The Great Depression in Economic Memory

PARIS – The dispute that has emerged in the United States and Europe between proponents of further government stimulus and advocates of fiscal retrenchment feels very much like a debate about economic history. Both sides have revisited the Great Depression of the 1930’s – as well as the centuries-long history of sovereign-debt crises – in a controversy that bears little resemblance to conventional economic-policy controversies.

The pro-stimulus camp often refers to the damage wrought by fiscal retrenchment in the US in 1937, four years after Franklin Roosevelt’s election as US president and the launch of the New Deal. According to computations by the economist Paul van den Noord, the net result of the 1937 budget was a fiscal contraction amounting to three percentage points of GDP – certainly not a trivial amount. Economic growth plummeted from 13% in 1936 to 6% in 1937, and GDP shrank 4.5% in 1938, while unemployment rose from 14% to roughly 20%. Although fiscal policy was not the only cause of the double dip, ill-timed retrenchment certainly contributed to it.

So, are we in 1936, and does the budgetary tightening contemplated in many countries risk provoking a similar double-dip recession?

Clearly there are limits to the comparison. For starters, much less time has elapsed since the financial crisis, the recession has been much shallower, and recovery has come faster. Moreover, important developments that occurred between the 1929 stock-market crisis and the 1937 fiscal retrenchment – especially America’s turn to protectionism in 1930 and the monetary turmoil of subsequent years – have no analog today.