One of the problems with economic history is that it is difficult to "test" it properly. With regard to the Great Depression and the New Deal, there is still a very loud contingent of Keynesian economists who insist that had Hoover and Roosevelt just spent even more money than they did, we would not have experienced a prolonged depression. Other economists, notably the Monetarist school founded by Milton Friedman and Anna Schwartz, insist that responsibility must lie with the Federal Reserve for not acting quickly enough to stem deflationary pressures, while still other economists, especially the Austrian school, claim the problem was caused by government intervention into the market place. All these writers can point to some evidence in support their position, though in the case of the Keynesians, that evidence is very narrow and often somewhat contrived, especially when it appears from the pen of popular columnist Paul Krugman. But the problem is that we cannot simply directly test what would have happened had their been no New Deal, or an even greater amount of spending on the New Deal. Similarly, we cannot directly test the effects of monetary policy. What we can do is carefully examine what actually happened before, during, and after the Great Depression using these three models and see which interpretation best accords with the known facts. Such a project requires a great deal more familiarity with economics than most historians possess. Not surprisingly, studies which have done this sort of analysis in the past, most notably Murray N. Rothbard's America's Great Depression have not been very accessible to the public at large. This new book by economist Robert Murphy is at once immanently readable and a good synopsis of present day scholarship.
After briefly discussing the three main schools of thought about this crisis in American history, Murphy is quick to dismiss with the Keynesians. The argument that government spending was what saved us from the Great Depression, and that a lack of spending by Hoover caused the problem is fairly easy to disprove. Historians have long known that Hoover was a staunch interventionist in the economy and he rejected the advice of his own Secretary of the Treasury to simply let the bad investments liquidate themselves, a policy that had worked wonders in the earlier contraction of 1921. (Indeed, some historians of a left wing bent have chosen to praise Hoover for his intervention, most notably Joan Hoff Wilson in her classic study Herbert Hoover: Forgotten Progressive.) Of course, we cannot know if the economy absolutely would have recovered in the absence of Hoover's many interventions into the market. All we can say for certain is that he was not a laissez-faire president who did nothing while the economy contracted around him. Those who make this claim, most notably Paul Krugman, are either astoundingly ignorant or fundamentally dishonest. I tend to lean (charitably) towards the former position. As an ironic aside, Hoover was anti-interventionist only in foreign policy. Yet the institute that still bears his name is now a hot bed of neo conservatives who favor intervention everywhere in the world. But as a politican he did remarkable work at trying to set a floor for wages and prices, created the Reconstruction Finance Corporation and ran budget deficits that make those of today under Bush and Obama seem modest by comparison. Hoover rightly claimed he was the first President to not let the economy go its own way and four years later we were in the midst of the worst economic downturn in the nation's history.
Of course, there was some initial recovery during the early Roosevelt administration, but nowhere near to the extent seen in any previous downturn, even on a percentage basis. Indeed, one of the strong points of this book is that, unlike most economic histories of the period, Murphy examines several of America's large downturns, including the dramatic economic collapse of the 1870s in order to give some sense of comparison. Eventually of course, the early gains of the New Deal collapsed in 1937 and the economy right back to where it was under Hoover. Indeed, Treasury Secretary Henry Morgenthau rightly recognized that all the New Deal policies had failed, though they had left the US with an enormous debt. He was far more honest than many of today's leftists who share similar political positions.
So on the whole, the thesis that government spending mitigated against the Great Depression, and ultimately helped end it is simply not supported by the evidence. We cannot say for certain that even more government spending would not have solved the problem, and that is precisely what many today are advocating. But we can say that this was the first time the government responded to a downturn using these policies and not coincidentally, this was the first time (and hopefully the last) that instead of quickly realigning resources, the market fell into a quagmire. But easy as it is to dismiss with the Keynesians, one of the strengths of this book is that it also takes to task the Monetarists who many naively believe are the opposite of the Keynesians.
Monetarists tend to be somewhat more sympathetic to a free market, though not as much as many people suspect. Friedman, for example, was not opposed to a welfare state as such. He rightly argued that a negative income tax was a more "efficient" way to obtain the goal of an income floor for people than our current hodgepodge of programs, but his argument was pragmatic, not principled. Similarly, he supported government funding of schools and his still controversial voucher system would have made this program even more universal than it is today. He did not consider the fact that with government funding comes government regulations governing the use of that funding, a policy that would have effectively killed the innovations found in many private schools. But it is only when one looks at Friedman's big claim to fame, his monetarist theory of the Great Depression, that one realizes just how similar his perspective is to the Keynesian one. Friedman argued the Fed sat and did nothing (similar to the Keynesian claim about Hoover) while the economy contracted. Had they been more actively interventionist, he argues, we could have avoided the depression altogether. But, like the Keynesian argument, Friedman's claim simply does not stand up to historical scrutiny. The Fed dramatically lowered interest rates immediately following Black Monday, and they continued to do so throughout Hoover's reign. By contrast, in the 1920-21 contraction, the Fed had actually increased rates! And in the final analysis, both the Keynesian and monetarist claims essentially state the same proposition: government inaction caused the depression. And the historical evidence suggest both are wrong: government inaction simply did not happen during the Great Depression.
On the other hand, the Austrian claim that government intervention in the market caused the depression, is far more substantiated. Beginning in 1927, the Fed decided to inflate US currency in order, of all things, to assist the bank of England in preventing devaluation of the pound sterling. But this inflation, which went through the banks, had the effect of making many investments that were not profitable appear so, and a stock market boom followed. When the bust inevitably came, rather than allowing these bad investments to liquidate, as had happened in all previous busts, the government boldly tried to keep inflating the currency, with disastrous results. And, as Murphy points out in the close of his book, the same could easily happen today. Many are calling upon President Obama to become the new FDR and based on the early days of his reign, he seems quite happy in this role. Already, bailouts of businesses (a bad policy that began under the Bush administration) is proceeding apace, and the administration has even made tenative steps towards nationalizing the largest banks. Promises of tax cuts for the middle class and pay as you go spending, so widely trumpeted during the campaign, now appear to be temporary, in terms of the former, or completely forgotten in terms of the latter.
There are, however, some signs of (real) hope. Several Senate Democrats have refused to sign on to the proposed cap and trade carbon tax, a boondoggle for the economy if there ever was one, and it seems unlikely a tax hike will occur until the 2010 Bush tax cuts expire. And more citizens are becoming increasingly skeptical of the whole bailout agenda. That is a good sign, and books like these are a good place to start if you want to understand why a new "New Deal" is the last thing this country needs.