Ending the Great Depression and the Regulation Legacy

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The Great Depression has enjoyed renewed interest in the last couple of years. Not only because the Great Recession of 2008/09 is the worst economic crisis since the 1930s, but also because there is the suspicion that the removal of the regulations that had lasted since the last great downturn have contributed to the recent fiscal woes. Current debates over the proper monetary and fiscal policy have been tinted with Keynesian revivalism, so a look at the New Deal stimulus programs and economic reforms is pertinent. There is also the wider question of whether or not the government should be involved in regulating the economy, financial markets or other industries. Fiscal stimulus may not have had much of an aggregate effect on production, but did supply optimism and hope. The most important lessons from the Great Depression are those regarding the monetary factors in the recovery and the stabilizing force of practical and balanced regulations.

Christina Romer provides strong evidence that a demand side stimulus, which spurred growth in aggregate demand, was the primary factor that resolved the Great Depression. This demand was triggered by a growth in the money supply as measured by M1, which from 1933 until 1937 grew at close to 10% per year. Without this extraordinary growth rate in money, Romer argues that GDP would have been 25% less in 1937 and almost 50% less in 1942. The increase in M1 led to expectations that inflation would take hold in the future and caused real interest rates to fall below zero, instigating a rise in spending (Romer 759). The average 8% expansion in GDP per year between 1933 and 1937 was stimulated by a boom in demand for durable goods and fixed investment originally encouraged by negative interest rates (Romer 757). Gold inflows to the US brought forth the rise in the money supply, and this was at first due to President Franklin D. Roosevelt’s policy of devaluing the dollar relative to gold, and later on to a larger degree with the safeguarding of gold in American banks by Europeans during the outbreak of World War II (Romer 773). The War signified the final end of the Great Depression, but the monetary inflows were the necessary factor rather than direct government spending.

In 1932, Franklin D. Roosevelt won the Presidency by promising the American people a New Deal. This policy stance was the polar opposite of incumbent President Hoover’s non-interventionist approach to the economy, and amounted to a view that government ought to use its unique power position in creative ways to search for a solution to persistent stagnation. The New Deal was a hodgepodge of fiscal stimulus for jobs and infrastructure, social safety nets, and economic regulations designed to ward against future depressions. Romer (767) demonstrates that fiscal policy was an immaterial factor in production growth after 1933 until 1942 where the difference it made was slight. Programs like the PWA and WPA contributed to the employment of 3.6 million people, but this still left 11 million without work even as late as 1938 (Johnson “The New Deal” Lecture). However, the New Deal reforms brought hope and confidence to the millions of Americans who were out of work and suffering from long term economic distress. The institution of Social Security is a lasting and popular benefit from the era. Additional new institutions included the formation of the SEC, which oversees the securities exchanges, and the passage of regulatory measures, such as Glass-Steagal, which separated commercial and investment banking, provided more security to investors and stabilized financial markets.

Starting in the 1970s, economics went through a dramatic paradigm shift that turned upside down the assumptions left over from the Great Depression. The new sentiment was that regulations had hurt the economy and that markets would be more efficient and lead to greater prosperity if they were free of government fetters. The new assumptions that dominated economic thinking at this time were not really new, but a revival of neoclassical theories led by the Chicago School and Milton Friedman. The first sector of the economy to be de-regulated was transportation. For example, the Motor Carrier Act of 1980, reduced authority over the trucking industry by the Interstate Commerce Commission (ICC), which allowed for easier entry into the market, as well as less controls on the weights and types of cargo transported. Regulations were originally imposed on the motor carrier industry in 1935 because the industry was experiencing rapid growth and such vigorous competition that the instability of trucking could have had a detrimental effect on the wider economy (“Regulation” 4). The deregulation of motor carriers has contributed to beneficial industry restructuring which resulted in lower prices and higher shipping volumes (“Regulation” 5).

The ideology that promotes deregulation hinges on the belief that market mechanisms create a self-correcting and self-policing environment that works better as a matter of economic law than any potential regulatory regime. In this view free markets are regulated by competition which ensures the greatest possible efficiency and pushes innovation. Government interventionism can even make things worse according to the laissez-faire perspective, because of the problem of agency capture. This is when the industry that is being regulated infiltrates their own oversight agency and runs it for the benefit of the industry rather than the consumer and the country, while additionally preventing any market mechanisms from correcting the problem (Johnson “Age of Deregulation” Lecture). Deregulation does not always work out for the best however. Lax controls over the energy markets did not lead to cheaper prices and more efficient production, but brought volatility to prices and risks to the constant supply of electricity. Energy deregulation was spearheaded by Enron with millions spent on campaigns and lobbying (Beder), and their ultimate downfall illustrates how deregulation, or no regulation, is not automatically the best economic policy.

Economic regulation should be considered by government whenever the risks to the wider economy can bring systemic distress. This can never be an exact science though, and will always involve a cost/benefit analysis of the particulars in each situation. Sometimes regulations may need to be imposed because circumstances demand it, such as the controls placed on the motor carriers in the 1930s to stabilize the industry. Circumstances at a different moment in time may demand deregulation, and in the future we may again need re-regulation of the same industry. The ideological rejection of any need for regulation in any circumstance is closer to economic religion than economic science, and generic references to the free market or socialism are tantamount to senselessly shouting “heresy”. To ensure stable growth and the widest share of prosperity, the government has to be ready to step in when observable facts illustrate that markets have failed and will likely continue to do so without intervention. The best example of this process in recent times was the Enron scandal and the subsequent passage of Sarbanes Oxley. As someone who works in a large corporation in financial services, I am familiar with Sarbanes Oxley audits and I am in total agreement with the need for this sort of accounting oversight. I think this protects me personally as well as society in general, and the associated costs are well worth it.

Jared Roy Endicott