Lessons from the Roosevelt Recession

At $1.08 billion in FY 2012, the federal deficit is distressingly large to most Americans. In the current election, both Republicans and Democrats are proposing austerity measures. Before either side develops proposals to cut deficit spending (and don’t worry, we have plenty of time), we might want to take a look once again at our country’s last great economic disaster. In 1937, just as the New Deal began to raise the country from the Great Depression, Franklin Roosevelt decided to cutback on spending in order to balance the budget. The recession that followed should serve as a compelling warning against hasty adoption of austerity measures today.

After a landslide victory in 1932, Roosevelt entered the White House determined to carry through on his pledge to provide “a new deal for the American people.” The first components of this economic recovery plan included programs that alleviated the most pressing concern: jobs. Through aid programs like the Federal Emergency Relief Administration (1933), the Civilian Conservation Corps (1933), and the Works Progress Administration (1935), the Roosevelt administration provided tens of millions of jobs to unemployed Americans. That’s right, the government can put people to work. In the early 1930s, government employment significantly helped reduce unemployment.

In 1937, however, the federal government reversed its expansionary fiscal policy, choosing instead to emphasize the importance of balanced budgets. Historian Alan Brinkley attributes this balanced budget impulsion to Treasury Secretary Henry Morganthau. Believing that New Deal programs had sufficiently improved the nation’s economic health, Morganthau pressured Roosevelt to reduce spending. To the chagrin of many members of the administration who helped formulate successful expansionary fiscal policy from 1933 to 1936, Roosevelt agreed with Morganthau. With an eye on balancing the budget, the administration significantly reduced spending and simultaneously raised taxes. By 1937, the United States federal government had nearly balanced its budget.

This premature contractionary policy resulted in another severe economic downturn. Unemployment rose once again and industrial production slowed. In response, the administration once again reversed course in 1938 and increased spending. The reversal of New Deal expansionary fiscal policy, however, had already caused another economic decline. The United States would not emerge from this new decline until World War II once again reduced unemployment through government spending.

Deficit spending is a temporary fix, but it must last long enough to bring us out of a recession. Morganthau and several other members of the administration incorrectly predicted that full employment was approaching in 1937, leading them to advocate for fiscal conservatism.

Today, the desire to reduce budget deficits is not driven by a notion that we have escaped the Great Recession. Rather, voters are fully aware that (even with declining unemployment) a significant amount of growth is required before the United States can be considered to have escaped the economic downturn. In this environment, more short-term deficit spending is needed. The American Recovery and Reinvestment Act, although weaker than necessary, helped stimulate employment and economic growth, as did other spending measures that the Obama administration enacted in recent years. While these programs increased the size of the federal deficit, they actively worked to jumpstart the nation’s economy.

Once the recession is behind us, we can return to the economic policies of President Clinton and balance budgets and even run surpluses. Further, long-term adjustments should be enacted to ensure that revenues align with projected spending for budget items such as Social Security, Medicare, Medicaid, and the military. But in order to avoid the Obama (or possibly, Romney…) Recession of 2013, we should shy away from a complete reversal of temporary expansionary fiscal policies.