A Raw Deal

Some readers -- those whose prior knowledge of the economic history of the Depression comes from high school or college textbooks -- may find the basic facts about the economy and economic policy reviewed by Shlaes a bit surprising. Most basic treatments of the Depression and the New Deal are written by social and political historians with limited knowledge of economics. They tend to view the Depression as an inevitable consequence of alleged market excesses of the 1920s and see the New Deal as having substantially aided economic recovery. (A notable exception to this rule is the recent best-selling textbook A Patriot's History of the United States, by Larry Schweikart and Michael Allen, which offers a detailed review of the deficiencies of other textbook treatments of the Depression and the New Deal.) However, the research of economists and economic historians tells a very different story, one consistent with Shlaes' account. The Depression resulted primarily from poor monetary policy by central banks, including the Federal Reserve, and was perpetuated by a combination of disastrous fixed-exchange-rate policies (which transmitted deflation around the world), protectionism, and the severe problems with the balance sheets of banks and firms. In the United States, added damage was done by the wrong-headed policy responses of the Hoover and Roosevelt administrations, including New Deal policies that raised prices and wages (phase 1 of the New Deal, before 1936) and those that raised taxes and increased the costs of hiring laborers (phase 2, after 1936). Whatever the desirability of the New Deal policies from other perspectives, they did not provide an effective boost to the economy.

Shlaes' criticisms of these policies will be familiar to economists and economic historians who have studied the Depression. (For a recent overview of the academic literature, see Randall Parker's The Economics of the Great Depression and Michael Bordo, Claudia Goldin, and Eugene White's The Defining Moment.) It is well known among scholars of the Depression that there was no consistent theme or philosophy underlying New Deal policies but rather that Roosevelt and his changing team of experts innovated in ways that were hard to predict and impossible to explain from the perspective of any coherent macroeconomic theory. Even economists at the time, including Irving Fisher and Keynes, recognized this.

Economists and economic historians today, echoing Fisher and Keynes in the 1930s, generally see the abandonment of the gold standard in 1933, which allowed the money supply and the economy to begin to grow, as Roosevelt's major contribution to economic recovery. Other New Deal policies are generally understood to have set back the recovery of production, employment, and asset prices, as Shlaes argues. The National Recovery Administration's price and wage hikes have long been seen as mistakes (and a continuation of Hoover's bad policies) that contributed to unemployment and the slow recovery of production from 1933 to 1935. The tax hikes and labor legislation of 1935-37 have been widely considered by scholars as having prolonged the economy's slow recovery and meager job growth during those years and as having helped caused the relapse into recession in 1937. Shlaes' contention that policy errors -- and, more important, the unpredictability of policy -- fed economic uncertainty and discouraged businesses and consumers from investing and consuming is not a new view of the New Deal.

A few scholars may quibble with some of Shlaes' claims. She argues that Roosevelt's ad hoc management of the dollar's value after March 1933 and his decision to abandon multilateral efforts to reestablish the international gold standard created unnecessary price-level uncertainty. This may be true, but the point seems a bit overemphasized in light of the positive effects of abandoning gold parity -- namely, the growth that came from decoupling monetary policy from worldwide deflation. Similarly, Shlaes' mainly tangential discussion of banking crises in the early 1930s exaggerates the impact of depositor panic, underestimates the difficulty of solving the problems that were then gripping banks, and overstates the ability the Federal Reserve had to prevent financial distress by pumping more liquidity into the system. The abolition of gold clauses in bonds in 1933 (which allowed creditors to repay their debts in depreciated paper dollars rather than in a fixed quantity of gold) was not, as Shlaes argues, merely a redistribution of wealth from creditors to debtors; as the economist and current Federal Reserve governor, Randall Kroszner, has shown, the measure benefited creditors -- and the whole economy -- by increasing the likelihood that depreciated debt would be repaid.

In spite of these few shortcomings, however, Shlaes' overall analysis of the economic history of the Depression is remarkably well informed and balanced. Her emphasis on the disastrous effects of higher taxation of corporate profits and retained earnings in the mid-1930s is especially incisive. In the areas where the analysis is a bit weak (especially pertaining to financial-sector issues), the controversies surrounding those matters are largely beside the point of the book.