UNIVERSITY OF CALIFORNIA DEPARTMENT OF ECONOMICS

LECTURE 14

THE NEW DEAL MARCH 12, 2018

I. OVERVIEW OF THE NEW DEAL A. Fiscal policy actions B. Financial rehabilitation C. Programs aimed at raising prices

D. Strengthening the social safety net and helping workers

E. The high-employment surplus F. Size of the overall fiscal expansion G. IS-LM analysis II. THE IMPACT OF THE 1936 VETERANS’ BONUS A. Size and nature of the bonus B. Hausman’s approaches C. Expenditure survey of households 1. Basic idea: difference-in-differences 2. Complication 3. Results D. Cross-state variation in spending 1. Basic idea 2. Results 3. “Placebo tests” E. Evidence from the American Legion Survey 1. The survey 2. Results F. Narrative Evidence

Economics 134 Spring 2018 Professor David Romer III. UNDERSTANDING THE RECESSION OF 1937-38 A. Timing B. Candidate explanations C. Fiscal policy D. Monetary developments E. Expectations F. Supply shocks?

LECTURE 14 The New Deal

March 12, 2018

Economics 134 David Romer Spring 2018

Announcement

• You should have a copy of the handout about the essay assignment.

• The essay is due at the beginning of lecture on Monday, April 16.

I. OVERVIEW OF THE NEW DEAL

What Do We Mean by the New Deal?

• Wide range of actions taken by Roosevelt to deal with the Depression.

• Included government spending, financial rehabilitation, industrial and farm policies, and safety net and labor legislation.

• Characterized by an activist approach to generating recovery.

Government Spending on Relief

• Civil Works Administration (CWA) (November 1933) Provided millions of jobs in the winter of 1934.

• Civilian Conservation Corps (CCC) (April 1933) Hired young people to build parks.

• Works Progress Administration (WPA) (May 1935) Hired unemployed to work on a vast array of public investment projects, including roads, bridges, dams,

art, etc.

Financial Rehabilitation

• Reconstruction Finance Corporation (RFC) (Jan. 1932, expanded under Roosevelt) Recapitalized banks.

• Federal Deposit Insurance Corporation (FDIC) (passed June 1933, took effect in 1934 and 1935) Provided deposit insurance.

• Home Owners’ Loan Corporation (HOLC) (June 1933) Bought distressed mortgages and modified them.

Programs to Raise Prices

• Devaluation and monetary expansion

• National Industrial Recovery Act (NIRA) (June 1933) Set up codes of conduct for business to limit competition and establish minimum wages. (Declared unconstitutional in May 1935)

• Agricultural Adjustment Act (AAA) (May 1933) Paid farmers to limit production to raise farm prices

Social Safety Net and Labor Legislation

• Social Security Act (August 1935) Established both old-age insurance (pensions) and unemployment insurance.

• National Labor Relations Act (Wagner Act) (May 1935) Encouraged collective bargaining.

• Fair Labor Standards Act (June 1938) Prohibited child labor, set maximum hours and minimum wages.

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941

Expenditures

Receipts

Surplus

Federal Receipts, Expenditures, and Surplus (as a percent of GDP)

A negative budget surplus is a budget deficit.

The Budget Surplus and the State of the Economy

• We usually assume T = T�. • But in fact, tax revenues depend on GDP: T =

T(Y). • One consequence: in the absence of policy

changes, the budget surplus tends to fall when GDP falls and rises when GDP rises.

• Such movements in the surplus are known as automatic stabilizers.

High-Employment Surplus

• The high-employment surplus: What the surplus would be if Y were equal to Y�: T Y� − G.

• The change in the high-employment surplus is a measure of the change in fiscal policy.

Key Fiscal Actions

• 1932 tax increase

• Start of New Deal Spending (mainly in 1934)

• Veterans Bonus 1936

• Start of Social Security taxes in 1937

• Increase in spending and taxes in 1941 related to World War II

Change in Federal High-Employment Surplus (as a percent of GDP)

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941

A negative number is an expansionary change in fiscal policy; positive is contractionary.

Size of the New Deal Fiscal Expansion

• Moderate in an absolute sense; small relative to the size of the problem.

• For comparison, the change in the high-employment surplus in 2009 was about −4%.

• New Deal fiscal policy varied between expansionary and contractionary.

Analytics of Roosevelt’s Fiscal Actions

Y

r LM0

IS0

Y0 Y

IS1

Y1 IS1 corresponds to a moderate overall fiscal expansion.

0 – πe(π0)

Could fiscal actions have had unusually large effects working through confidence?

Roosevelt’s First Inaugural Address This great Nation will endure as it has endured, will revive and will prosper. So, first of all, let me assert my firm belief that the only thing we have to fear is fear itself—nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance. …

Our greatest primary task is to put people to work. This is no unsolvable problem if we face it wisely and courageously. It can be accomplished in part by direct recruiting by the Government itself, treating the task as we would treat the emergency of a war, but at the same time, through this employment, accomplishing greatly needed projects to stimulate and reorganize the use of our natural resources.

Roosevelt’s First Inaugural Address I am prepared under my constitutional duty to recommend the measures that a stricken Nation in the midst of a stricken world may require. These measures, or such other measures as the Congress may build out of its experience and wisdom, I shall seek, within my constitutional authority, to bring to speedy adoption.

But in the event that the Congress shall fail to take one of these two courses, and in the event that the national emergency is still critical, I shall not evade the clear course of duty that will then confront me. I shall ask the Congress for the one remaining instrument to meet the crisis—broad Executive power to wage a war against the emergency, as great as the power that would be given to me if we were in fact invaded by a foreign foe.

II. IMPACT OF THE VETERANS’ BONUS OF 1936

Average Veteran’s Bonus was $547 in 1936

Did the Bonus Raise Consumption of Veterans (and Overall Consumption)?

• Time-series analysis not likely to be helpful because it was a one-time event.

• Need cross-section evidence.

Hausman’s Approaches

• Expenditure survey of households (the 1935–1936 Survey of Consumer Purchases).

• Cross-state and cross-city evidence.

• American Legion survey of members’ spending plans.

• Narrative evidence (that is, qualitative information from the time).

Expenditure Survey of Households

• Fortuitously, some households were surveyed before the bonus was paid, and some were surveyed after.

• What key variable is missing from the survey? Veteran status.

If Hausman Had Data on Veteran Status

Pre-Bonus Post-Bonus

Non-Veteran α α + β3

Veteran α + β2 α + β2+ β3 + β4

Consumption over Previous 12 mos.

β2 shows the average difference in pre-bonus consumption between veterans and non-veterans.

How much does consumption rise post-bonus for a non-veteran? β3 How much does consumption rise post-bonus for a veteran? β3 + β4

So β4 shows the change in consumption post-bonus of a veteran versus a non-veteran.

Economists call specifications like this “difference-in-differences.”

Consumption over previous 12 monthsi = α + β2 • Veteran dummyi

+ β3 • Post bonus dummyi + β4 • Veteran dummyi • Post bonus dummyi + εi.

Is β4 Likely to Be a Good Estimate of the Effect of the Bonus on Veterans vs.

Nonveterans?

• Yes, if the main thing changing the consumption of veterans vs. nonveterans in mid-1936 was the bonus.

• Given the size of the bonus, this seems like a reasonable assumption!

How Does Hausman Deal with the Fact That He Does Not Have Data on Veteran Status?

• He uses data for the 1930 census to see how veteran status can be predicted from households’ demographic characteristics (age, race, etc.).

• He uses that to construct an estimate of the probability that each household in his survey contained a veteran.

• He adjusts his estimation to deal with the fact that he knows probabilities of being a veteran.

• The details are complicated!

What Is the Basic Idea of Hausman’s Cross-State Test?

• Did car sales rise more in states with a higher proportion of veterans?

• Strengths and weaknesses of this approach?

Proportion of Veterans across States

Darker shades mean more veterans per 100 people.

Veterans and Car Sales by State in 1936

Car sales rose more in states with more veterans.

1936

Cha

nge

in C

ar P

urch

ases

per

Cap

ita

Veterans per Capita in 1930

“Placebo Tests”

• Basic idea: Do we appear to find an effect when: (1) We shouldn't; and (2) It’s plausible that we would if the results were picking up something other than an effect of the variable we are interested in?

• Hausman’s placebo test: Run his test in other years.

The Results of Hausman’s Tests in Other Years Ch

ange

in C

ar P

urch

ases

per

Cap

ita

Hausman argues that the statistically significant estimates for 1932 and 1937 make sense.

American Legion Survey

Darker shades mean more veterans per 100 people.

… Strengths and weaknesses?

American Legion Survey Tabulations

Narrative Evidence

Strengths and weaknesses?

Hausman’s Bottom Line

• Veterans’ Bonus likely raised GDP growth by 2.5 to 3 percentage points in 1936 (actual growth was 13%).

• Reduced the unemployment rate by 1.3 to 1.5 percentage points (actual unemployment rate was 17%).

III. UNDERSTANDING THE RECESSION OF 1937-38

1929

-01

1929

-07

1930

-01

1930

-07

1931

-01

1931

-07

1932

-01

1932

-07

1933

-01

1933

-07

1934

-01

1934

-07

1935

-01

1935

-07

1936

-01

1936

-07

1937

-01

1937

-07

1938

-01

1938

-07

1939

-01

1939

-07

1940

-01

1940

-07

1941

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1941

-07

1

1.2

1.4

1.6

1.8

2

2.2

2.4

Indu

stria

l Pr

oduc

tion

(Log

arith

ms)

Industrial Production, 1929-1941

August 1929

March 1933

May 1937

June 1938

Figuring out cause of the 1937 recession is important:

• Some authors argue that it was the result of New Deal.

• What are other explanations?

Possible Causes of the 1937-38 Recession

• Fiscal contraction

• Monetary contraction

• Change in expectations

• Supply shock/inflation shock

• Loss of confidence in government

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941

Expenditures

Receipts

Surplus

Federal Receipts, Expenditures, and Surplus (as a percent of GDP)

Budget deficit fell substantially in 1937.

Fiscal Shocks in 1937

• End of the one-time veterans bonus.

• Introduction of Social Security payroll tax (less than 1% of GDP, but not small).

15

20

25

30

35

40

45

50

01/3

1/19

2907

/31/

1929

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1/19

3007

/31/

1930

01/3

1/19

3107

/31/

1931

01/3

1/19

3207

/31/

1932

01/3

1/19

3307

/31/

1933

01/3

1/19

3407

/31/

1934

01/3

1/19

3507

/31/

1935

01/3

1/19

3607

/31/

1936

01/3

1/19

3707

/31/

1937

01/3

1/19

3807

/31/

1938

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1/19

3907

/31/

1939

01/3

1/19

4007

/31/

1940

01/3

1/19

4107

/31/

1941

M1

(Bill

ions

of $

)

Money Supply

The money supply fell in 1937-38 – but was that a cause of the recession or a consequence?

Monetary Shock in 1937

• Doubling of reserve requirements.

• Sterilization of gold inflows lowered the growth rate of the money supply.

Expectations Shock

• Roosevelt started to sound less committed to reflation.

• This could have raised real interest rates.

Possible Supply Shock

• National Labor Relations Act passed in 1935.

• Led to wage increases in some industries, particularly autos.

• This could have affected the timing of production and sales in autos.