Did FDR End the Great Depression?

My prediction is that politicians will eventually be tempted to resolve the [fiscal] crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt. And as that temptation becomes obvious, interest rates will soar. – Paul Krugman, 2003

Funny how the worm turns: now Krugman is cheerleading for inflation. Our economic leadership seems to have no way out of chronic budget deficits other living with them and turning Japanese, or inflating the burden away.

The huge ramp of spending gets the US to 6% (of GDP) chronic deficits by 2020 and after. Anything over 5% is considered unsustainable.

It is too large to be eliminated with income tax increases. Brookings estimates the top rate would have to go to 91% to get to a 2% chronic shortfall. At 77%, it would leave a 3% shortfall.

Both of these estimates assume the huge tax hike does not hammer future GDP growth, and that higher rates can increase the Federal tax take from 18% to 22% of GDP. History of rate changes, however, has has shown that changing rates does not modify appreciably the income tax take of around 18% of GDP. Instead, it slows or speeds up GDP growth. Higher rates, slower growth – and the gap does not close even to 2-3%.

Inflate or confiscate – which poor choice is it to be?

There is an alternative which has been tried three times in dire situations and worked each time. It is a sad commentary on the sorry state of our political discourse that the party in power will not even countenance the debate over the alternative, so in thrall they seem to be to a long-dead economist (Keynes). We may end up where we were in 1920 and 1980: having to finally apply the alternative after the inflation remedy gets out of control.

We know what happened in 1980: a tough Fed chair combined with tax cuts ended the Great Inflation that started with LBJ and spiraled out of control under Jimmy Carter. The Great Moderation followed for 25 years.

Less is remembered about 1920, when we had double-digit inflation and high interest rates coming after WWI and Wilson’s Democratic Party interregnum between many years of Republican rule with sound money policies. Harding took power amidst 15% unemployment and GDP falling off a cliff worse than we saw in 2008. Harding’s Commerce Secy, Herbert Hoover, coming off a government position managing part of the recent war effort, tugged at the new President’s sleeve urging Intervention! Spending! Harding wisely ignored him, cut taxes, cut spending, tightened money, and ended his Great Recession in ten months. The Roaring Twenties followed.

Even less remembered is what happened in 1945, at the end of WWII. The WSJ revitalized the history of the end of the New Deal in a recent op-ed, Did FDR End the Great Depression? FDR was convinced the only way to employ the 12 million returning soldiers was another New Deal program, but he died before he could impose his plan. The new President, Truman, proposed it (and note, this is when Truman is said to have pushed for national healthcare), but as the article explains, it was soundly rebuffed:

Congress—both chambers with Democratic majorities—responded by just saying “no.” No to the whole New Deal revival: no federal program for health care, no full-employment act, only limited federal housing, and no increase in minimum wage or Social Security benefits.

Instead, Congress reduced taxes. Income tax rates were cut across the board. … [T]op marginal corporate tax rates effectively went to 38% from 90% after 1945. …

By the late 1940s, a revived economy was generating more annual federal revenue than the U.S. had received during the war years, when tax rates were higher. Price controls from the war were also eliminated by the end of 1946. The U.S. began running budget surpluses.

Unemployment had remained double-digit throughout the whole New Deal. One year after the end of New Deal policies and the return of economic freedom, it was under 4% despite the huge return of soldiers.

As with FDR then, we have Krugman now, pushing a new New Deal. Peter Shiff takes Krugman’s arguments head on and shreds them. Here is the key argument on both sides:

In simple terms, Krugman believes that inflation is the best cure for burdensome debt problems. To prove his arguments, he points to the course followed by the United States in the decade after the Second World War. In 1946, due to unprecedented military spending during the war, U.S. public debt as a percentage of GDP came in at a staggering 122 percent – which is even higher than the 113 percent currently weighing on Greece.

Krugman endorses U.S. policy at the time which, he claims, concentrated on fostering growth instead of taking measures to drastically cut the post-war debt. He notes that by the end of 1956, the federal debt had not diminished in nominal terms, but had become much easier to bear because of the decade of GDP growth that inflationary policies had created.

He neglects to mention that during the five years from 1945 to 1949, federal spending dropped by 58% and taxes fell by 12%. Meanwhile, the budget deficit fell by 66% in 1946 and was in surplus from 1947 to 1949. In other words, although we did not pay down our nominal debt in the decade after the war, we did succeed in massively shrinking government and the burden that it places on society. Could it be that this had something to do with the post-war boom, or should we give all the credit to the monetary policy? (It is important to point out that our national debt did initially decline from 1945 to 1949,but the extra spending necessary to finance the Korean War reversed that trend.)