Government Intervention or Austerity

Which Prevents a Prolonged Depression?

During the 20th century up to the 21st century we have seen a dramatic growth in government and government intervention in the economy when the markets attempt to correct themselves. There are two schools of thought regarding the lengths that government should intervene in the situation. The Keynesian theory states that massive fiscal stimulus is necessary to stave off an economic collapse while the Freidman or small government monetarists believe that increases in the money supply will prevent a recession from becoming a depression. Additionally, both sides agree that allowing the free markets to correct themselves without government intervention would be a disaster. However, the two different approaches to economic downturns in the 20th century torpid each other and instead the free market path and government austerity prevail.

From 1920 to 1921, the United States went into a depression that is rarely known or taught. It began as a result of government expansion during World War I when the federal deficit exploded, and by the end of the war, consumer price inflation was above 20%. Additionally at the end of the War, unemployment sat at 1.4% and productivity had increased exponentially because of the war effort. Once the war was over, and 1.6 million soldiers were returning, which amounted to a 4.1% growth in the civilian workforce resulting in an increase in the unemployment rate the economy began to weaken. This massive increase of workers also led to the weaking of union power resulting in lower wages and increased the likelihood of an economic slump.

Between 1920 and 1921 production would fall by 32.5% compared to the previous year, prices decreased by 15% and because of the influx of returning labor, the unemployment rate soared to 12%; higher than at the beginning of the Great Depression. Businesses failed and others saw revenues decrease exponentially while the stock market – specifically the Dow Jones Industrial Average dropped by 47% - causing notable anxiety with the public. During this time, the monetary base collapsed as well, and it was the largest collapse in the country’s history – even larger than at the beginning of the Great Depression. And yet the government did not intervene. In fact, Presidents Wilson and Harding contracted the government by 65%, reducing federal spending from $18.5 billion to $6.5 billion dollars between 1919 and 1920. Then in fiscal year 1922, the federal budget was reduced an additional $2.2 billion dollars to $3.3 billion dollars. During this same period, interest rates were increased to 7% by the New York Fed for its discounted rate. This cause the national government to have a budget surplus of $509 million dollars in 1921 and then in 1922 a $736 million dollar surplus which was used to pay down the debt from World War I. What followed next was an economic boom, the likes of which we had never seen with budget surplus ever year for the national government and prosperity for many individuals, especially those who were careful with their investments.

Now during this first depression, Herbert Hoover was the Secretary of Commerce, and he was advising both Presidents Wilson and Harding to increase government spending through deficit spending and lower interest rates. They refused as stated above but when he was President at the start of the Great Depression that is exactly what he did.

Between 1929 and 1930 the United States experienced another financial decline which became known as the Great Depression. As we all know, the stock market crashed in October of 1929, wiping out billions of dollars with the total stock of money collapsing by 1/3rd by 1933. While he did reduce income taxes by 1%, he was a Keynesian by nature and would eventually raise taxes. Between 1930 and 1933 when his term ended, he had increased government spending by 42% creating unheard of federal deficits during peacetime. He also signed numerous public works projects including the Hoover Dam and the creation of the Reconstruction Finance Corporation which invested more than 1 billion dollars into failing banks. On top of that, his tax cut for 1929 taxes was short lived because by 1932 he was raising taxes. Now the top tax bracket for 1933 was 63% versus the 25% it had been in 1932, and yet federal revenue only increased 3.8 percent between 1932 and 1933 while the Federal budget deficit was 4.5% of GDP. Additionally during this time, the New York Fed slashed the interest rate to 1.5% to encourage borrowing and fund a financial system to prevent the failure of certain firms. All of this was contrary to what had been done previously when the Feds increased the discount rate. Prior to the Great Depression, the idea was that the increase in the discount rate would save the solvent firms who just didn’t have liquid capital and the firms that were insolvent even if they had liquid capital understood that they had to close because they couldn’t afford the higher rates. Lionel Robbins, a British economist, would write:

“In the present depression we have changed all that. We eschew the sharp purge. We prefer the lingering disease. Everywhere, in the money market, in the commodity markets and in the broad field of company finance and public indebtedness, the efforts of Central Banks and governments have been directed to propping up bad business positions.” (Murphy)

And yet all this government injection into the economy did nothing to alleviate the economic situation in the 1930’s. Instead it created one of the least prosperous decades in the history of the United States. It was only a World War that began to pull us out of it but with price controls and rationing and increased productivity to support the war effort that didn’t stop us from slipping back into a mild recession after World War II due to a decline in wartime spending and the shift back to a peacetime economy so the effects of the Keynesian experiment of increased government intervention into the economy are hard to assuage due to World War II’s intervention.

Unfortunately, what happened in the Great Depression becomes the economic formula that is used to this day. Since then we have had 13 recessions, and we can see the effects of Keynesian economics on a clearer basis. Most recently in 2007-2008 with the collapse of Lehman Brothers and the housing market in the United States that sparked a global recession and the COVID pandemics of 2020 where the government injected massive amounts of money into the economy to stave off either a depression or recession but ended up causing increased debt and higher taxation with no end in sight for our massive debt.

Now we have a bloated national government with an ever expanding bureaucracy that is hampering the innovation of the American people and the economic change we need to return our country to its great status. So what can we do about this? We can continue to demand the contraction of government (austerity) which appears to be what the current President wants to do. It will be economically painful initially if government decreases but eventually it will be better for the country as a whole to return to balanced trade, budgets, and economic prosperity. When more money is returned to the people, then innovation and prosperity are secured, and the failing businesses are forced to close rather than being propped up leading to financially stable businesses being created or expanded to meet the demand. It does no one nor a country any good if we prop up failing businesses in favor of business or individuals that can and will succeed.

Murphy, Robert P. 2009. “The Depression You’ve Never Heard Of: 1920-1921 | Robert P. Murphy.” Fee.org. Foundation for Economic Education. November 18, 2009. https://fee.org/articles/the-depression-youve-never-heard-of-1920-1921/.

Roundtree, Devin. 2014. “1920 Depression v. Great Depression | AIER.” Aier.org. August 11, 2014. https://aier.org/article/1920-depression-v-great-depression/.

‌staff, B. E. R. 2021. “In the Shadow of the Slump: The Depression of 1920-1921.” Berkeley

Economic Review. March 18, 2021. https://econreview.studentorg.berkeley.edu/in-the-shadow-of-the-slump-the-depression-of-1920-1921/.

This post originally appeared on the Bastrop County Republican Party Website which is another organization I write for.