What 1933 can teach us about coherent policies
In early 1933, output in the US had fallen 25 percent from its peak, deflation was averaging 7 percent a year, and the money supply dropped over 30 percent as waves of bank runs engulfed the financial system. In April 1933 Roosevelt abandoned the gold standard, converting what had been effectively real government debt into nominal government debt and opened the door to implementing an “unbacked fiscal expansion.” Jacobson and al. define “unbacked fiscal expansion” as one where people are convinced that a deficit today does not come with a promise of future surpluses to repay the debt. Soon after Roosevelt took these measures the deflation stopped and the price level rebounded.
Jacobson and al. argue that this was a coherent policy since it combined a monetary policy that pegged short-term nominal interest rates near zero and a fiscal policy that followed sound finance by balancing the regular budget, while running chronic deficits on the “emergency budget.” The lessons for today:
- Many countries now suffer from below-target inflation rates and tepid economic growth. Rather than relying on a joint monetary-fiscal attack on the problem, as Roosevelt did, these countries are leaning entirely on monetary policy. Central banks in the Euro Area, Sweden, Switzerland, and Japan have set policy interest rates below zero and undertaken large-scale asset purchases in an effort to reduce real interest rates and stimulate aggregate demand and inflation. But fiscal policies in these areas fluctuate between fiscal stimulus and fiscal austerity.
- A second lesson from the Roosevelt policies is that fiscal stimulus and fiscal sustainability need not be in conflict. When the aim is to raise inflation and economic growth, higher nominal government debt—if people are convinced it does not portend higher future taxes—can achieve both the macroeconomic objectives and the goal of stabilizing debt.
Recovery of 1933
Authors: Margaret M. Jacobson, Eric M. Leeper, Bruce Preston
From: Indiana University, University of Melbourne
