Quote of the Week

"Europe was created by history. America was created by philosophy." --Margaret Thatcher


April 1, 2009

Are our leaders following the playbook for turning this recession into a depression?

Serious students of history know that the Great Depression could have been avoided. The stock market crash in 1929 triggered a recession, but it was policy decisions that were subsequently made by our federal government under the leadership of first Herbert Hoover and then FDR which deepened the recession into a depression and lengthen its duration.

Given this history, and the state of our current recession, it is only fitting to evaluate the actions being taken by our political leaders as compared to what was tried before. William A. Niskanen did just that when he wrote "How to turn a Recession into a Depression" which first appeared in the Cato Policy Report, March/April 2009.

States Mr. Niskanen:
Four federal economic policies transformed the Hoover recession into the Great Depression: higher tariffs, stronger unions, higher marginal tax rates, and a lower money supply. President Obama, unfortunately, has endorsed some variant of the first three of these policies, and he will face a critical choice on monetary policy in a year or so.

Mr. Niskanen examined the policies of the 1930's and today addressing trade, taxes, labor, monetary issues and other related policy issues and unfortunately found several parallels between the ineffective and even disastrous policy decisions of the past with policies supported by our government today.

Consider the trade policies advocated by President Obama, including the treaty-violating "buy American" provisions advocated by Congress in the stimulus bill, and add card check legislation being pushed by power-drunk unions, and increased taxes under consideration along with the indirect taxes that would be imposed by regulatory schemes such as cap-and-trade. While the jury is still out on the monetary policy decisions, so far our leaders are not inspiring confidence (as least not with the The Freedom Diva). Only time will tell.

Concludes William Niskanen:
The most important lesson of this paper is to avoid repeating the policies that increased the depth and duration of the Great Depression, particularly in combination. Unfortunately, some of these policies still have broad political appeal—limiting international trade, strengthening unions, other measures to support the prices of some products and labor services, and higher taxes on the wealthy and the income from capital. One important lesson that we seem to have learned from the 1930s is to avoid reducing the supply of money in response to an increased demand for money. Another important lesson that we have not yet learned is that some government spending for infrastructure may be both popular and valuable but is not very effective in countering a recession.

We have yet to learn the lessons about what caused the current recession and the general financial crisis. The United States had experienced 11 prior recessions since World War II without a general financial crisis, so something new must have happened that caused the current financial crisis. My judgment is that the government policies and private practices that changed the way mortgages are financed are that dangerous new development, but that is a story for another occasion. In this respect, I agree with Chairman Bernanke's recent conclusion that "we should revisit capital regulations, accounting rules, and other aspects of the regulatory regime to ensure that they do not induce excessive procyclicality in the financial system and the economy."

Click here to access a copy of Mr. Niskanen's article.

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