The Return of Great Depression Economics

To help sell his bailout package last month, President Bush raised the specter of the Great Depression. This was sleazy politics.

While the country does in fact face the worst financial and economic crisis since the Great Depression, there is no reason that it should lead to a decade of double-digit unemployment. There is a simple way to get out of that sort of prolonged downturn: spend money.

If the government had opted to go the route of large-scale deficit spending during the depression, it would have created jobs and provided the jump-start needed to get the economy moving again. However, this fact was not widely appreciated at the time. John Maynard Keynes classic work, The General Theory, was not published until 1936 and it was not widely accepted until much later.

It wasn't until World War II forced the government to engage in large-scale deficit spending that the economy finally got the demand boost needed to restore its normal growth pattern. Prior to that point, the people who dominated economic thinking argued that balancing the budget should be the country's top priority. This fixation with balancing the budget prompted the government to cut back spending as soon as the economy showed any signs of life, thereby heading off growth and raising the unemployment rate.

Since we have the benefit of knowing the history of the Great Depression, as well as the analysis of Keynes and many great economists who followed in his footsteps, we should not have to worry about repeating the mistakes that allowed the initial financial collapse in 1929 to turn into a decade-long downturn. Unfortunately, the world is not that simple.

We do have the benefit of knowing Keynesian economics, but there are many people in positions of authority who either do not understand the importance of running deficits to sustain demand or who argue for deficit reduction regardless of the harm that it will cause the economy.

For example, the moderators of both of the presidential debates and the vice-presidential debate asked questions that implied that the money spent on financial bailouts will require large reductions in spending and/or tax increases in the immediate future. There have been numerous columns and news stories making the same point and berated the presidential candidates for not proposing big spending cuts and/or tax increases.

And there is the Wall Street-funded Peter Peterson Foundation with its billion dollar endowment. This outfit has been taking out full page ads in major newspapers pushing its line that the federal government must take immediate steps to reduce the budget deficit.  There are many powerful members of Congress who share the Peterson Foundation's basic view of the economy.

In short, while we now know how to prevent a decade of stagnation and double-digit unemployment, "we" may not be setting economic policy. It is entirely possible that the people who control economic policy will have the same views of the economy as the people who controlled levers of power 70 years ago. If that turns out to be the case, a decade of stagnation and high unemployment is a real possibility.

At this point, we should already be pushing ahead with a major stimulus package that focuses on helping the people hardest by the downturn through programs such as unemployment insurance, food stamps, and Medicaid. In addition, the stimulus package should include substantial aid to state and local governments so that they are not forced to layoff workers and cut back important programs in the middle of a downturn.

Since this downturn is going to be long, the package should include substantial investment components that will both boost demand in the short-term and also provide lasting economic benefits. Retrofitting buildings to make them more energy efficient would be an obvious priority as would be repairing and improving the infrastructure by moving forward with projects that are already planned. Fixing the health care system is another type of priority that will require some additional funding up front, but will produce enormous long-term savings.

The list of unmet needs is a long one, and a government committed to sustaining high levels of employment could see this downturn as an extraordinary opportunity to move the country forward. It remains to be seen whether we have that sort of government.