Paul Krugman writes:
Now, you might say that the incomplete recovery shows that “pump-priming”, Keynesian fiscal policy doesn’t work. Except that the New Deal didn’t pursue Keynesian policies. Properly measured, that is, by using the cyclically adjusted deficit, fiscal policy was only modestly expansionary, at least compared with the depth of the slump. Here’s the Cary Brown estimates, from Brad DeLong…Net stimulus of around 3 percent of GDP — not much, when you’ve got a 42 percent output gap.
Alex Tabarrok responds:
Now there is actually a lot of truth to this but the way in which Krugman, Rauchway, DeLong and others present this point is esoteric and likely to mislead even many economists. What Krugman seems to be saying is that the government didn’t spend enough during the thirties (Rauchway, who also cites Cary Brown, says directly “there was never enough spending to achieve the desired effect.”) Yet federal spending during this time increased tremendously. So what is really going on? The answer is actually quite simple.
During the Great Depression federal expenditures increased tremendously but so did taxes. Thus, the reason spending was not stimulative was not that spending wasn’t tried it’s that taxes were also raised to prohibitive levels.
This may seem a bit strange, but both Krugman and Tabarrok are correct here. Much of the increased spending was offset by tax increases as Tabarrok notes. However, I would also point out that one of the main problems with New Deal policies was that they were decidedly NOT Keynesian in that they did not attempt to stimulate demand, but rather attempted to stimulate prices. Many of the New Deal policies were aimed at restricting supply (namely in the agricultural sector) in order to raise prices. Keynes himself in an open letter to Franklin Roosevelt argued against such policies:
Now there are indications that two technical fallacies may have affected the policy of your administration. The first relates to the part played in recovery by rising prices. Rising prices are to be welcomed because they are usually a symptom of rising output and employment. When more purchasing power is spent, one expects rising output at rising prices. Since there cannot be rising output without rising prices, it is essential to ensure that the recovery shall not be held back by the insufficiency of the supply of money to support the increased monetary turn-over. But there is much less to be said in favour of rising prices, if they are brought about at the expense of rising output. Some debtors may be helped, but the national recovery as a whole will be retarded. Thus rising prices caused by deliberately increasing prime costs or by restricting output have a vastly inferior value to rising prices which are the natural result of an increase in the nation’s purchasing power.
But too much emphasis on the remedial value of a higher price-level as an object in itself may lead to serious misapprehension as to the part which prices can play in the technique of recovery. The stimulation of output by increasing aggregate purchasing power is the right way to get prices up; and not the other way round. [Emphasis added.]