means of providing a ready supply of securities for the banking system to purchase, thereby mobilizing their large and steadily growing stock of excess reserves. The first set of measures would in due course become associated with Keynesian economics, and so to a degree would the second, though it is worth noting that Currie’s particular version of the case for deficit finance bore a closer resemblance to the possibility which Hawtrey (1925) had broached, albeit briefly and purely hypothetically, as a means for breaking a credit deadlock that would not succumb to open-market operations, than to anything that Keynes would propose in the 1930s.
As Simon Kuznets, Willard King and Morris Copeland’s early estimates of US national income became available, Currie was able to conduct the first estimate of the income velocity of circulation of the nation’s money stock (previous estimates were of the transactions velocity which was much less relevant, indeed misleading, for policy). He was also the first to compute a money supply series, defining money as means of payment – currency plus checkable demand deposits (now known as M1). His calculations of the movement in income velocity showed that it rose fairly steadily from 2.82 in 1921 to 3.48 in 1929. It fell thereafter, seriously aggravating the effects of the decline in the money stock.
Prior to Roosevelt’s inauguration on March 4, 1933, a new crisis developed. The resources of the Reconstruction Finance Corporation, established in 1932, were inadequate to prevent more and more bank failures in the absence of more vigorous open market purchases by the reserve banks. When Roosevelt assumed office in March 1933 he immediately declared a bank holiday. More than 3000 banks never opened their doors again and while their reserves remained frozen yet more of the nation’s money supply, hence monetary expenditure, was extinguished.
Thereafter the first phase of Roosevelt’s New Deal began. His original “brain trusters”, Rexford Tugwell, Raymond Moley and Adolf Berle of Columbia University, concentrated on the abuses of big business and attempted to curb profiteering through price and quantity regulations, profits taxes, and moves toward comprehensive national planning. The ill-starred National Industrial Recovery Act (NIRA) was signed into law on June 16, 1933 but struck down as unconstitutional in May 1935 by a Supreme Court that had no sympathy for the structuralist measures that the National Recovery Administration (NRA) had been promoting. A positive short-term effect of the NRA was that work-sharing provisions caused nearly two and a half million workers to be re-employed between June and October 1933: Barber [1996: 4]). Other measures included “codes of fair competition” submitted by trade and industrial associations, minimum wage laws, output restrictions and price fixing (similar schemes in farming were instituted through the Agricultural Adjustment Administration). There were bitter disputes, both inside and outside the administration, between those who favoured price ceilings (to help consumers) versus those who wanted price floors (to help business); and between those who favoured higher wages to help labour versus those who argued that this would raise costs above prices, squeeze profits and hinder recovery.
On the macroeconomic front Roosevelt had campaigned in 1932 on a budget-balancing platform but in office pushed hard, on pragmatic and humanitarian grounds,for appropriations for the Works Progress Administration. The NIRA included a peacetime record appropriation of $3.3 billion, to be allocated at the discretion of the WPA administrator. Though a record figure, this was still very modest in relation to need. As Currie (1978: 545) later remarked “It took too little to keep people alive”; and Barber (1996: 37) remarked that “Honest” Harold Ickes, the WPA administrator, “stood firm against authorizing projects before their long-run social utility had been clearly demonstrated. These qualities were not well calculated to produce timely action. Ickes’s posture, however, was congenial to a president who was then not persuaded that public works spending could be a pump primer and who stood for budget balancing in the normal operations of government.” The Budget Director, Lewis W. Douglas, emphasized that these expenditures were of an extraordinary and emergency character and that the administration’s commitment to budget balancing would not be compromised. And he insisted that soundness required new revenues, from taxes on business, to cover the service charges ($220 million per year) on the debt issued to finance the public works programme. The ubiquitous Yale monetary theorist Irving Fisher proposed a self-liquidating “stamped scrip issue” to finance the annual service charges, but his proposal was rejected.
Fisher was no fan of public works as a re-employment device. He preferred to see the private sector creating jobs, and believed this could be accomplished via monetary stimuli to counteract “debt deflation” (the burden on debtors as prices fell) that he thought was at the root of the depression. He was one of the voices, along with Cornell agricultural economist George Warren, who had argued for a rise in the price of gold through a gold purchase programme. This was implemented between September 1933 and January 1934 and the price of gold rose from $29 to $35 an ounce. The aim was to increase the money supply and so raise commodity prices to their pre-depression levels. However, despite strong monetary growth over the next four years (further boosted by flight of gold from a troubled Europe to a haven in the United States) prices recovered relatively little (from an index of 75 in 1933 to about 83 in 1937, with 1929 = 100). Galbraith (1975: 210-11) remarked that another of George Warren’s aims was that “by manipulating the gold price he believed that a great deal of other public and reformist action, including most of the New Deal farm program, could be avoided. He was one of the first in a long line of monetary reformers extending to Professor Milton Friedman… who have hoped that their changes would make other and more comprehensive government action unnecessary. They are monetary radicals because they are political conservatives.” The same is probably true of Irving Fisher.
As Barber (1996: 50) has observed:
The designs of both the structuralists and the monetarists shared a price orientation in their diagnoses of and prescriptions for the economy’s ills. The structuralists were preoccupied with price behavior in specific sectors: Thus, AAA’s policies sought to raise the prices of farm outputs deemed to be “basic”, and the NRA codes sought to stabilize the prices of manufactured goods and to banish “destructive” price wars. The gold purchase program, on the other hand, was intended to raise the general price level.
There was much tension between the supporters of these two strands of the early New Deal, but neither was “Keynesian” in the sense of offering a coherent intellectual (as opposed to humanitarian) rationale for deficit spending to maintain the flow of aggregate demand at the full employment potential level of output. The structuralists were preoccupied with relative prices to achieve full employment through allocative efficiency; the monetarists thought all this could best be achieved through the stabilization of the general price level at its pre-depression level. However, by the time Roosevelt had assumed office it had become clear to some that though monetary policy (and traditional monetary theory) may be relevant in normal times and normal cycles, the times now were far from normal. Monetary measures alone would therefore now have very weak effects. From the end of 1933 the expansion of money coincided with a big increase in commercial banks’ holdings of reserves in excess of their legal requirements. They were scarred by the wave of bank failures and were also experiencing difficulty finding credit-worthy customers in the depressed private sector. Interest rates were falling to unprecedentedly low levels.
Faced with what Ralph Hawtrey had diagnosed as a rare “credit deadlock” and that Keynesians refer to as a “liquidity trap”, the most articulate champions of deficit finance were to emerge from a surprising quarter. Galbraith (1971: 48) has remarked that “Not often have important new ideas entered a government by way of its central bank. There is not the slightest indication that it will ever happen again.” In June 1934 Eugene Black resigned as governor of the Federal Reserve Board and President Roosevelt was looking for a successor. Earlier in 1934 Marriner S. Eccles, an unorthodox millionaire Mormon banker from Utah had joined the US Treasury as an adviser to the newly appointed Treasury Secretary Henry Morgenthau Jr. On the urging of Rexford Tugwell and other leading members of the Roosevelt administration who were impressed by Eccles’s bold advocacy of deficit spending, Morgenthau was persuaded, against his own conservative instincts and despite the evident clash of personalities that was to worsen over the years, to appoint him as a special adviser in the reorganization of the Treasury Department.
Most bankers shared Morgenthau’s strong commitment to “fiscal responsibility” without which, they claimed, there could be no business confidence, hence no recovery. Eccles challenged these nostrums. Though untrained in economics he was a very successful practical banker and businessman who took pride in the fact that none of his bank’s depositors had lost a cent, despite the wave of failures affecting other banks in the early 1930s. At the Treasury he met and teamed up with Lauchlin Currie who was at that time preparing a report for Jacob Viner. His remit was to devise “the most perfect monetary system for the United States” without immediate attention to political considerations. He developed a 100% reserve plan that would enhance monetary control by insulating the nation’s supply of money from the lending of money, from shifts between cash and deposits, and from the holding of excess reserves (Phillips, 1995, chapter 8). When Eccles met Roosevelt in November to discuss the terms on which he might become head of the Federal Reserve, he took with him a memorandum prepared by Currie that outlined desirable reforms of the system. Roosevelt promised his support and Eccles began his long tenure at the Fed, taking Currie with him. He immediately drafted legislation to strengthen the powers of the Fed to conduct discretionary counter-cyclical open market operations and to vary reserve requirements (but stopping well short of the 100% reserve plan), with a shift in the locus of control from New York to Washington to create a central bank for the first time in US history.
There was fierce opposition to the new banking bill from those who still believed that the primary duty of a central bank was to monitor the quality of bank credit (loans) – the pro-cyclical real bills approach to monetary policy favoured by Senator Carter Glass, the father of the 1913 Federal Reserve Act -- rather than the quantity of money (means of payment). In his testimony to the House Banking Committee in February 1935 Eccles nonetheless expressed his view that at that time recovery depended not on monetary policy per se but on fiscal deficits financed by government borrowing. An activation of idle balances was required rather than an expansion of money, since the latter would merely create more excess reserves and store up a potentially excessive expansion of loans and money at a future date. Monetary policy was asymmetric, it being easier to stop an expansion than to end a severe contraction. So long as there was an unwillingness to borrow, monetary expansion would be “like pushing on a string”. This was a much-quoted phrase first introduced by Congressman Goldsborough in support of Eccles, echoing Hawtrey’s concept of a “credit deadlock”. Eccles himself, however, was more influenced by the under-consumptionist thinking of William Foster and Waddill Catchings (with its emphasis on income distribution and the low purchasing power of workers) than of Keynes whom he had never read except in small extracts (Eccles, 1951: 132). He relied on Currie to draft his more formal speeches in defence of the “Keynesian” polices he had thought through for himself on somewhat different grounds.
Senator Carter Glass fought hard and long in the Senate to block the new legislation (details are in Meltzer, 2000: chapter 6). As Barber (1996: 94-95) writes:
In the end, Eccles got the essentials of what he wanted, but not without a fight. Professional opinion among economists and alleged monetary “experts” was sharply divided about the merits of the bill. James P. Warburg, a New York banker and sometime consultant to the administration in 1933, was outspokenly hostile. He rejected the theory underlying the structure of the bill, which he characterised as Curried Keynes, “for it is in fact a half-cooked lump of J. Maynard Keynes – the well-known British economist whose theories find more support in this country than in his own – liberally seasoned with a sauce prepared by Prof. Laughlin [sic] Currie.
During the turbulent months during which the Banking Act, signed in August 1935, was passing through Congress the economy was beginning to recover from the depths of the Depression. But there was a long way to go before output and employment could recover their 1928-29 levels. A combination of shell-shock from earlier failures and sluggish demand for loans meant that banks were accumulating substantial excess reserves rather than seeking potential investors as gold flowed in from Europe. Interest rates were at historically very low levels and since there were still fears that inflation could resume (prices rose by 8% in 1936), with nominal interest rates following suit, it was understandable (even before Keynes presented his formal analysis of the “speculative motive” for holding idle balances) that banks would be reluctant to exploit their full ability to increase their earning assets. Under these circumstances Eccles and Currie realized that greater emphasis would need to be placed on measures to stimulate public and private spending through direct fiscal means, even though this meant a turf war with the Treasury and repeated clashes with Secretary Morgenthau whose main prescription for recovery was “to boost confidence” by balancing the budget.
The power given by the 1935 Banking Act to vary reserve requirements was to prove highly controversial. As excess reserves piled up there was widespread anxiety (shared by John H Williams, Lauchlin Currie, Irving Fisher and others) that as the economy continued to recover there would be an increase in loan demand, interest rates would pick up from the current floor, and banks would be able to expand deposits without check. The required reserve ratio was increased by 50 percent in August 1936. This reduced excess reserves by $1.5 billions, but this still left nearly $2 billion excess. There was no adverse effect on interest rates, the money supply continued to increase, and the economy continued its upward course. But there were worrying developments arising from a growing tendency to mark up commodity prices following increased unionization and associated wage increases. Wholesale prices rose by about 7 percent in 1936. This, together with anticipation of labour market strife and further wage increases, was encouraging large inventory accumulations that posed a danger of recession if sales did not keep pace and excess stocks were worked off at the expense of current production. Nevertheless, in January 1937 the Board announced a second increase in reserve requirements, effective March 1, followed by a final increase on May 1. Excess reserves remained high because of a continuing inflow of gold, though the Treasury sterilized much of this in late 1936. The rapid growth in the stock of money slowed, and halted in March. These measures were all designed to be “precautionary” rather than restrictive. It was believed that since excess reserves were “redundant” or superfluous, the mopping up would have no effect on recovery.
However, beginning around June 1937 recovery turned rapidly into a deeply alarming recession. Real GDP would fall by 18% over the next thirteen months (Meltzer, 2000, chapter 6: 125). At the time few people blamed the monetary measures, though the slight increase in bond yields, from an all-time low of 2.46 percent in early March to 2.8 percent in early April (after which they declined again), had angered Treasury Secretary Morgenthau (though it was the Treasury that took the decision to sterilize gold inflows from December). His main concern was that a rise in interest rates would increase the financial cost of the deficit, and he kept pressing Roosevelt to trim government spending and balance the budget. Eccles agreed that higher interest rates were undesirable and he supported the Federal Open Market Committee’s decision in April to engage in compensatory open market purchases.
There is no evidence that the banks were suddenly denying requests for loans by business or government, or imposing stricter conditions as a result of the increased reserve requirements. Thus the almost exclusive modern focus on a supposedly inept monetary policy as the cause of the sharp downturn in 1937 seems misplaced (for example, Steindl, 1995, in support of Friedman and Schwartz’s influential 1963 study). Meltzer (2000), however, offers a more eclectic explanation, and another exception is Romer and Romer (1989: 131-32) who emphasise two non-monetary forces acting to decrease output in 1937: the fiscal downturn, and the way in which the Wagner Act led to large inventory accumulations in anticipation of labour market strife that did indeed occur in 1937, coinciding with an end to inventory accumulations. They also note that the behaviour of reserve holdings ran counter to Friedman and Schwartz’s interpretation, in that there was no discernible change in the behaviour of reserves as a fraction of deposits until December 1937, seventeen months after the first increase in reserve requirements was announced and after the declines in money and industrial production were largely complete.
In a note to the writer, August 2, 1988, Currie admitted that probably the reserve requirements would not have been raised if the recession of 1937 had been accurately forecast. But he wrote that “this is a different matter than holding the raising responsible for the recession. For that the very sharp, even drastic, reduction in the fiscal cash deficit is the more convincing explanation of the sharp decline in the rate of growth in sales and the consequent piling up of inventories.” He also noted that “few theorists would expect an immediate impact on incomes and sales to result from the small decline in deposits that took place, especially as there is such an other more convincing explanation of the causation of the fall in aggregate demand.”
By the fall of 1937 it was clear to all that the economy was in decline. Morgenthau infuriated Eccles (a tireless advocate of public spending) by declaring that this was proof that deficits cause recessions through their adverse effect on business confidence. He placed his faith in the driving force of private enterprise. By contrast, Barber (1996: 111) states that the recession was a conversion experience for Alvin Hansen who had reacted adversely when the Keynes’s General Theory first appeared. In a paper to the Academy of Political Science, November 1937, before the depth of the recession could be fully appreciated, he began to rethink his position. He wrote:
We are currently witnessing a rapid shift in income-creating expenditures both public and private. The props which have been lifting the level of consumption are being withdrawn. The automobile boom has tapered off. We are moving toward a saturation point in installment sales. The government stimulus to consumption is in process of being completely withdrawn in a dramatic reversal from a plus of three billion to a minus of four hundred million dollars within a single year. The full force of this sudden change upon our recovery has perhaps not been adequately appraised. (Hansen, 1938: 66)
In fact the fiscal stance had been subjected to detailed and continuous scrutiny for its net income-creating effect ever since 1934. While still at the Treasury, and encouraged by Jacob Viner, Lauchlin Currie began work with Martin Krost, a brilliant student whom he had brought with him from Harvard, to develop a monthly series initially known as a “pump-priming deficit”. These figures adjusted the government’s official budget statement of revenues and expenditures to reflect the varying effectiveness of different categories on the circular flow of income and expenditure, making allowance for those expenditure that were for currently produced goods and services and those that were merely transfers, or that merely changed savings.
In a memorandum Federal Income-Increasing Expenditures, 1933-35, written late 1935 (reprinted in Currie, 1978), Currie and Krost reported that any similarity between the “net contribution” and the reported cash deficit was purely coincidental. The reported budget could be in balance while the net contribution was in heavy deficit. Thus there was no necessary conflict between those who wanted a balanced budget in the official sense and those who wanted the federal government to provide a big stimulus to business: “By selecting income-increasing types of expenditure and non-income-decreasing methods of raising revenue, it is conceivable that a balanced budget could be maintained and at the same time a considerable stimulus given to business.” Investment subsidies, for example, could have a powerful stimulatory effect while a tax on undistributed profits might have only a small negative effect. But there was no doubt in Currie’s mind that the conditions prevailing in the mid-1930s called for much more than a balanced expansion of taxes and spending. The size of the required deficit, whether in its explicit or “net contribution” form, was calculated according to the size of potential, full-employment income (based on 1928 with adjustments for population and productivity growth) and the size of the leakages from that income that would need to be offset.
The 1935 Currie-Krost memorandum can be seen to have anticipated not only the full-employment budget concept but also a rudimentary version of the “balanced-budget multiplier” idea. However, Currie never thought that the algebraic version that was later developed as a theorem had any relevance for policy purposes (Sandilands, 1990: 74-78). The theorem assumed a constant marginal propensity to consume and given money supply. This implies that velocity adjusts passively to support higher incomes. But if individuals and firms are subject to higher taxes their initial portfolios are disturbed. When they get their money back (in practice not immediately) they may use some of it to restore their depleted cash balances. Thus the marginal velocity (corresponding to the marginal propensity to consume) could fall in the next round and reverse the initial stimulus.
The net impact on spending would in any case be much smaller than if the increased government spending were financed by borrowing. So even if there were a positive balanced-budget multiplier effect, the economic boost required in the 1930s would have called for a non-feasible tax-and-spend package. Samuelson (in Colander and Landreth, 1996: 166-67) hails the balanced-budget theorem without addressing its realism. In this respect Currie’s adherence to period or sequence analysis of pre-General Theory monetary theory, and his detailed studies of the demand for and supply of money in explaining the flow of aggregate expenditure was superior, for policy purposes, to Keynes’s instantaneous multiplier analysis. Patinkin (1976: 1101) noted that Currie was one of the first economists to subject Keynes’s investment multiplier to empirical test, finding that it was highly variable in the short term. But Blaug (1991: 174) has maintained that it was precisely the rigour and simplicity of Keynes’s static, single-period equilibrium approach that explains the appeal of the General Theory and why the Keynesian revolution took hold so quickly.
Because of the intense passion aroused at that time by the very word deficit, the term “pump-priming deficit series” was soon dropped in favour of the “Federal net income-increasing expenditures series”. It was also realised early on that in the prevailing conditions, more than a one-shot priming of the pump would be required and that deficits would probably need to be sustained for some time. According to Alan Sweezy (1972: 118-19) the new title was “a semantic triumph of the first magnitude. It brought out the common element in all the government’s fiscal operations. No one used to thinking in terms of the net contribution could advocate promoting recovery by increasing public works spending while at the same time cutting government salaries and raising tax rates.” The figures were never published (the Federal Reserve Board’s director of research, E. A. Goldenweiser, blocked this and similar publications on the grounds that “it might cause trouble”) but mimeographs circulated widely in New Deal circles.
The income-increasing expenditure series was to assume considerable significance in diagnosing the causes of the 1937-38 recession. The outlines of what Barber (1996: 125) has called a “domesticated Keynesian” analysis of recovery and relapse was contained in a prescient pre-General Theory memorandum to Eccles from Currie, April 13, 1935, entitled “Recovery”. The stress is on the importance of contra-cyclical fiscal measures to combat a “deadlock”, with monetary policy assuming a passive role at such times. After analyzing the prospects in various fields, Currie concluded that:
[I]n each important outlay for construction and equipment expenditures which we have considered, the conclusion is the same: increased expenditures wait on increased demand and increased demand waits on increased expenditures… The most feasible way in which this deadlock may be broken is for the Government through its expenditures to increase incomes, and hence demand for goods, sufficient to create conditions making it profitable to increase the production of new capital. This, very simply, is the theory of pump-priming operations… As incomes and the demand for goods increase it is to be expected that the operations of one industry after another will approach a point where it appears profitable to invest in new plant and equipment. Similarly, in one town after another the rise in rents will make it profitable to build houses. The ideal, which it is admittedly difficult for a government to achieve, would be to vary the rate of expenditures in such a way as to insure a steady and uninterrupted growth in demand. This, more specifically, would require a slower rate of expenditure during the inventory buying upswings we have been experiencing in recent years, and then a greatly accelerated rate of expenditure when such buying decreases. When non-federal expenditure for equipment and construction increase, the Government may taper off its expenditures.
As economic recovery faltered in 1937 it became evident that “pump-priming operations” had not been sufficiently vigorous or steady. Fiscal policy was now operating in a perverse direction and Currie began to send increasingly urgent memoranda to Eccles. In February he condemned the 1937 Social Security Act because of the deflationary implications of building up a large reserve fund, especially when in 1937 there was nothing to replace the large pay-out of veterans’ bonuses (passed by Congress over the president’s veto) in 1936. In his memorandum “Comments on Business Prospects” (September 28, 1937) Currie emphasized the rapid advance in building costs (hourly wages in the construction industry had increased by 16 percent in little over a year, and building materials prices by 13 percent) relative to the increase in rents, and residential contracts awarded had been declining since June. In “The Decline in the Federal Contribution to the Growth in Community Expenditures” (October 19), he showed that in the three years 1934-36 the net federal contribution had been $3.2 billion, $3.1 billion, and $4.0 billion. These were sizable fractions of the growth of national income in those same years: $7.8 billion, $5.4 billion, and $8.8 billion respectively. In the nine months to September 1937, the Currie-Krost series showed that the net contribution had fallen to only $810 million ($90 million a month and still falling) compared to $3,080 million ($342 million a month) in the same period of 1936. He warned that the government’s contribution to buying power, already insufficient to offset the slowdown in private expenditures, may well turn negative in the near future.
On a Keynesian interpretation of the downturn in 1937-38, this fiscal reversal was a crucial causal factor. By comparison, variations in the degree of excess liquidity in the banks was of secondary importance. By cutting the federal deficit there was a fall in the supply of safe earning assets that the banks had previously relied on. They could not easily or quickly replace them with private sector lending, for the decline in government spending and the increase in tax and social security receipts were depressing demand for private sector output. This naturally reduced private sector loan demand. These factors, rather than the raising of reserve requirements, may account for some diminution of demand deposits and the continued high level of excess reserves. That the Fed resumed the purchase of government securities after April 1937 gives some credence to this view.
On November 8 WPA administrator Harry Hopkins and his economic adviser Leon Henderson, together with Lauchlin Currie and Isador Lubin, Commissioner of Labour Statistics met with the president in an unprecedented 4-hour session (Lash, 1988: 317-27). The New York Post reported the next day that “the four advisers minced no words in giving Roosevelt a hard-boiled review of economic conditions and with equal bluntness and vigor they told him that a disastrous recession can only be averted by a resumption of big-scale Government spending.” The group laid a report before the president that showed how, for the first time since 1931 the government took more out of the income stream than it poured back in. “If the Government takes taxes away from workers or corporations and uses these in bookkeeping items, such as old age reserve accounts, gold purchases, debt retirement, etc., and the amount exceeds what is paid for men and materials, then there is a deficit. That is what is happening now.”
It is noteworthy that here they used the term “deficit” to refer to a deficit of overall spending, not the budget deficit. The deficit in the income stream had to be reduced by increasing the federal contribution; that is, by increasing the budget deficit. But in a speech the very next day (November 10) Secretary Morgethau declared that the latter deficit was excessive. A balanced budget was needed to restore business confidence.
As Stein (1969: chapter 6) put it, the Keynesians and the budget-balancers were now locked in a furious “struggle for the soul of FDR”. The report that the Keynesians placed before the president stated that if the government continued to take out more than it puts in then “(1) prices will not adjust quickly enough, (2) budget balancing will be pursued too far and deflation will result, (3) unemployment will increase, (4) buying power will be impaired, and (5) things will get out of hand.” The large increase in production in 1936 should have led to a vigorous increase in retail business in 1937. Instead, a combination of cost-induced (as distinct from demand-induced) price increases and cuts in government spending meant that the large increase in production could not be taken off the market because purchasing power was not large enough. Cost advances in the key construction sector were also highly damaging and needed to be offset by reduced financing charges. The report continued:
A part of the deficit was filled by increase in installment buying, which merely means that future buying power is already spent. All this talk about production creating its own purchasing power is absurd when prices increase. Then inventories pile up and real purchasing power stays the same.
Some experts believe this is merely a lull, catching up with the frantic inventory buying which took place when prices were going up last winter and that when these stocks are worked off, business will resume as usual. It is far from certain that the matter is so simple as just overloading of inventories.
It is difficult to see where additional purchasing power is to come from, that is, large and effective quantities of it, such as are needed if we are to move forward vigorously. Farm income is at its peak. Steel will hold its prices up too long. Automobiles will run into sales difficulties. There is little hope for big volume in textiles. Men’s clothing and all garment selling is having trouble. Rayon yarn production for the first time in months is being reduced. Auto tire companies and many others are slowing down production.
Regardless of whether this decline is temporary or whether it is the beginning of a major depression, there is urgent need to keep a close watch on things.”
In fact the economy was in a tail spin. In a speech to Congress a few days after his “Keynesian” seminar, Roosevelt asked: “What does the country ultimately gain if we encourage businessmen to enlarge the capacity of American industry to produce unless we see to it that the income of our working population actually expands sufficiently to create markets to absorb the increased production.” But Roosevelt initially sided with Morgenthau. Disaster followed (Brinkley, 1996: 28); and not until April 14, 1938, after the worst period of his long tenure in the White House and after a strong letter from Keynes in February, did Roosevelt at last ask Congress (over the continuing objections of the Secretary of the Treasury) for more than $3 billion of spending or lending in the immediate future for relief, public works, housing and assistance to state and local governments (Barber, 1996: 114).
Shortly afterwards, Roosevelt delivered a “Monopoly Message” to Congress, April 29, in which he proposed an appropriation of $500,000 to fund an exhaustive investigation into the concentration of economic power. The resultant Temporary National Economic Committee (TNEC) was to generate some 30 volumes of testimony over the next three years.
This inquiry had been mooted for over a year. In a letter to Eccles, March 23, 1937, Currie wrote: “Friday I attended a meeting of the Industrial Committee of the National Resources Committee… They are planning to recommend to the President that a national conference on productivity be called… Most of the emphasis was placed on the removal of restrictions on output of various kinds and I suggested that some emphasis be placed on the problem of securing full and continuous employment, since our greatest waste of resources in the past has been attributable to depressions.” It was with this in mind that Currie arranged for Galbraith to conduct a review for the National Resources Planning Board of the impact of public works (see above). He also persuaded Leon Henderson and Jerome Frank at the Securities and Exchange Commission (SEC), the main instigators of the TNEC, to include the study of macroeconomic policy as well as the study of monopoly and industrial concentration. Stein (1969: 168; Brinkley: 1996: 128-36) observed that the TNEC hearings turned out to be mainly a showcase for Keynesian economics, with Lauchlin Currie and Alvin Hansen the star witnesses, having teamed up, as “Mr Inside and Mr Outside” (Tobin, 1976: 33) to present complementary presentations in May 1939 of the theoretical and empirical case for compensatory fiscal policy.
Hansen used the occasion to elaborate on the “mature economy” and “secular stagnation” theme he had first presented as his presidential address to the American Economic Association in December 1938. To the TNEC he registered his “growing conviction that the combined effect of declining population growth, together with the failure of any really important innovations of a magnitude sufficient to absorb large capital outlays, weighs very heavily as an explanation of the failure of the recent recovery to reach full employment.” It was clear that public investment on a very considerable scale would be needed to supplement private investment. To drive the point home, Currie (1939) then explained and presented charts showing the “income-producing expenditures that offset savings”. Barber (1996: 124) summarizes his argument thus:
As savings were withdrawals from the income stream, the economy was doomed to a chronic state of underemployment unless these withdrawals were “offset” by capital spending by business, outlays for residential housing construction, lending abroad, or loan-financed expenditures by government. As a shortfall in the private sector’s capital spending was expected, government’s role as a spender would be crucial. Under questioning, Hansen and Currie acknowledged that tax reductions might pay dividends in stimulating private spending. But their central argument held that government could better manipulate aggregate demand by other means.
Barber concluded that the Hansen-Currie line of analysis amounted to a domesticated Keynesian perspective on the performance of the economy. It was Hansen’s belief, however, that it was the war rather than the 1937-38 recession that finally shifted opinion to accept the practical applications of Keynesianism in terms of employment policy (Colander and Landreth, 1996: 104-6). There was violent opposition to Hansen’s views on the public debt: “The American economists were all dead against it”, and he singled out Henry Moulton, the president of the prestigious Brookings Institution. “There was practically nobody in the United States who accepted Keynesianism up to and as we got into the war.” (See also Evsey Domar’s interview in Colander and Landreth, 1996: 187-88.) Currie too, in an unpublished memoir (1951: 92), wrote:
Those of us who pioneered in the field of forecasting and in advocating policies of adjustment not only received little credit but actually were subjected to a good deal of criticism and abuse. I was somewhat protected from the latter by the fact that nearly all of my work was carried on inside the Government, though I was regarded with suspicion by many of the academic economists and certainly by many business men. Alvin Hansen, however, was abused and ridiculed and even accused of something like lack of patriotism for daring to suggest that there might be too much saving or that there were limits to the possibilities of profitable private investments of savings. I doubt very much if he would have been offered a chair in economics in Harvard if those views had been known in advance. Keynes was for years regarded as the Archpriest of economic unsoundness and few people were the target of so much criticism from the professional economists of the United States.
On the other hand, no criticism was meted out to those professional economists who through this tragic decade betrayed their trust and continued to talk nonsense about balancing the budget and restoring confidence.
Such attitudes help explain the defeat, as late as 1939, of the Works Financing Bill even though this was framed in such a way that a major spending programme would be financed “outside the budget”, in hopes of appeasing the budget balancers. Nonetheless, Roosevelt was by then less reticent about spending a way out of recession and the federal net contribution nearly doubled in 1939 to around $3.6 billion.
The New Deal of course was about much more than the size of public spending. However, in the absence of macroeconomic balance relatively little could be expected of microeconomic reforms. Gardiner C. Means continued to insist that laissez faire was played out and that detailed industrial planning was called for to eradicate the malevolent influence of administered prices and the output-suppressing propensities of producers with market power (Barber, 1996: 126; Lee, 1990). By 1938-39, however, the stress was on spending first, structural reform second. The spenders thought that monopoly was as much the consequence as the cause of depression. Expansion of the market, domestic and foreign, would offer opportunities for greater competition from new firms and products.
In fact the greatest expansion of markets would come from the demands of war. Yet, as Galbraith has emphasized, for the United States the Second World War was the cheapest in history in terms of the squeeze it imposed on non-military production. So great was the slack in the system that it was possible, with substantially the same capital equipment as existed in 1940, to wage a mighty war on two fronts, equip the allies, put 12 million men in the armed forces, and at the same time increase the civilian standard of living. Nevertheless, the refusal of Congress to pass the 1939 Works Financing Bill, for example, meant that the United States entered the war with much less addition to railroad and electricity generating capacity and improved highways than, as the war showed, it was capable of producing. Naturally, however, there were many specific bottlenecks and shortages in the transition to a war economy. Also, too little was done to apply the logic of Keynesianism to wartime, and close an excessive deficit by raising taxes. It was left to J K Galbraith, in his capacity as the “czar of prices”, to subject price and wage advances to close scrutiny and to fight the profiteers.
The lasting legacy of the theoretical, empirical, and practical experience of the depression and war years was the February 1946 Employment Act and the creation of the Council of Economic Advisers. Its passage through Congress was stormy, and the original bill that Alvin Hansen drafted in August 1944 was much watered down. Nevertheless, a statute that affirmed governmental responsibility for “maximum employment, production and purchasing power” was a significant advance, for Keynesians, over the much more limited mandate for government that, for example, was preferred by Irving Fisher and the Chicago School with their rules-based price stability goal for monetary policy, and with fiscal policy aimed at low-level balanced budgets. The war itself accustomed people to higher and more progressive rates of taxation and government spending and these were only partially retrenched in peacetime. This introduced a much greater degree of built-in stability by effectively increasing the marginal savings rate at the full employment level of income and expenditure.
Nonetheless, with Roosevelt’s death in April 1945 the liberal establishment that had surrounded him was rapidly replaced by a more conservative power elite, and the potential peace dividend was squandered for 40 years on a futile Cold War and several nasty hot wars. Unlike in the 1941-45 war when vast underused resources could be mobilized, in the era of full employment the military-industrial complex (Galbraith’s term) has sucked resources and talent away from education, health, housing and the arts. The challenge of the “mature economy” has turned out to be not Hansen’s stagnation thesis, but the challenge of public squalor, crime and incivility amidst unprecedented but unequally distributed private affluence, much of it due to the unearned increments of land values and to inadequate competition and mobility. In the affluent society what matters for economic and social welfare is not the size of GDP but its composition and distribution.
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