We live in uncertain times…that’s for sure!
Lot’s of chatter these days about what role the uncertainty over future policy regimes is playing in holding back a complete economic recovery. On the one side, we have the usual suspects claiming that the problem has little, if anything, to do with policy uncertainty. Instead, it is a lack of “aggregate demand.” Mark Thoma provides a link to an interesting study here that appears to support this hypothesis–on the surface, at least.
The study highlights the fact that small businesses are citing a lack of sales volume as their main source of trouble. Well, sure. But it’s not immediately obvious what this micro data tells us about the empirical relevance of the theory of “effective demand failure” in the current climate. Small businesses living in an intersectoral real business cycle model (a la Long and Plosser, JPE 1983) are likely to report similar things in the event of a large negative shock to an important sector of the economy (like the residential investment sector). If I’m a supplier of home furnishings, I’m going to cite a lack of demand for my product. But does this necessarily mean that the macro problem is a lack of aggregate demand? Possibly–but not necessarily.
In an earlier post, I entertained the idea of investment demand falling off the cliff in response to fundamentally bad news relating to the future return to capital spending; see here. I still think there is some merit in this idea, though the data I presented here has led me to re-think this position. I could be wrong, but I think this data presents a similar difficulty for standard Keynesian interpretations of investment spending collapse. In particular, the survey data I cite shows that long-horizon forecasts of real GDP growth remain resiliently optimistic throughout the worst parts of the recession. (Presumably, it is the long-horizon that bears most forcefully on current planned investment decisions). The same data shows an increasing amount of “uncertainty” (or disagreement) over forecasts. Of course, the data does not tell us the source of this uncertainty; but it seems reasonable to suppose that at least some of it is being generated by the government and the Fed (Disclaimer: the views expressed here are obviously my own!)
With respect to this uncertainty theme, a reader of my earlier post provided an interesting link Regime Uncertainty: Reports Keep Coming In. The author of this is one Robert Higgs (never heard of him before), who has also written this interesting paper: Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Resumed After the War. I’m not sure what you think of all this, but maybe the guy has a valid point.
Oddly enough, Brad DeLong provides some support for this hypothesis here: The New Deal: Lessons for Today. What do I mean by this? Well, let me quote:
Drawing lessons from the New Deal for the Great Depression requires, first, and understanding what the New Deal was. It was a gumbo: FDR took everything that was on the kitchen shelf and threw it into the pot on March 4, 1933 and then began stirring.
He quotes FDR himself as saying:
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.
Now, whether you agree with FDR’s approach here or not, I think you’d be hard pressed to argue that it did not contribute to a heightened degree of uncertainty over the likely future path of policy interventions. But clearly, something had to be done; so perhaps this approach was defensible under the circumstances.
Or was it? What sort of “common sense” was FDR referring to anyway? The U.S. economy had experienced severe economic contractions prior to 1930, the most recent in the early 1920s. While severe and distressing for many people, the economy always recovered on its own (the size of the federal government in those years was tiny in comparison to today). What was it about the contraction in 1930-33 that made it so much more different than before? Was there any reason to believe at that time that the economy would not recover on its own as it did before, without anything resembling a New Deal intervention? Why did the contraction of that period result in a “lost decade?” Is it really crazy to suppose that FDR’s “gumbo soup” approach may have prolonged the misery of that decade? I honestly do not know the answer to these questions, but I think they should be taken seriously.
Many people appear to buy into the standard myth of an established and stubborn free-market orthodoxy, led by Herbert Hoover, ready to drive the U.S. economy to hell–until FDR saved the free world with his New Deal. My own reading of that period in American history has left me with a different perspective (my views are still evolving as I continue to read, of course).
The economic orthodoxy of the time was largely persuaded by the benefits of countercyclical public works (see, Fabricating the Keynesian Revolution, by David Laidler). And Herbert Hoover was (initially, at least) a big proponent of public works (remember, he served as Secretary of Commerce from 1920-28). He described himself as a “progressive” and a “reformer” and in his writings, he criticized laissez-faire economics. His response during the great contraction was to introduce his own New Deal; see here.
Naturally, Herbert Hoover’s New Deal had many critics. Not the least of these were the Democrats in Congress (who were in a majority at that time), led by FDR himself. I am still reading through the history of that time (one needs to check several sources, since there appear to be conflicting reports and interpretations). But it seems clear enough that there was quite a bit of political wrangling going on–very much like what we see today, in fact. The Democrats at that time (much like the Republicans today) apparently did everything they could to stonewall the President and his policies. But at the end of the day, many of FDR’s New Deal policies were lifted from Hoover’s. Consider, in particular, this quote from one of FDR’s early advisers (Raymond Moley, writing in Newsweek, June 14, 1948):
When we all burst into Washington…we found every essential idea (of the New Deal) enacted in the 100-day Congress in the Hoover administration itself. The essentials of the NRA, the PWA, the emergency relief setup were all there. Even the AAA was known to the Department of Agriculture. Only the TVA and the Securities Act was drawn from other sources. The RFC, probably the greatest recovery agency, was of course a Hoover measure, passed long before the inauguration.
Of course, the U.S. economy continued to collapse despite Hoover’s New Deal. Does this not require some explaining? The most tumultuous events appear to coincide with the period between Hoover’s election loss and FDR’s official appointment to office. Consider this quote from here:
The election brought hope to many Americans in the autumn of 1932.
But Roosevelt did not become president until March 1933, four months after the election. And those months saw the American economy fall to its lowest level in the history of the nation. President Hoover tried to arrange a world economic conference. And he called on President-elect Roosevelt to join him in making conservative statements in support of business.
Roosevelt refused. He did not think it was correct to begin acting like a president until he actually became the head of government. He did not want to tie himself to policies that the voters had just rejected. Congress, controlled by Democrats, also refused to help Hoover.
It was a strange period, a season of uncertainty and anger. The Economic Depression was worse than ever. The lines of people waiting for food were longer than before. Angry mobs of farmers were gathering in the countryside. And the politicians in Washington seemed unable to work together to end the crisis.
Hoover said: “We are at the end of our rope. There is nothing more we can do.” And across the country, Americans waited — worried, uncertain, afraid. What would the new president do?
Whatever one’s political philosophy, I think that we might all agree that uncertainty over policy regimes has played a role in past depressions. And it may very well be playing a role in depressing the current recovery.