Sunday, February 22, 2009

Did the US recover from the Great Depression because of WWII?

There is a popular misconception that the US economy recovered from the Great Depression as a result of the military spending associated with World War II. A more extreme version of this statement is that Roosevelt’s policies had nothing to do with the recovery.

These statements are inconsistent with the data. Franklin D. Roosevelt became president of the United States in March 1933. Promptly he introduced four key policy initiatives: (1) suspend the Gold Standard, which allowed the Fed to expand money supply; (2) restore confidence in the financial sector through a process of restructuring and sanitizing commercial banks; (3) implement a fiscal stimulus package; (4) introduce new regulation. As a result of these measures, the growth rate of the economy was 10.8% in 1934, 8.9% in 1935, 13% in 1936, and 5% in 1937! Overall the US economy expanded by 44% during his first term. The US economy is supposed to grow at about 3% per year and not 3 or 4 times this rate. During the first term of Roosevelt, the US real GDP had returned to its pre-Depression level.

There is also a claim that Roosevelt’s term was associated with the highest unemployment rate and therefore his policies were unsuccessful. The high unemployment rate was a legacy of the Great Depression. During his first term, however, unemployment declined from 25.2% in 1933 to 14.3% in 1937.

The economy had another recession in 1938, which was a result of a policy mistake again, but the mistake was quickly reversed with a fiscal injection of $5 billion. And the economy continued its recovery. Because of the severity of the depression and its depth, it took many years for the economy to return back to its trend. But to say that there was no recovery until WWII is a clear misinterpretation of the data.

Ilian Mihov