How is it that, with all these people out of work and a president who’s doing nothing to help them, that Obama isn’t facing a primary challenge? But I digress: Why is he so determined to do the wrong thing? Go read it all:
The Mistake of 1937 was a preemptive policy tightening in a fragile economic environment. Specifically, it was a decision to abandon the policy of “reflation” introduced in 1933. After prices tumbled during the 1929-33 depression, the administration of Franklin Delano Roosevelt (FDR) and the Federal Reserve made a commitment to increase the price level to pre-depression levels. (For more on this key initiative of the 1933-37 recovery period, see my article in the American Economic Review, “Great Expectations and the End of the Depression.”) The reflation policy was backed by an aggressive increase in government spending, the maintenance of large deficits, the abandonment of the gold standard, and monetary easing. If we accept the account of modern macroeconomic models, this reflationary policy mix can be very expansionary once the short-term interest rate is constrained at zero (as it was at the time). Why? Because at zero interest rates, if people start expecting that prices will rise instead of continuing to fall, the real rate of interest—a critical determinant of aggregate spending—turns from positive to negative. Thus, it becomes economical to spend money rather than save it. A further benefit of reflation is that it can repair balance sheets of overleveraged households and firms, a point explained in more detail in my recent paper with Paul Krugman, “Debt, Deleveraging, and the Liquidity Trap.”
The Mistake of 1937 was to relinquish the benefits of reflation and to set all policy levers in reverse. The Fed and key administration officials hinted at interest rate hikes and endorsed austerity in fiscal policy; the key concern now was containing inflation rather than sustaining recovery.
The effects of this policy reversal on prices and production are evident in the charts below. The top chart tracks the consumer price index (CPI) and the wholesale price index (WPI) over the period 1927-41, while the bottom chart plots the movements in industrial production over the same period. In both charts, the first vertical line marks the point at which FDR became president and announced a policy of reflation, while the second vertical line marks the Mistake of 1937. What we see in the top chart is that at the time in 1937 when the administration started warning that inflation was too high, the price level had not yet reached the pre-depression levels that had previously been the administration’s goal. Following this policy reversal, both prices and industrial production tumbled. The line indicating the “reversal of 1938” marks the point when the administration recommitted to inflating the price level to pre-depression levels. Significantly, this renewed commitment was followed by robust growth, as the bottom chart makes clear.
The difference is, FDR wasn’t committed to making the transition to a third-world economy for American workers, the way Obama is. I really think he believes that the slide to the bottom for the paycheck class is inevitable and he may as well help speed it along.