Category Archives: Great Depression

The Great Slump of 1930 – John Maynard Keynes.

The world has been slow to realize that we are living this year in the shadow of one of the greatest economic catastrophes of modern history.

But now that the man in the street has become aware of what is happening, he, not knowing the why and wherefore, is as full to-day of what may prove excessive fears as, previously, when the trouble was iirst coming on, he was lacking in what would have been a reasonable anxiety. He begins to doubt the future. Is he now awakening from a pleasant dream to face the darkness of facts? Or dropping off into a nightmare which will pass away?

He need not be doubtful. The other was not a dream. This is a nightmare, which will pass away with the morning. For the resources of nature and men’s devices are just as fertile and productive as they were. The rate of our progress towards solving the material problems of life is not less rapid. We are as capable as before of affording for everyone a high standard of life, high, I mean, compared with, say, twenty years ago, and will soon learn to afford a standard higher still.

We were not previously deceived. But to-day we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time, perhaps for a long time.

I doubt whether I can hope, in these articles, to bring what is in my mind into fully effective touch with the mind of the reader. I shall be saying too much for the layman, too little for the expert. For, though no one will believe it, economics is a technical and difficult subject. It is even becoming a science. However, I will do my best, at the cost of leaving out, because it is too complicated, much that is necessary to a complete understanding of contemporary events.

First of all, the extreme violence of the slump is to be noticed. In the three leading industrial countries of the world, the United States, Great Britain, and Germany, 10,000,000 workers stand idle. There is scarcely an important industry anywhere earning enough profit to make it expand, which is the test of progress. At the same time, in the countries of primary production the output of mining and of agriculture is selling, in the case of almost every important commodity, at a price which, for many or for the majority of producers, does not cover its cost. In 1921, when prices fell as heavily, the fall was from a boom level at which producers were making abnormal profits; and there is no example in modern history of so great and rapid a fall of prices from a normal figure as has occurred in the past year. Hence the magnitude of the catastrophe.

The time which elapses before production ceases and unemployment reaches its maximum is, for several reasons, much longer in the case of the primary products than in the case of manufacture. In most cases the production units are smaller and less well organized amongst themselves for enforcing a process of orderly contraction; the length of the production period, especially in agriculture, is longer; the costs of a temporary shut-down are greater; men are more often their own employers and so submit more readily to a contraction of the income for which they are willing to work; the social problems of throwing men out of employment are greater in more primitive communities; and the financial problems of a cessation of production of primary output are more serious in countries where such primary output is almost the whole sustenance of the people. Nevertheless we are fast approaching the phase in which the output of primary producers will be restricted almost as much as that of manufacturers; and this will have a further adverse reaction on manufacturers, since the primary producers will have no purchasing power wherewith to buy manufactured goods; and so on, in a vicious circle.

In this quandary individual producers base illusory hopes on courses of action which would benefit an individual producer or class of producers so long as they were alone in pursuing them, but which benefit no one if everyone pursues them. For example, to restrict the output of a particular primary commodity raises its price, so long as the output of the industries which use this commodity is unrestricted; but if output is restricted all round, then the demand for the primary commodity falls off by just as much as the supply, and no one is further forward. Or again, if a particular producer or a particular country cuts wages, then, so long as others do not follow suit, that producer or that country is able to get more of what trade is going. But if wages are cut all round, the purchasing power of the community as a whole is reduced by the same amount as the reduction of costs; and, again, no one is further forward.

Thus neither the restriction of output nor the reduction of wages serves in itself to restore equilibrium.

Moreover, even if we were to succeed eventually in re-establishing output at the lower level of money-wages appropriate to (say) the pre-war level of prices, our troubles would not be at an end. For since 1914 an immense burden of bonded debt, both national and international, has been contracted, which is fixed in terms of money. Thus every fall of prices increases the burden of this debt, because it increases the value of the money in which it is fixed.

For example, if we were to settle down to the prewar level of prices, the British National Debt would be nearly 40 per cent. greater than it was in 1924 and double what it was in 1920; the Young Plan would weigh on Germany much more heavily than the Dawes Plan, which it was agreed she could not support; the indebtedness to the United States of her associates in the Great War would represent 40-50 per cent. more goods and services than at the date when the settlements were made; the obligations of such debtor countries as those of South America and Australia would become insupportable without a reduction of their standard of life for the benefit of their creditors; agriculturists and householders throughout the world, who have borrowed on mortgage, would find themselves the victims of their creditors.

In such a situation it must be doubtful whether the necessary adjustments could be made in time to prevent a series of bankruptcies, defaults, and repudiations which would shake the capitalist order to its foundations.

Here would be a fertile soil for agitation, seditions, and revolution. It is so already in many quarters of the world. Yet, all the time, the resources of nature and men’s devices would be just as fertile and productive as they were. The machine would merely have been jammed as the result of a muddle. But because we have magneto trouble, we need not assume that we shall soon be back in a rumbling waggon and that motoring is over.

We have magneto trouble. How, then, can we start up again? Let us trace events backwards:

1. Why are workers and plant unemployed? Because industrialists do not expect to be able to sell without loss what would be produced if they were employed.

2. Why cannot industrialists expect to sell without loss? Because prices have fallen more than costs have fallen-indeed, costs have fallen very little.

3. How can it be that prices have fallen more than costs? For costs are what a business man pays out for the production of his commodity, and prices determine what he gets back when he sells it. It is easy to understand how for an individual business or an individual commodity these can be unequal. But surely for the community as a whole the business men get back the same amount as they pay out, since what the business men pay out in the course of production constitutes the incomes of the public which they pay back to the business men in exchange for the products of the latter? For this is what we understand by the normal circle of production, exchange, and consumption.

4. No! Unfortunately this is not so; and here is the root of the trouble.

It is not true that what the business men pay out as costs of production necessarily comes back to them as the saleproceeds of what they produce. It is the characteristic of a boom that their sale-proceeds exceed their costs; and it is the characteristic of a slump that their costs exceed their sale-proceeds. Moreover, it is a delusion to suppose that they can necessarily restore equilibrium by reducing their total costs, whether it be by restricting their output or cutting rates of remuneration; for the reduction of their outgoings may, by reducing the purchasing power of the earners who are also their customers, diminish their sale-proceeds by a nearly equal amount.

5. How, then, can it be that the total costs of production for the world’s business as a whole can be unequal to the total sale-proceeds? Upon what does the inequality depend? I think that I know the answer. But it is too complicated and unfamiliar for me to expound it here satisfactorily. (Elsewhere I have tried to expound it accurately.) So I must be somewhat perfunctory.

Let us take, first of all, the consumption-goods which come on to the market for sale. Upon what do the profits (or losses) of the producers of such goods depend? The total costs of production, which are the same thing as the community’s total earnings looked at from another point of view, are divided in a certain proportion between the cost of consumption-goods and the cost of capital-goods. The incomes of the public, which are again the same thing as the community‘s total earnings, are also divided in a certain proportion between expenditure on the purchase of consumption-goods and savings.

Now if the first proportion is larger than the second, producers of consumption-goods will lose money; for their sale proceeds, which are equal to the expenditure of the public on consumption-goods, will be less (as a little thought will show) than what these goods have cost them to produce. If, on the other hand, the second proportion is larger than the first, then the producers of consumption-goods will make exceptional gains. It follows that the profits of the producers of consumption goods can only be restored, either by the public spending a larger proportion of their incomes on such goods (which means saving less), or by a larger proportion of production taking the form of capital-goods (since this means a smaller proportionate output of consumption-goods).

But capital-goods will not be produced on a larger scale unless the producers of such goods are making a profit. So we come to our second question, upon what do the profits of the producers of capital-goods depend? They depend on whether the public prefer to keep their savings liquid in the shape of money or its equivalent or to use them to buy capital-goods or the equivalent. If the public are reluctant to buy the latter, then the producers of capital-goods will make a loss; consequently less capital-goods will be produced; with the result that, for the reasons given above, producers of consumption goods will also make a loss. In other words, all classes of producers will tend to make a loss; and general unemployment will ensue. By this time a vicious circle will be set up, and, as the result of a series of actions and reactions, matters will get worse and worse until something happens to turn the tide.

This is an unduly simplified picture of a complicated phenomenon. But I believe that it contains the essential truth. Many variations and fugal embroideries and orchestrations can be superimposed; but this is the tune.

If, then, I am right, the fundamental cause of the trouble is the lack of new enterprise due to an unsatisfactory market for capital investment. Since trade is international, an insufficient output of new capital-goods in the world as a whole affects the prices of commodities everywhere and hence the profits of producers in all countries alike.

Why is there an insuflicient output of new capital-goods in the world as a whole? It is due, in my opinion, to a conjunction of several causes. In the first instance, it was due to the attitude of lenders, for new capital-goods are produced to a large extent with borrowed money. Now it is due to the attitude of borrowers, just as much as to that of lenders.

For several reasons lenders were, and are, asking higher terms for loans, than new enterprise can afford:

First, the fact, that enterprise could afford high rates for some time after the war whilst war wastage was being made good, accustomed lenders to expect much higher rates than before the war.

Second, the existence of political borrowers to meet Treaty obligations, of banking borrowers to support newly restored gold standards, of speculative borrowers to take part in Stock Exchange booms, and, latterly, of distress borrowers to meet the losses which they have incurred through the fall of prices, all of whom were ready if necessary to pay almost any terms, have hitherto enabled lenders to secure from these various classes of borrowers higher rates than it is possible for genuine new enterprise to support.

Third, the unsettled state of the world and national investment habits have restricted the countries in which many lenders are prepared to invest on any reasonable terms at all. A large proportion of the globe is, for one reason or another, distrusted by lenders, so that they exact a premium for risk so great as to strangle new enterprise altogether.

For the last two years, two out of the three principal creditor nations of the world, namely, France and the United States, have largely withdrawn their resources from the international market for long-term loans.

Meanwhile, the reluctant attitude of lenders has become matched by a hardly less reluctant attitude on the part of borrowers. For the fall of prices has been disastrous to those who have borrowed, and anyone who has postponed new enterprise has gained by his delay. Moreover, the risks that frighten lenders frighten borrowers too.

Finally, in the United States, the vast scale on which new capital enterprise has been undertaken in the last five years has somewhat exhausted for the time being, at any rate so long as the atmosphere of business depression continues, the profitable opportunities for yet further enterprise. By the middle of 1929 new capital undertakings were already on an inadequate scale in the world as a whole, outside the United States. The culminating blow has been the collapse of new investment inside the United States, which today is probably 20 to 30 per cent less than it was in 1928. Thus in certain countries the opportunity for new profitable investment is more limited than it was; whilst in others it is more risky.

A wide gulf, therefore, is set between the ideas of lenders and the ideas of borrowers for the purpose of genuine new capital investment; with the result that the savings of the lenders are being used up in financing business losses and distress borrowers, instead of financing new capital works.

At this moment the slump is probably a little overdone for psychological reasons. A modest upward reaction, therefore, may be due at any time. But there cannot be a real recovery, in my judgment, until the ideas of lenders and the ideas of productive borrowers are brought together again; partly by lenders becoming ready to lend on easier terms and over a wider geographical field, partly by borrowers recovering their good spirits and so becoming readier to borrow.

Seldom in modern history has the gap between the two been so wide and so diflicult to bridge. Unless we bend our wills and our intelligences, energized by a conviction that this diagnosis is right, to find a solution along these lines, then, if the diagnosis is right, the slump may pass over into a depression, accompanied by a sagging price level, which might last for years, with untold damage to the material wealth and to the social stability of every country alike. Only if we seriously seek a solution, will the optimism of my opening sentences be confirmed, at least for the nearer future.

It is beyond the scope of this article to indicate lines of future policy. But no one can take the first step except the central banking authorities of the chief creditor countries; nor can any one Central Bank do enough acting in isolation. Resolute action by the Federal Reserve Banks of the United States, the Bank of France, and the Bank of England might do much more than most people, mistaking symptoms or aggravating circumstances for the disease itself, will readily believe.

In every way the more effective remedy would be that the Central Banks of these three great creditor nations should join together in a bold scheme to restore confidence to the international long-term loan market; which would serve to revive enterprise and activity everywhere, and to restore prices and profits, so that in due course the wheels of the world’s commerce would go round again. And even if France, hugging the supposed security of gold, prefers to stand aside from the adventure of creating new wealth, I am convinced that Great Britain and the United States, like-minded and acting together, could start the machine again within a reasonable time; if, that is to say, they were energized by a confident conviction as to what was wrong. For it is chiefly the lack of this conviction which today is paralyzing the hands of authority on both sides of the Channel and of the Atlantic.

How Economics Survived the Economic Crisis – Robert Skidelsky * Good enough for government work? Macroeconomics since the crisis – Paul Krugman.

Unlike the Great Depression of the 1930s, which produced Keynesian economics, and the stagflation of the 1970s, which gave rise to Milton Friedman’s monetarism, the Great Recession has elicited no such response from the economics profession. Why?

The tenth anniversary of the start of the Great Recession was the occasion for an elegant essay by the Nobel laureate economist Paul Krugman, who noted how little the debate about the causes and consequences of the crisis have changed over the last decade. Whereas the Great Depression of the 1930s produced Keynesian economics, and the stagilation of the 1970s produced Milton Friedman’s monetarism, the Great Recession has produced no similar intellectual shift.

This is deeply depressing to young students of economics, who hoped for a suitably challenging response from the profession.

Why has there been none?

Krugman’s answer is typically ingenious: the old macroeconomics was, as the saying goes, “good enough for government work.” It prevented another Great Depression. So students should lock up their dreams and learn their lessons.

A decade ago, two schools of macroeconomists contended for primacy: the New Classical or the “freshwater” School, descended from Milton Friedman and Robert Lucas and headquartered at the University of Chicago, and the New Keynesian, or “saltwater,” School, descended from John Maynard Keynes, and based at MIT and Harvard.

Freshwater-types believed that budgets deficits were always bad, whereas the saltwater camp believed that deficits were beneficial in a slump. Krugman is a New Keynesian, and his essay was intended to show that the Great Recession vindicated standard New Keynesian models.

But there are serious problems with Krugman’s narrative. For starters, there is his answer to Queen Elizabeth II’s nowfamous question: “Why did no one see it coming?” Krugman’s cheerful response is that the New Keynesians were looking the other way. Theirs was a failure not of theory, but of “data collection.” They had “overlooked” crucial institutional changes in the financial system. While this was regrettable, it raised no “deep conceptual issue” that is, it didn’t demand that they reconsider their theory.

Faced with the crisis itself, the New Keynesians had risen to the challenge. They dusted off their old sticky-price models from the 1950s and 1960s, which told them three things. First, very large budget deficits would not drive up near zero interest rates. Second, even large increases in the monetary base would not lead to high inflation, or even to corresponding increases in broader monetary aggregates. And, third, there would be a positive national income multiplier, almost surely greater than one, from changes in government spending and taxation.

These propositions made the case for budget deficits in the aftermath of the collapse of 2008. Policies based on them were implemented and worked “remarkably well.” The success of New Keynesian policy had the ironic effect of allowing “the more inflexible members of our profession [the New Classicals from Chicago] to ignore events in a way they couldn’t in past episodes.” So neither school, sect might be the better word, was challenged to re-think first principles.

This clever history of pre- and post-crash economics leaves key questions unanswered.

First, if New Keynesian economics was “good enough,” why didn’t New Keynesian economists urge precautions against the collapse of 2007-2008? After all, they did not rule out the possibility of such a collapse a priori.

Krugman admits to a gap in “evidence collection.” But the choice of evidence is theory-driven. In my view, New Keynesian economists turned a blind eye to instabilities building up in the banking system, because their models told them that financial institutions could accurately price risk. So there was a “deep conceptual issue” involved in New Keynesian analysis: its failure to explain how banks might come to “underprice risk worldwide,” as Alan Greenspan put it.

Second, Krugman fails to explain why the Keynesian policies vindicated in 2008-2009 were so rapidly reversed and replaced by fiscal austerity. Why didn’t policymakers stick to their stodgy fixed-price models until they had done their work? Why abandon them in 2009, when Western economies were still 4-5% below their precrash levels?

The answer I would give is that when Keynes was briefly exhumed for six months in 2008-2009, it was for political, not intellectual, reasons. Because the New Keynesian models did not offer a sufficient basis for maintaining Keynesian policies once the economic emergency had been overcome, they were quickly abandoned.

Krugman comes close to acknowledging this: New Keynesians, he writes, “start with rational behavior and market equilibrium as a baseline, and try to get economic dysfunction by tweaking that baseline at the edges.” Such tweaks enable New Keynesian models to generate temporary real effects from nominal shocks, and thus justify quite radical intervention in times of emergency. But no tweaks can create a strong enough case to justify sustained interventionist policy.

The problem for New Keynesian macroeconomists is that they fail to acknowledge radical uncertainty in their models, leaving them without any theory of what to do in good times in order to avoid the bad times. Their focus on nominal wage and price rigidities implies that if these factors were absent, equilibrium would readily be achieved. They regard the financial sector as neutral, not as fundamental (capitalism’s “ephor,” as Joseph Schumpeter put it).

Without acknowledgement of uncertainty, saltwater economics is bound to collapse into its freshwater counterpart. New Keynesian “tweaking” will create limited political space for intervention, but not nearly enough to do a proper job. So Krugman’s argument, while provocative, is certainly not conclusive. Macroeconomics still needs to come up with a big new idea.


Robert Skidelsky, Professor Emeritus of Political Economy at Warwick University and a fellow of the British Academy in history and economics, is a member of the British House of Lords. The author of a three-volume biography of John Maynard Keynes.

Project Syndicate

Oxford Review of Economic Policy, 2018

Good enough for government work? Macroeconomics since the crisis

Paul Krugman


This paper argues that when the financial crisis came policy-makers relied on some version of the Hicksian sticky-price IS-LM as their default model; these models were ”good enough for government work’.

While there have been many incremental changes suggested to the DSGE model. there has been no single ‘big new idea” because the even simpler lS-LM type models were what worked well. In particular, the policy responses based on lS-LM were appropriate.

Specifically, these models generated the insights that large budget deficits would not drive up interest rates and, while the economy remained at the zero lower bound, that very large increases in monetary base wouldn’t be inflationary, and that the multiplier on government spending was greater than 1.

The one big exception to this satisfactory understanding was in price behaviour. A large output gap was expected to lead to a large fall in inflation, but did not. If new research is necessary. it is on pricing behaviour. While there was a failure to forecast the crisis, it did not come down to a lack of understanding of possible mechanisms, or of a lack of data, but rather through a lack of attention to the right data.

I. Introduction

It’s somewhat startling, at least for those of us who bloviate about economics for a living, to realize just how much time has passed since the 2008 financial crisis. Indeed, the crisis and aftermath are starting to take on the status of an iconic historical episode, like the stagflation of the 1970s or the Great Depression itself, rather than that of freshly remembered experience. Younger colleagues sometimes ask me what it was like during the golden age of economics blogging, mainly concerned with macroeconomic debates, which they think of as an era that ended years ago.

Yet there is an odd, interesting difference, both among economists and with a wider audience, between the intellectual legacies of those previous episodes and what seems to be the state of macroeconomics now.

Each of those previous episodes of crisis was followed both by a major rethinking of macroeconomics and, eventually, by a clear victor in some of the fundamental debates. Thus, the Great Depression brought on Keynesian economies, which became the subject of fierce dispute, and everyone knew how those disputes turned out: Keynes, or Keynes as interpreted by and filtered through Hicks and Samuelson, won the argument.

In somewhat the same way, stagflation brought on the Friedman Phelps natural rate hypothesis, yes, both men wrote their seminal papers before the 1970s, but the bad news brought their work to the top of the agenda. And everyone knew, up to a point anyway, how the debate over that hypothesis ended up: basically everyone accepted the natural rate idea, abandoning the notion of a long-run trade-off between inflation and unemployment. True, the profession then split into freshwater and saltwater camps over the effectiveness or lack thereof of short-run stabilization policies, a development that I think presaged some of what has happened since 2008. But I’ll get back to that.

For now, let me instead just focus on how different the economics profession response to the post-2008 crisis has been from the responses to depression and stagflation. For this time there hasn’t been a big new idea, let alone one that has taken the profession by storm. Yes, there are lots of proclamations about things researchers should or must do differently, many of them represented in this issue of the Oxford Review. We need to put finance into the heart of the models! We need to incorporate heterogeneous agents! We need to incorporate more behavioural economics! And so on.

But while many of these ideas are very interesting, none of them seems to have emerged as the idea we need to grapple with. The intellectual impact of the crisis just seems far more muted than the scale of crisis might have led one to expect. Why?

Well, I’m going to offer what I suspect will be a controversial answer: namely, macroeconomics hasn’t changed that much because it was. in two senses, what my father’s generation used to call ‘good enough for government work”. On one side, the basic models used by macroeconomists who either practise or comment frequently on policy have actually worked quite well, indeed remarkably well. On the other, the policy response to the crisis, while severely lacking in many ways, was sufficient to avert utter disaster, which in turn allowed the more inflexible members of our profession to ignore events in a way they couldn‘t in past episodes.

In what follows I start with the lessons of the financial crisis and Great Recession, which economists obviously failed to predict. I then move on to the aftermath, the era of fiscal austerity and unorthodox monetary policy, in which I’ll argue that basic macroeconomics, at least in one version, performed extremely well. I follow up with some puzzles that remain. Finally, I turn to the policy response and its implications for the economics profession.

II. The Queen’s question

When all hell broke loose in financial markets, Queen Elizabeth II famously asked why nobody saw it coming. This was a good question but maybe not as devastating as many still seem to think.

Obviously, very few economists predicted the crisis of 2008-9; those who did, with few exceptions I can think of, also predicted multiple other crises that didn’t happen. And this failure to see what was coming can’t be brushed aside as inconsequential.

There are, however, two different ways a forecasting failure of this magnitude can happen, which have very different intellectual implications. Consider an example from a different field, meteorology. In 1987 the Met Office dismissed warnings that a severe hurricane might strike Britain; shortly afterwards, the Great Storm of 1987 arrived, wreaking widespread destruction. Meteorologists could have drawn the lesson that their fundamental understanding of weather was fatally flawed which they would presumably have done if their models had insisted that no such storm was even possible. Instead, they concluded that while the models needed refinement, the problem mainly involved data collection that the network of weather stations, buoys, etc. had been inadequate, leaving them unaware of just how bad things were looking.

How does the global financial crisis compare in this respect? To be fair, the DSGE models that occupied a lot of shelf space in journals really had no room for anything like this crisis. But macroeconomists focused on international experience, one of the hats I personally wear, were very aware that crises triggered by loss of financial confidence do happen, and can be very severe. The Asian financial crisis of 1997-9, in particular, inspired not just a realization that severe l930s-type downturns remain possible in the modern world, but a substantial amount of modelling of how such things can happen.

So the coming of the crisis didn’t reveal a fundamental conceptual gap. Did it reveal serious gaps in data collection? My answer would be, sort of, in the following sense: crucial data weren’t so much lacking as overlooked.

This was most obvious on the financial side. The panic and disruption of financial markets that began in 2007 and peaked after the fall of Lehman came as a huge surprise, but one can hardly accuse economists of having been unaware of the possibility of bank runs. lf most of us considered such runs unlikely or impossible in modern advanced economies, the problem was not conceptual but empirical: failure to take on board the extent to which institutional changes had made conventional monetary data inadequate.

This is clearly true for the United States, where data on shadow banking on the repo market, asset-backed commercial paper, etc. were available but mostly ignored. In a less obvious way, European economists failed to pay sufficient intention to the growth of interbank lending as a source of finance. In both cases the institutional changes undermined the existing financial safety net, especially deposit insurance. But this wasn’t a deep conceptual issue: when the crisis struck, I’m sure I wasn’t the only economist whose reaction was not ‘How can this be happening?” but rather to yell at oneself, ‘Diamond Dybvig, you idiot!’

(The Diamond-Dybvig model is an influential model of bank runs and related financial crises. The model shows how banks’ mix of illiquid assets (such as business or mortgage loans) and liquid liabilities (deposits which may be withdrawn at any time) may give rise to selffulfilling panics among depositors.)

In a more subtle way, economists were also under-informed about the surge in housing prices that we now know represented a huge bubble, whose bursting was at the heart of the Great Recession. In this case, rising home prices were an unmistakable story. But most economists who looked at these prices focused on broad aggregates say, national average home prices in the United States. And these aggregates, while up substantially, were still in a range that could seemingly be rationalized by appealing to factors like low interest rates. The trouble, it turned out, was that these aggregates masked the reality, because they averaged home prices in locations with elastic housing supply (say, Houston or Atlanta) with those in which supply was inelastic (Florida or Spain); looking at the latter clearly showed increases that could not be easily rationalized.

Let me add a third form of data that were available but largely ignored: it’s fairly remarkable that more wasn’t made of the sharp rise in household debt, which should have suggested something unsustainable about the growth of the 2001-7 era. And in the aftermath of the crisis macroeconomists, myself included (Eggertsson and Krugman, 2012) began taking private-sector leverage seriously in a way they should arguably have been doing before.

So did economists ignore warning signs they should have heeded? Yes. One way to summarize their (our) failure is that they ignored evidence that the private sector was engaged in financial overreach on multiple fronts, with financial institutions too vulnerable, housing prices in a bubble, and household debt unsustainable. But did this failure of observation indicate the need for a fundamental revision of how we do macroeconomics? That’s much less clear.

First, was the failure of prediction a consequence of failures in the economic framework that can be fixed by adopting a radically different framework? It’s true that a significant wing of both macroeconomists and financial economists were in the thrall of the efficient markets hypothesis, believing that financial overreach simply cannot happen or at any rate that it can only be discovered after the fact, because markets know what they are doing better than any observer. But many macroeconomists, especially in policy institutions, knew better than to trust markets to always get it right especially those who had studied or been involved with the Asian crisis of the 1990s. Yet they (we) also missed some or all of the signs of overreach. Why?

My answer may seem unsatisfying, but I believe it to be true: for the most part what happened was a demonstration of the old line that predictions are hard, especially about the future. It’s a complicated world out there, and one’s ability to track potential threats is limited. Almost nobody saw the Asian crisis coming, either. For that matter, how many people worried about political disruption of oil supplies before 1973? And so on. At any given time there tends to be a set of conventional indicators everyone looks at, determined less by fundamental theory than by recent events, and big, surprise crises almost by definition happen due to factors not on that list. If you like, it’s as if meteorologists with limited resources concentrated those resources in places that had helped track previous storms, leading to the occasional surprise when a storm comes from an unusual direction.

A different question is whether, now that we know whence the 2008 crisis came, it points to a need for deep changes in macroeconomic thinking. As I’ve already noted, bank runs have been fairly well understood for a long time; we just failed to note the changing definition of banks. The bursting of the housing bubble, with its effects on residential investment and wealth, was conceptually just a negative shock to aggregate demand.

The role of household leverage and forced deleveraging is a bigger break from conventional macroeconomics, even as done by saltwater economists who never bought into efficient markets and were aware of the risk of financial crises. That said, despite the impressive empirical work of Mian and Sufi (2011) and my own intellectual investment in the subject, I don’t think we can consider incorporating debt and leverage a fundamental new idea, as opposed to a refinement at the margin.

It’s true that introducing a role for household debt in spending behaviour makes the short-run equilibrium of the economy dependent on a stock variable, the level of debt. But this implicit role of stock variables in short-run outcomes isn‘t new: after all, nobody has ever questioned the notion that investment flows depend in part on the existing capital stock, and I’m not aware that many macroeconomists consider this a difficult conceptual issue.

And I’m not even fully convinced that household debt played that large a role in the crisis. Did household spending fall that much more than one would have expected from the simple wealth effects of the housing bust?

My bottom line is that the failure of nearly all macroeconomists, even of the saltwater camp, to predict the 2008 crisis was similar in type to the Met Office failure in 1987, a failure of observation rather than a fundamental failure of concept. Neither the financial crisis nor the Great Recession that followed required a rethinking of basic ideas.

III. Not believing in (confidence) fairies

Once the Great Recession had happened, the advanced world found itself in a situation not seen since the 1930s, except in Japan, with policy interest rates close to zero everywhere. This raised the practical question of how governments and central banks should and would respond, of which more later.

For economists, it raised the question of what to expect as a result of those policy responses. And the predictions they made were, in a sense, out-of-sample tests of their theoretical framework: economists weren’t trying to reproduce the historical time-series behaviour of aggregates given historical policy regimes, they were trying to predict the effects of policies that hadn’t been applied in modern times in a situation that hadn’t occurred in modern times.

In making these predictions, the deep divide in macroeconomics came into play, making a mockery of those who imagined that time had narrowed the gap between saltwater and freshwater schools. But let me put the freshwater school on one side, again pending later discussion, and talk about the performance of the macroeconomists, many of them trained at MIT or Harvard in the 1970s, who had never abandoned their belief that activist policy can be effective in dealing with short-run fluctuations. I would include in this group Ben Bernanke, Olivier Blanchard, Christina Romer, Mario Draghi, and Larry Summers, among those close to actual policy, and a variety of academics and commentators, such as Simon Wren-Lewis, Martin Wolf, and, of course, yours truly, in supporting roles.

I think it’s fair to say that everyone in this group came into the crisis with some version of Hicksian sticky-price IS-LM as their default, back-of-the-envelope macroeconomic model. Many were at least somewhat willing to work with DSGE models, maybe even considering such models superior for many purposes. But when faced with what amounted to a regime change from normal conditions to an economy where policy interest rates couldn’t fall, they took as their starting point what the Hicksian approach predicted about policy in a liquidity trap. That is, they did not rush to develop new theories, they pretty much stuck with their existing models.

These existing models made at least three strong predictions that were very much at odds with what many inhuential figures in the political and business worlds (backed by a few economists) were saying.

First. Hicksian macroeconomics said that very large budget deficits, which one might normally have expected to drive interest rates sharply higher, would not have that effect near the zero lower bound.

Second, the same approach predicted that even very large increases in the monetary base would not lead to high inflation, or even to corresponding increases in broader monetary aggregates.

Third, this approach predicted a positive multiplier, almost surely greater than 1, on changes in government spending and taxation.

These were not common-sense propositions. Non-economists were quite sure that the huge budget deficits the US ran in 2009-10 would bring on an attack by the ‘bond vigilantes’. Many financial commentators and political figures warned that the Fed’s expansion of its balance sheet would ‘debase the dollar’ and cause high inflation. And many political and policy figures rejected the Keynesian proposition that spending more would expand the economy, spending less lead to contraction.

In fact, if you‘re looking for a post-2008 equivalent to the kinds of debate that raged in the 1930s and again in the 1970s, a conflict between old ideas based on pre-crisis thinking, and new ideas inspired by the crisis, your best candidate would be fiscal policy. The old guard clung to the traditional Keynesian notion of a government spending multiplier somewhat limited by automatic stabilizers, but still greater than 1. The new economic thinking that achieved actual real-world influence during the crisis and aftermath-as opposed, let’s be honest, to the kind of thinking found in this issue mostly involved rejecting the Keynesian multiplier in favour of the doctrine of expansionary austerity, the argument that cutting public spending would crowd in large amounts of private spending by increasing confidence (Alesina and Ardagna, 2010). (The claim that bad things happen when public debt crosses a critical threshold also played an important real-world role, but was less a doctrine than a claimed empirical observation.)

So here, at least, there was something like a classic crisis-inspired confrontation between tired old ideas and a radical new doctrine. Sad to say, however, as an empirical matter the old ideas were proved right, at least insofar as anything in economics can be settled by experience, while the new ideas crashed and burned. Interest rates stayed low despite huge deficits. Massive expansion in the monetary base did not lead to infiation. And the experience of austerity in the euro area, coupled with the natural experiments created by some of the interregional aspects of the Obama stimulus, ended up strongly supporting a conventional, Keynesian view of fiscal policy, Even the magnitude of the multiplier now looks to be around 1.5, which was the number conventional wisdom suggested in advance of the crisis.

So the crisis and aftermath did indeed produce a confrontation between innovative new ideas and traditional views largely rooted in the 1930s. But the movie failed to follow the Hollywood script: the stodgy old ideas led to broadly accurate predictions, were indeed validated to a remarkable degree, while the new ideas proved embarrassingly wrong. Macroeconomics didn’t change radically in response to crisis because old-fashioned models, confronted with a new situation, did just fine.

IV. The case of the missing deflation

I’ve just argued that the lack of a major rethinking of macroeconomics in the aftermath of crisis was reasonable, given that conventional, off-the-shelf macroeconomics performed very well. But this optimistic assessment needs to be qualified in one important respect: while the demand side of economy did just about what economists trained at MIT in the 1970s thought it would, the supply side didn’t.

As I said, the experience of stagflation effectively convinced the whole profession of the validity of the natural-rate hypothesis. Almost everyone agreed that there was no long-run inflation unemployment trade-off. The great saltwater freshwater divide was, instead, about whether there were usable short-run trade-offs.

But if the natural-rate hypothesis was correct, sustained high unemployment should have led not just to low inflation but to continually declining inflation, and eventually deflation. You can see a bit of this in some of the most severely depressed economies, notably Greece. But deflation fears generally failed to materialize.

Put slightly differently, even saltwater, activist-minded macroeconomists came into the crisis as ‘accelerationists’: they expected to see a downward-sloping relationship between unemployment and the rate of change of inflation. What we’ve seen instead is, at best, something like the 1960s version of the Phillips curve, a downward-sloping relationship between unemployment and the level of inflation and even that relationship appears weak.

Obviously this empirical failure has not gone unnoticed. Broadly, those attempting to explain price behaviour since 2008 have gone in two directions. One side, e.g. Blanchard (2016), invokes ‘anchored’ inflation expectations: the claim that after a long period of low, stable inflation, price-setters throughout the economy became insensitive to recent inflation history, and continued to build 2 per cent or so inflation into their decisions even after a number of years of falling below that target. The other side. e.g. Daly and Hobijn (2014), harking back to Tobin (1972) and Akerlof er a1. (1996), invokes downward nominal wage rigidity to argue that the natural rate hypothesis loses validity at low inflation rates.

In a deep sense, I’d argue that these two explanations have more in common than they may seem to at first sight. The anchored-expectations story may preserve the outward form of an accelerationist Phillips curve, but it assumes that the process of expectations formation changes, for reasons not fully explained, at low inflation rates. The nominal rigidity story assumes that there is a form of money illusion. opposition to outright nominal wage cuts, that is also not fully explained but becomes significant at low overall inflation rates.

Both stories also seem to suggest the need for aggressive expansionary policy when inflation is below target: otherwise there’s the risk that expectations may become unanchored on the downward side, or simply that the economy will suffer persistent, unnecessary slack because the downward rigidity of wages is binding for too many workers.

Finally. I would argue that it is important to admit that both stories are ex post explanations of macroeconomic behaviour that was not widely predicted in advance of the post-2008 era. Pre-2008, the general view even on the saltwater side was that stable inflation was a sufficient indicator of an economy operating at potential output, that any persistent negative output gap would lead to steadily declining inflation and eventually outright deflation. This view was, in fact, a key part of the intellectual case for inflation targeting as the basis of monetary policy. If inflation will remain stable at, say, 1 per cent even in a persistently depressed economy. it’s all too easy to see how policymakers might give themselves high marks even while in reality failing at their job.

But while this is a subjective impression, I haven’t done a statistical analysis of recent literature, it does seem that surprisingly few calls for a major reconstruction of macroeconomics focus on the area in which old-fashioned macroeconomics did, in fact, perform badly post-crisis.

There have, for example, been many calls for making the financial sector and financial frictions much more integral to our models than they are, which is a reasonable thing to argue. But their absence from DSGE models wasn’t the source of any major predictive failures. Has there been any comparable chorus of demands that we rethink the inflation process, and reconsider the natural rate hypothesis? Of course there have been some papers along those lines, but none that have really resonated with the profession.

Why not? As someone who came of academic age just as the saltwater freshwater divide was opening up, I think I can offer a still-relevant insight: understanding wage and price-setting is hard, basically just not amenable to the tools we as economists have in our kit. We start with rational behaviour and market equilibrium as a baseline, and try to get economic dysfunction by tweaking that baseline at the edges; this approach has generated big insights in many areas, but wages and prices isn’t one of them.

Consider the paths followed by the two schools of macroeconomics.

Freshwater theory began with the assumption that wage and price-setters were rational maximizers, but with imperfect information, and that this lack of information explained the apparent real effects of nominal shocks. But this approach became obviously untenable by the early 1980s, when inflation declined only gradually despite mass unemployment. Now what?

One possible route would have been to drop the assumption of fully rational behaviour, which was basically the New Keynesian response. For the most part, however, those who had bought into Lucas-type models chose to cling to the maximizing model, which was economics as they knew how to do it, despite attempts by the data to tell them it was wrong. Let me be blunt: real business cycle theory was always a faintly (or more than faintly) absurd enterprise, a desperate attempt to protect intellectual capital in the teeth of reality.

But the New Keynesian alternative, while far better, wasn’t especially satisfactory either. Clever modellers pointed out that in the face of imperfect competition the aggregate costs of departures from perfectly rational price-setting could be much larger than the individual costs. As a result, small menu costs or a bit of bounded rationality could be consistent with widespread price and wage stickiness.

To be blunt again. however, in practice this insight served as an excuse rather than a basis for deep understanding. Sticky prices could be made respectable just allowing modellers to assume something like one-period-ahead price-setting, in turn letting models that were otherwise grounded in rationality and equilibrium produce something not too inconsistent with real-world observation. New Keynesian modelling thus acted as a kind of escape clause rather than a foundational building block.

But is that escape clause good enough to explain the failure of deflation to emerge despite multiple years of very high unemployment? Probably not. And yet we still lack a compelling alternative explanation, indeed any kind of big idea. At some level, wage and price behaviour in a depressed economy seems to be a subject for which our intellectual tools are badly fitted.

The good news is that if one simply assumed that prices and wages are sticky, appealing to the experience of the 1930s and Japan in the 1990s (which never experienced a true deflationary spiral), one did reasonably well on other fronts.

So my claim that basic macroeconomics worked very well after the crisis needs to be qualified by what looks like a big failure in our understanding of price dynamics but this failure didn’t do too much damage in giving rise to bad advice, and hasn’t led to big new ideas because nobody seems to have good ideas to offer.

V. The system sort of worked

In 2009 Barry Eichengreen and Kevin O’Rourke made a splash with a data comparison between the global slump to date and the early stages of the Great Depression; they showed that at the time of writing the world economy was in fact tracking quite close to the implosion that motivated Keynes’s famous essay ‘The Great Slump of 1930’ (Eichengreen and O’Rourke, 2009)

Subsequent updates, however, told a different story. Instead of continuing to plunge as it did in 1930, by the summer of 2009 the world economy first stabilized, then began to recover. Meanwhile, financial markets also began to normalize; by late 2009 many measures of financial stress were more or less back to pre-crisis levels.

So the world financial system and the world economy failed to implode. Why?

We shouldn’t give policy-makers all of the credit here. Much of what went right, or at least failed to go wrong, refiected institutional changes since the 1930s. Shadow banking and wholesale funding markets were deeply stressed, but deposit insurance still protected at good part of the banking system from runs. There never was much discretionary fiscal stimulus, but the automatic stabilizers associated with large welfare states kicked in, well, automatically: spending was sustained by government transfers, while disposable income was buffered by falling tax receipts.

That said, policy responses were clearly much better than they were in the 1930s. Central bankers and fiscal authorities officials rushed to shore up the financial system through a combination of emergency lending and outright bailouts; international cooperation assured that there were no sudden failures brought on by shortages of key currencies. As a result, disruption of credit markets was limited in both scope and duration. Measures of financial stress were back to pre-Lehman levels by June 2009.

Meanwhile, although fiscal stimulus was modest, peaking at about 2 per cent of GDP in the United States, during 2008-9 governments at least refrained from drastic tightening of fiscal policy, allowing automatic stabilizers, which, as I said, were far stronger than they had been in the 1930s to work.

Overall, then, policy did a relatively adequate job of containing the crisis during its most acute phase. As Daniel Drezner argues (2012), ‘the system worked’-well enough, anyway, to avert collapse.

So far, so good. Unfortunately, once the risk of catastrophic collapse was averted, the story of policy becomes much less happy. After practising more or less Keynesian policies in the acute phase of the crisis, governments reverted to type: in much of the advanced world, fiscal policy became Hellenized, that is, every nation was warned that it could become Greece any day now unless it turned to fiscal austerity. Given the validation of Keynesian multiplier analysis, we can confidently assert that this turn to austerity contributed to the sluggishness of the recovery in the United States and the even more disappointing, stuttering pace of recovery in Europe.

Figure 1 sums up the story by comparing real GDP per capita during two episodes: Western Europe after 1929 and the EU as a whole since 2007. In the modern episode, Europe avoided the catastrophic declines of the early 1930s, but its recovery has been so slow and uneven that at this point it is tracking below its performance in the Great Depression.

Now, even as major economies turned to fiscal austerity, they turned to unconventional monetary expansion. How much did this help? The literature is confusing enough to let one believe pretty much whatever one wants to. Clearly Mario Draghi’s “whatever it takes’ intervention (Draghi, 2012) had a dramatic effect on markets, heading off what might have been another acute crisis, but we never did get a clear test of how well outright monetary transactions would have worked in practice, and the evidence on the effectiveness of Fed policies is even less clear.

The purpose of this paper is not, however, to evaluate the decisions of policy-makers, but rather to ask what lessons macroeconomists should and did take from events. And the main lesson from 2010 onwards was that policy-makers don’t listen to us very much, except at moments of extreme stress.

This is clearest in the case of the turn to austerity, which was not at all grounded in conventional macroeconomic models. True, policy-makers were able to find some economists telling them what they wanted to hear, but the basic Hicksian approach that did pretty well over the whole period clearly said that depressed economies near the zero lower bound should not be engaging in fiscal contraction. Never mind, they did it anyway.

Even on monetary policy, where economists ended up running central banks to a degree I believe was unprecedented, the influence of macroeconomic models was limited at best. A basic Hicksian approach suggests that monetary policy is more or less irrelevant in a liquidity trap. Refinements (Krugman, 1998; Eggertsson and Woodford, 2003) suggested that central banks might be able to gain traction by raising their inflation targets, but that never happened.

The point, then, is that policy failures after 2010 tell us relatively little about the state of macroeconomics or the ways it needs to change, other than that it would be nice if people with actual power paid more attention. Macroeconomists aren’t, however, the only researchers with that problem; ask climate scientists how it’s going in their world.

Meanwhile, however, what happened in 2008-9, or more precisely, what didn’t happen, namely utter disaster, did have an important impact on macroeconomics. For by taking enough good advice from economists to avoid catastrophe, policy-makers in turn took off what might have been severe pressure on economists to change their own views.

VI. That 80s show

Why hasn’t macroeconomics been transformed by (relatively) recent events in the way it was by events in the 1930s or the 1970s? Maybe the key point to remember is that such transformations are rare in economics, or indeed in any field. ‘Science advances one funeral at a time,’ quipped Max Planck: researchers rarely change their views much in the light of experience or evidence. The 1930s and the 1970s, in which senior economists changed their minds, eg. Lionel Robbins converting to Keynesianism, were therefore exceptional.

What made them exceptional? Each case was marked by developments that were both clearly inconsistent with widely held views and sustained enough that they couldn’t be written off as aberrations. Lionel Robbins published The Great Depression, a very classical/Austrian interpretation that prescribed a return to the gold standard, in 1934. Would he have become a Keynesian if the Depression had ended by the mid-1930s? The widespread acceptance of the natural-rate hypothesis came more easily, because it played into the neoclassical mindset, but still might not have happened as thoroughly if stagflation had been restricted to a few years in the early 1970s.

From an intellectual point of view, I’d argue, the Great Recession and aftermath bear much more resemblance to the 1979-82 Volcker double-dip recession and subsequent recovery in the United States than to either the 1930s or the 1970s. And here I can speak in part from personal recollection.

By the late 1970s the great division of macroeconomics into rival saltwater and freshwater schools had already happened, so the impact of the Volcker recession depended on which school you belonged to. But in both cases it changed remarkably few minds.

For saltwater macroeconomists, the recession and recovery came mainly as validation of their pre-existing beliefs. They believed that monetary policy has real effects, even if announced and anticipated; sure enough, monetary contraction was followed by a large real downturn. They believed that prices are sticky and inflation has a great deal of inertia, so that monetary tightening would produce a ‘clockwise spiral’ in unemployment and inflation: unemployment would eventually return to the NAIRU (non-accelerating inflation rate of unemployment) at a lower rate of inflation, but only after a transition period of high unemployment. And that’s exactly what we saw.

Freshwater economists had a harder time: Lucas-type models said that monetary contraction could cause a recession only if unanticipated, and as long as economic agents couldn’t distinguish between individual shocks and an aggregate fall in demand. None of this was a tenable description of 1979-82. But recovery came soon enough and fast enough that their worldview could, in effect, ride out the storm. (I was at one conference where a freshwater economist, questioned about current events, snapped ‘I’m not interested in the latest residual.’)

What I see in the response to 2008 and after is much the same dynamic. Half the macroeconomics profession feels mainly validated by events-correctly, I’d say, although as part of that faction I would say that, wouldn’t I? The other half should be reconsidering its views but they should have done that 30 years ago, and this crisis, like that one, was sufficiently well-handled by policy-makers that there was no irresistible pressure for change. (Just to be clear, I’m not saying that it was well-handled in an objective sense: in my view we suffered huge, unnecessary losses of output and employment because of the premature turn to austerity. But the world avoided descending into a full 1930s-style depression, which in effect left doctrinaire economists free to continue believing what they wanted to believe.)

If all this sounds highly cynical, well, I guess it is. There’s a lot of very good research being done in macroeconomics now, much of it taking advantage of the wealth of new data provided by bad events. Our understanding of both fiscal policy and price dynamics are, I believe, greatly improved. And funerals will continue to feed intellectual progress: younger macroeconomists seem to me to be much more flexible and willing to listen to the data than their counterparts were, say, 20 years ago.

But the quick transformation of macroeconomics many hoped for almost surely isn’t about to happen, because events haven’t forced that kind of transformation. Many economists myself included are actually feeling pretty good about our basic understanding of macro. Many others, absent real-world catastrophe, feel free to take the blue pill and keep believing what they want to believe.

What happened when the US last introduced tariffs? – Dominic Rushe.


Willis Hawley and Reed Smoot were reviled for a bill blamed for triggering the Great Depression. Will Trump follow their lead?

America inches towards a potential trade war over steel prices, can Donald Trump hear whispering voices?

Alone in the Oval Office in the wee dark hours, illuminated by the glow of his Twitter app, does he feel the sudden chill flowing from those freshly hung gold drapes? It is the shades of Smoot and Hawley.

Willis Hawley and Reed Smoot have haunted Congress since the 1930s when they were the architects of the Smoot Hawley tariff bill, among the most decried pieces of legislation in US history and a bill blamed by some for not only for triggering the Great Depression but also contributing to the start of the second world war.

Pilloried even in their own time, their bloodied names have been brought out like Jacob Marley’s ghost every time America has taken a protectionist turn on trade policy. And America has certainly taken a protectionist turn.

Successful presidents including Barack Obama and Bill Clinton have campaigned on the perils of free trade only to drop the rhetoric once installed in the White House. Trump called Mexicans “rapists” on the campaign trail. And China? “There are people who wish I wouldn’t refer to China as our enemy. But that’s exactly what they are,” Trump said.

As commander in chief he has shown no signs of softening and this week took major action announcing steel imports would face a 25% tariff and aluminium 10%.

Canada and the EU said they would bring forward their own countermeasures. Mexico, China and Brazil have also said they are considering retaliatory steps.

Trump doesn’t seem worried. “Trade wars are good,” he tweeted even as the usually friendly Wall Street Journal thundered that “Trump’s tariff folly ”is the “biggest policy blunder of his Presidency”.

It is not his first protectionist move. In his first days in office the president has vetoed the Trans Pacific Partnership (TPP), the biggest trade deal in a generation, said he will review the North American Free Trade Agreement (Nafta), a deal he has called “the worst in history”, and had his visit with Mexico’s president cancelled over his plans to make them pay for a border wall.

Free traders may have become complacent after hearing tough talk on trade from so many presidential candidates on the campaign trail only to watch them furiously back pedal when they get into ofhce, said Dartmouth professor and trade expert Douglas Irwin. “Unfortunately that pattern may have been broken,” he says. “It looks like we have to take Trump literally and seriously about his threats on trade.”

Not since Herbert Hoover has a US president been so down on free trade. And Hoover was the man who signed off on Smoot and Hawley’s bill.

Hawley, an Oregon congressman and a professor a history and economics, became a stock figure in the textbooks of his successors thanks to his partnership with the lean, patrician figure of Senator Reed Smoot, a Mormon apostle known as the “sugar senator” for his protectionist stance towards Utah’s sugar beet industry.

Before he was shackled to Hawley for eternity Smoot was more famous for his Mormonism and his abhorrence of bawdy books, a disgust that inspired the immortal headline “Smoot Smites Smut” after he attacked the importation of Lady’s Chatterley’s Lover, Robert Burns’ more risque poems and similar texts as “worse than opium I would rather have a child of mine use opium than read these books.”

But it was imports of another kind that secured Smoot and Hawley’s place in infamy.

The US economy was doing well in the 1920s as the consumer society was being born to the sound of jazz. The Tariff Act began life largely as a politically motivated response to appease the agricultural lobby that had fallen behind as American workers, and money, consolidated in the cities.

Foreign demand for US produce had soared during the first world war, and farm prices doubled between 1915 and 1918. A wave of land speculation followed and farmers took on debt as they looked to expand production. By the early 1920s farmers had found themselves heavily in debt and squeezed by tightening monetary policy and an unexpected collapse in commodity prices.

Nearly a quarter of the American labor force was then employed on the land, and Congress could not ignore heartland America. Cheap foreign imports and their toll on the domestic market became a hot issue in the 1928 election. Even bananas weren’t safe. Irwin quotes one critic in his book Peddling Protectionism: Smoot Hawley and the Great Depression: “The enormous imports of cheap bananas into the United States tend to curtail the domestic consumption of fresh fruits produced in the United States.”

Hoover won in a landslide against Albert E Smith, an out of touch New Yorker who didn’t appeal to middle America, and soon after promised to pass “limited” tariff reforms.

Hawley started the bill but with Smoot behind him it metastasized as lobby groups shoehorned their products into the bill, eventually proposing higher tariffs on more than 20,000 imported goods.

Siren voices warned of dire consequences. Henry Ford reportedly told Hoover the bill was “an economic stupidity”.

Critics of the tariffs were being aided and abetted by “internationalists” willing to “betray American interests”, said Smoot. Reports claiming the bill would harm the US economy were decried as fake news. Republican Frank Crowther, dismissed press criticism as “demagoguery and untruth, scandalous untruth”.

In October 1929 as the Senate debated the tariff bill the stock market crashed. When the bill finally made it to Hoover’s desk in June 1930 it had morphed from his original “limited” plan to the “highest rates ever known”, according to a New York Times editorial.

The extent to which Smoot and Hawley were to blame for the coming Great Depression is still a matter of debate. “Ask a thousand economists and you will get a thousand and five answers,” said Charles Geisst, professor of economics at Manhattan College and author of Wall Street: A History.

What is apparent is that the bill sparked international outrage and a backlash. Canada and Europe reacted with a wave of protectionist tariffs that deepened a global depression that presaged the rise of Hitler and the second world war. A myriad other factors contributed to the Depression, and to the second world war, but inarguably one consequence of Smoot Hawley in the US was that never again would a sitting US president be so avowedly anti trade. Until today.

Franklin D Roosevelt swept into power in 1933 and for the first time the president was granted the authority to undertake trade negotiations to reduce foreign barriers on US exports in exchange for lower US tariffs.

The backlash against Smoot and Hawley continued to the present day. The average tariff on dutiable imports was 45% in 1930; by 2010 it was 5%.

The lessons of Smoot Hawley used to be taught in high schools. Presidents from Lyndon Johnson to Ronald Reagan have enlisted the unhappy duo when facing off with free trade critics. “I have been around long enough to remember that when we did that once before in this century, something called Smoot Hawley, we lived through a nightmare,” Reagan, who came of age during the Great Depression, said in 1984.

They even got a mention in Ferris Bueller’s Day Off when actor Ben Stein’s teacher bores his class with it. “I don’t think the current generation are taught it. It’s in the past and we are more interested in the future.”

But that might be about to change. “The main lesson is that you have to worry about what other countries do. Countries will retaliate,” said Irwin. “When Congress was considering Smoot Hawley in the 1930s they didn’t consider what other countries might do in reaction. They thought other countries would remain passive. But other countries don’t remain passive.”

The consequences of a trade war today are far worse than in the 1930s. Exports of goods and services account for about 13% of US gross domestic product (GDP) the broadest measure of an economy. It was roughly 5% back in 1920.

“The US is much more engaged in trade, it’s much more a part of the fabric of the country, than it was in the 1920s and 1930s. That means the ripple effects are widespread. Many more industries will be hit by it and the scope for foreign retaliation, which in the case of Smoot Hawley was quite limited, is going to be much more widespread if a trade war was to start.”

“When you start talking about withdrawing from trade agreements or imposing tariffs of 35%, if you are doing that as a protectionist measure, that would be blowing up the system.”

That the promise of “blowing up the system” got Trump elected may be why the ghosts of Smoot and Hawley are once again walking the halls of Congress.

The Guardian

The 1930s were humanity’s darkest, bloodiest hour. Are you paying attention? – Jonathan Freedland. 

Even to mention the 1930s is to evoke the period when human civilisation entered its darkest, bloodiest chapter. No case needs to be argued; just to name the decade is enough. It is a byword for mass poverty, violent extremism and the gathering storm of world war. “The 1930s” is not so much a label for a period of time than it is rhetorical shorthand – a two-word warning from history.

Witness the impact of an otherwise boilerplate broadcast by the Prince of Wales last December that made headlines. “Prince Charles warns of return to the ‘dark days of the 1930s’ in Thought for the Day message.” Or consider the reflex response to reports that Donald Trump was to maintain his own private security force even once he had reached the White House. The Nobel prize-winning economist Paul Krugman’s tweet was typical: “That 1930s show returns.”

Because that decade was scarred by multiple evils, the phrase can be used to conjure up serial spectres. It has an international meaning, with a vocabulary that centres on Hitler and Nazism and the failure to resist them: from brownshirts and Goebbels to appeasement, Munich and Chamberlain. And it has a domestic meaning, with a lexicon and imagery that refers to the Great Depression: the dust bowl, soup kitchens, the dole queue and Jarrow. It was this second association that gave such power to a statement from the usually dry Office for Budget Responsibility, following then-chancellor George Osborne’s autumn statement in 2014. The OBR warned that public spending would be at its lowest level since the 1930s; the political damage was enormous and instant.

In recent months, the 1930s have been invoked more than ever, not to describe some faraway menace but to warn of shifts under way in both Europe and the United States. The surge of populist, nationalist movements in Europe, and their apparent counterpart in the US, has stirred unhappy memories and has, perhaps inevitably, had commentators and others reaching for the historical yardstick to see if today measures up to 80 years ago.

Why is it the 1930s to which we return, again and again? For some sceptics, the answer is obvious: it’s the only history anybody knows. According to this jaundiced view of the British school curriculum, Hitler and Nazis long ago displaced Tudors and Stuarts as the core, compulsory subjects of the past. When we fumble in the dark for a historical precedent, our hands keep reaching for the 30s because they at least come with a little light.

The more generous explanation centres on the fact that that period, taken together with the first half of the 1940s, represents a kind of nadir in human affairs. The Depression was, as Larry Elliott wrote last week, “the biggest setback to the global economy since the dawn of the modern industrial age”, leaving 34 million Americans with no income. The hyperinflation experienced in Germany – when a thief would steal a laundry-basket full of cash, chucking away the money in order to keep the more valuable basket – is the stuff of legend. And the Depression paved the way for history’s bloodiest conflict, the second world war which left, by some estimates, a mind-numbing 60 million people dead. At its centre was the Holocaust, the industrialised slaughter of 6 million Jews by the Nazis: an attempt at the annihilation of an entire people.

In these multiple ways, then, the 1930s function as a historical rock bottom, a demonstration of how low humanity can descend. The decade’s illustrative power as a moral ultimate accounts for why it is deployed so fervently and so often.

Less abstractly, if we keep returning to that period, it’s partly because it can justifiably claim to be the foundation stone of our modern world. The international and economic architecture that still stands today – even if it currently looks shaky and threatened – was built in reaction to the havoc wreaked in the 30s and immediately afterwards. The United Nations, the European Union, the International Monetary Fund, Bretton Woods: these were all born of a resolve not to repeat the mistakes of the 30s, whether those mistakes be rampant nationalism or beggar-my-neighbour protectionism. The world of 2017 is shaped by the trauma of the 1930s.

The international and economic architecture that still stands today was built in reaction to the havoc of the 1930s

One telling, human illustration came in recent global polling for the Journal of Democracy, which showed an alarming decline in the number of people who believed it was “essential” to live in a democracy. From Sweden to the US, from Britain to Australia, only one in four of those born in the 1980s regarded democracy as essential. Among those born in the 1930s, the figure was at or above 75%. Put another way, those who were born into the hurricane have no desire to feel its wrath again.

Most of these dynamics are long established, but now there is another element at work. As the 30s move from living memory into history, as the hurricane moves further away, so what had once seemed solid and fixed – specifically, the view that that was an era of great suffering and pain, whose enduring value is as an eternal warning – becomes contested, even upended.

Witness the remarks of Steve Bannon, chief strategist in Donald Trump’s White House and the former chairman of the far-right Breitbart website. In an interview with the Hollywood Reporter, Bannon promised that the Trump era would be “as exciting as the 1930s”. (In the same interview, he said “Darkness is good” – citing Satan, Darth Vader and Dick Cheney as examples.)

“Exciting” is not how the 1930s are usually remembered, but Bannon did not choose his words by accident. He is widely credited with the authorship of Trump’s inaugural address, which twice used the slogan “America first”. That phrase has long been off-limits in US discourse, because it was the name of the movement – packed with nativists and antisemites, and personified by the celebrity aviator Charles Lindbergh – that sought to keep the US out of the war against Nazi Germany and to make an accommodation with Hitler. Bannon, who considers himself a student of history, will be fully aware of that 1930s association – but embraced it anyway.

That makes him an outlier in the US, but one with powerful allies beyond America’s shores. Timothy Snyder, professor of history at Yale and the author of On Tyranny: Twenty Lessons from the Twentieth Century, notes that European nationalists are also keen to overturn the previously consensual view of the 30s as a period of shame, never to be repeated. Snyder mentions Hungary’s prime minister, Viktor Orban, who avowedly seeks the creation of an “illiberal” state, and who, says Snyder, “looks fondly on that period as one of healthy national consciousness”.

The more arresting example is, perhaps inevitably, Vladimir Putin. Snyder notes Putin’s energetic rehabilitation of Ivan Ilyin, a philosopher of Russian fascism influential eight decades ago. Putin has exhumed Ilyin both metaphorically and literally, digging up and moving his remains from Switzerland to Russia.

Among other things, Ilyin wrote that individuality was evil; that the “variety of human beings” represented a failure of God to complete creation; that what mattered was not individual people but the “living totality” of the nation; that Hitler and Mussolini were exemplary leaders who were saving Europe by dissolving democracy; and that fascist holy Russia ought to be governed by a “national dictator”. Ilyin spent the 30s exiled from the Soviet Union, but Putin has brought him back, quoting him in his speeches and laying flowers on his grave.

European nationalists are keen to overturn the view of the 1930s as a period of shame, never to be repeated.

Still, Putin, Orbán and Bannon apart, when most people compare the current situation to that of the 1930s, they don’t mean it as a compliment. And the parallel has felt irresistible, so that when Trump first imposed his travel ban, for example, the instant comparison was with the door being closed to refugees from Nazi Germany in the 30s. (Theresa May was on the receiving end of the same comparison when she quietly closed off the Dubs route to child refugees from Syria.)

When Trump attacked the media as purveyors of “fake news”, the ready parallel was Hitler’s slamming of the newspapers as the Lügenpresse, the lying press (a term used by today’s German far right). When the Daily Mail branded a panel of high court judges “enemies of the people”, for their ruling that parliament needed to be consulted on Brexit, those who were outraged by the phrase turned to their collected works of European history, looking for the chapters on the 1930s.

The Great Depression

So the reflex is well-honed. But is it sound? Does any comparison of today and the 1930s hold up?

The starting point is surely economic, not least because the one thing everyone knows about the 30s – and which is common to both the US and European experiences of that decade – is the Great Depression. The current convulsions can be traced back to the crash of 2008, but the impact of that event and the shock that defined the 30s are not an even match. When discussing our own time, Krugman speaks instead of the Great Recession: a huge and shaping event, but one whose impact – measured, for example, in terms of mass unemployment – is not on the same scale. US joblessness reached 25% in the 1930s; even in the depths of 2009 it never broke the 10% barrier.

The political sphere reveals another mismatch between then and now. The 30s were characterised by ultra-nationalist and fascist movements seizing power in leading nations: Germany, Italy and Spain most obviously. The world is waiting nervously for the result of France’s presidential election in May: victory for Marine Le Pen would be seized on as the clearest proof yet that the spirit of the 30s is resurgent.

There is similar apprehension that Geert Wilders, who speaks of ridding the country of ‘Moroccan scum”, has led the polls ahead of Holland’s general election on Wednesday. And plenty of liberals will be perfectly content for the Christian Democrat Angela Merkel to prevail over her Social Democratic rival, Martin Schulz, just so long as the far-right Alternative Fur Deutschland makes no ground. Still, so far and as things stand, in Europe only Hungary and Poland have governments that seem doctrinally akin to those that flourished in the 30s.

That leaves the US, which dodged the bullet of fascistic rule in the 30s – although at times the success of the America First movement which at its peak could count on more than 800,000 paid-up members, suggested such an outcome was far from impossible. (Hence the intended irony in the title of Sinclair Lewis’s 1935 novel, It Can’t Happen Here.)

Donald Trump has certainly had Americans reaching for their history textbooks, fearful that his admiration for strongmen, his contempt for restraints on executive authority, and his demonisation of minorities and foreigners means he marches in step with the demagogues of the 30s.

But even those most anxious about Trump still focus on the form the new presidency could take rather than the one it is already taking. David From, a speechwriter to George W. Bush, wrote a much-noticed essay for the Atlantic titled, “How to build an autocracy”. It was billed as setting out “the playbook Donald Trump could use to set the country down a path towards illiberalism”. He was not arguing that Trump had already embarked on that route, just that he could (so long as the media came to heel and the public grew weary and worn down, shrugging in the face of obvious lies and persuaded that greater security was worth the price of lost freedoms).

Similarly, Trump has unloaded rhetorically on the free press – castigating them, Mail-style, as “enemies of the people” – but he has not closed down any newspapers. He meted out the same treatment via Twitter to a court that blocked his travel ban, rounding on the “so-called judge” – but he did eventually succumb to the courts’ verdict and withdrew his original executive order. He did not have the dissenting judges sacked or imprisoned; he has not moved to register or intern every Muslim citizen in the US; he has not suggested they wear identifying symbols.

These are crumbs of comfort; they are not intended to minimise the real danger Trump represents to the fundamental norms that underpin liberal democracy. Rather, the point is that we have not reached the 1930s yet. Those sounding the alarm are suggesting only that we may be travelling in that direction – which is bad enough.

Two further contrasts between now and the 1930s, one from each end of the sociological spectrum, are instructive. First, and particularly relevant to the US, is to ask: who is on the streets? In the 30s, much of the conflict was played out at ground level, with marchers and quasi-military forces duelling for control. The clashes of the Brownshirts with communists and socialists played a crucial part in the rise of the Nazis. (A turning point in the defeat of Oswald Mosley, Britain’s own little Hitler, came with his humbling in London’s East End, at the 1936 battle of Cable Street.)

But those taking to the streets today – so far – have tended to be opponents of the lurch towards extreme nationalism. In the US, anti-Trump movements – styling themselves, in a conscious nod to the 1930s, as “the resistance” – have filled city squares and plazas. The Women’s March led the way on the first day of the Trump presidency; then those protesters and others flocked to airports in huge numbers a week later, to obstruct the refugee ban. Those demonstrations have continued, and they supply an important contrast with 80 years ago. Back then, it was the fascists who were out first – and in force.

Snyder notes another key difference. “In the 1930s, all the stylish people were fascists: the film critics, the poets and so on.” He is speaking chiefly about Germany and Italy, and doubtless exaggerates to make his point, but he is right that today “most cultural figures tend to be against”. There are exceptions – Le Pen has her celebrity admirers, but Snyder speaks accurately when he says that now, in contrast with the 30s, there are “few who see fascism as a creative cultural force”.

Fear and loathing

So much for where the lines between then and now diverge. Where do they run in parallel?

The exercise is made complicated by the fact that ultra-nationalists are, so far, largely out of power where they ruled in the 30s – namely, Europe – and in power in the place where they were shut out in that decade, namely the US. It means that Trump has to be compared either to US movements that were strong but ultimately defeated, such as the America First Committee, or to those US figures who never governed on the national stage.

In that category stands Huey Long, the Louisiana strongman, who ruled that state as a personal fiefdom (and who was widely seen as the inspiration for the White House dictator at the heart of the Lewis novel).

“He was immensely popular,” says Tony Badger, former professor of American history at the University of Cambridge. Long would engage in the personal abuse of his opponents, often deploying colourful language aimed at mocking their physical characteristics. The judges were a frequent Long target, to the extent that he hounded one out of office – with fateful consequences.

Long went over the heads of the hated press, communicating directly with the voters via a medium he could control completely. In Trump’s day, that is Twitter, but for Long it was the establishment of his own newspaper, the Louisiana Progress (later the American Progress) – which Long had delivered via the state’s highway patrol and which he commanded be printed on rough paper, so that, says Badger, “his constituents could use it in the toilet”.

All this was tolerated by Long’s devotees because they lapped up his message of economic populism, captured by the slogan: “Share Our Wealth”. Tellingly, that resonated not with the very poorest – who tended to vote for Roosevelt, just as those earning below $50,000 voted for Hillary Clinton in 2016 – but with “the men who had jobs or had just lost them, whose wages had eroded and who felt they had lost out and been left behind”. That description of Badger’s could apply just as well to the demographic that today sees Trump as its champion.

Long never made it to the White House. In 1935, one month after announcing his bid for the presidency, he was assassinated, shot by the son-in-law of the judge Long had sought to remove from the bench. It’s a useful reminder that, no matter how hate-filled and divided we consider US politics now, the 30s were full of their own fear and loathing.

“I welcome their hatred,” Roosevelt would say of his opponents on the right. Nativist xenophobia was intense, even if most immigration had come to a halt with legislation passed in the previous decade. Catholics from eastern Europe were the target of much of that suspicion, while Lindbergh and the America Firsters played on enduring antisemitism.

This, remember, was in the midst of the Great Depression, when one in four US workers was out of a job. And surely this is the crucial distinction between then and now, between the Long phenomenon and Trump. As Badger summarises: “There was a real crisis then, whereas Trump’s is manufactured.”

And yet, scholars of the period are still hearing the insistent beep of their early warning systems. An immediate point of connection is globalisation, which is less novel than we might think. For Snyder, the 30s marked the collapse of the first globalisation, defined as an era in which a nation’s wealth becomes ever more dependent on exports. That pattern had been growing steadily more entrenched since the 1870s (just as the second globalisation took wing in the 1970s). Then, as now, it had spawned a corresponding ideology – a faith in liberal free trade as a global panacea – with, perhaps, the English philosopher Herbert Spencer in the role of the End of History essayist Francis Fukuyama. By the 1930s, and thanks to the Depression, that faith in globalisation’s ability to spread the wealth evenly had shattered. This time around, disillusionment has come a decade or so ahead of schedule.

The second loud alarm is clearly heard in the hostility to those deemed outsiders. Of course, the designated alien changes from generation to generation, but the impulse is the same: to see the family next door not as neighbours but as agents of some heinous worldwide scheme, designed to deprive you of peace, prosperity or what is rightfully yours. In 30s Europe, that was Jews. In 30s America, it was eastern Europeans and Jews. In today’s Europe, it’s Muslims. In America, it’s Muslims and Mexicans (with a nod from the so-called alt-right towards Jews). Then and now, the pattern is the same: an attempt to refashion the pain inflicted by globalisation and its discontents as the wilful act of a hated group of individuals. No need to grasp difficult, abstract questions of economic policy. We just need to banish that lot, over there.

The third warning sign, and it’s a necessary companion of the second, is a growing impatience with the rule of law and with democracy. “In the 1930s, many, perhaps even most, educated people had reached the conclusion that democracy was a spent force,” says Snyder. There were plenty of socialist intellectuals ready to profess their admiration for the efficiency of Soviet industrialisation under Stalin, just as rightwing thinkers were impressed by Hitler’s capacity for state action. In our own time, that generational plunge in the numbers regarding democracy as “essential” suggests a troubling echo.

Today’s European nationalists exhibit a similar impatience, especially with the rule of law: think of the Brexiters’ insistence that nothing can be allowed to impede “the will of the people”. As for Trump, it’s striking how very rarely he mentions democracy, still less praises it. “I alone can fix it” is his doctrine – the creed of the autocrat.

The geopolitical equivalent is a departure from, or even contempt for, the international rules-based system that has held since 1945 – in which trade, borders and the seas are loosely and imperfectly policed by multilateral institutions such as the UN, the EU and the World Trade Organisation. Admittedly, the international system was weaker to start with in the 30s, but it lay in pieces by the decade’s end: both Hitler and Stalin decided that the global rules no longer applied to them, that they could break them with impunity and get on with the business of empire-building.

If there’s a common thread linking 21st-century European nationalists to each other and to Trump, it is a similar, shared contempt for the structures that have bound together, and restrained, the principal world powers since the last war. Naturally, Le Pen and Wilders want to follow the Brexit lead and leave, or else break up, the EU. And, no less naturally, Trump supports them – as well as regarding Nato as “obsolete” and the UN as an encumbrance to US power (even if his subordinates rush to foreign capitals to say the opposite).

For historians of the period, the 1930s are always worthy of study because the decade proves that systems – including democratic republics – which had seemed solid and robust can collapse. That fate is possible, even in advanced, sophisticated societies. The warning never gets old.

But when we contemplate our forebears from eight decades ago, we should recall one crucial advantage we have over them. We have what they lacked. We have the memory of the 1930s. We can learn the period’s lessons and avoid its mistakes. Of course, cheap comparisons coarsen our collective conversation. But having a keen ear tuned to the echoes of a past that brought such horror? That is not just our right. It is surely our duty.

The Guardian

What the 21st century can learn from the 1929 crash – Larry Elliott. 

As the summer of 1929 drew to a close, the celebrated Yale university economist Irving Fisher took to the pages of the New York Times to opine about Wall Street. Share prices had been rising all year; investors had been speculating with borrowed money on the assumption that the good times would continue. It was the bull market of all time, and those taking a punt wanted reassurance that their money was safe.

Fisher provided it for them, predicting confidently: “Stock markets have reached what looks like a permanently high plateau.” On that day, the Wall Street Crash of October 1929 was less than two months away. It was the worst share tip in history. Nothing else comes close.

The crisis broke on Thursday 24 October, when the market dropped by 11%. Black Thursday was followed by a 13% fall on Black Monday and a further 12% tumble on Black Tuesday. By early November, Fisher was ruined and the stock market was in a downward spiral that would only bottom out in June 1932, at which point companies quoted on the New York stock exchange had lost 90% of their value and the world had changed utterly.

The Great Crash was followed by the Great Depression, the biggest setback to the global economy since the dawn of the modern industrial age in the middle of the 18th century. Within three years of Fisher’s ill-judged prediction, a quarter of America’s working population was unemployed and desperate. As the economist JK Galbraith put it: “Some people were hungry in 1930, 31 and 32. Others were tortured by the fear that they might go hungry.”

Banks that weren’t failing were foreclosing on debtors. There was no welfare state to cushion the fall for those such as John Steinbeck’s Okies – farmers caught between rising debts and crashing commodity prices. One estimate suggests 34 million Americans had no income at all. By mid-1932, the do-nothing approach of Herbert Hoover was discredited and the Democrat Franklin Roosevelt was on course to become US president.

Across the Atlantic, Germany was suffering its second economic calamity in less than a decade. In 1923, the vindictive peace terms imposed by the Treaty of Versailles had helped to create the conditions for hyperinflation, when one dollar could be exchanged for 4.2 trillion marks, people carted wheelbarrows full of useless notes through the streets, and cigarettes were used as money. In 1932, a savage austerity programme left 6 million unemployed.

Germany suffered as the pound fell and rival British exports became cheaper. More than 40% of Germany’s industrial workers were idle and Nazi brownshirts were fighting communists for control of the streets. By 1932, the austerity policies of the German chancellor Heinrich Brüning were discredited and Adolf Hitler was on course to replace him.

Timeline of turmoil

It would be wrong to think nobody saw the crisis coming. Fisher’s prediction may well have been a riposte to a quite different (and remarkably accurate) prediction made by the investment adviser Roger Babson in early September 1929. Babson to the US National Business Conference that a crash was coming and that it would be a bad one. “Factories will shut down,” Babson predicted, “men will be thrown out of work.” Anticipating how the slump would feed on itself, he warned: “The vicious cycle will get in and the result will be a serious business depression.”

Cassandras are ignored until it is too late. And Babson, who had form as a pessimist, was duly ignored. The Dr Doom of the 2008 crisis, New York University Nouriel Roubini, suffered the same fate.

F Scott Fitzgerald described the Great Crash as the moment the jazz age dived to its death. It marked the passing of a first age of globalisation that had flourished in the decades before the first world war with free movements of capital, freedom and – to a lesser extent – goods. In the decade or so after the guns fell silent in 1918, policymakers had been trying to re-create what they saw as a golden period of liberalism. The Great Depression put paid to those plans, ushering in, instead, an era of isolationism, protectionism, aggressive nationalism and totalitarianism. There was no meaningful recovery until nations took up arms again in 1939.

In Britain, recovery was concentrated in the south of England and too weak to dent ingrained unemployment in the old industrial areas. The Jarrow march for jobs took place in 1936, seven years after the start of the crisis. It was a similar story in the US, where a recovery during Roosevelt’s first presidential term ended in a second mini-slump in 1937. Sir Winston Churchill, who lost a packet in the Crash, described the period 1914 to 1945 as the second 30 years’ war.

Only one other financial meltdown can compare to the Wall Street Crash for the length of its impact: the one that hit a climax with the bankruptcy of Lehman Brothers in September 2008. Without the Great Depression, there would have been no New Deal and no Keynesian revolution in economics. Roosevelt might never have progressed beyond the New York governor’s mansion in Albany. Hitler, whose political star was on the wane by the late 1920s, would have been a historical footnote .

Similarly, without the long-lingering effects of the 2008 crash, there would have been no Brexit, Donald Trump would still be a New York City builder and Europe would not be quaking at the possibility of Marine Le Pen replacing François Hollande as French president.

Not since the 1930s have there been such acute fears of a populist backlash against the prevailing orthodoxy. As then, a prolonged period of poor economic performance has led to a political reaction that looks like feeding back into a desire for a different economic approach. The early 30s share with the mid-2010s a sense that the political establishment has lost the confidence of large numbers of voters, who have rejected “business as usual” and backed politicians they see as challenging the status quo.

Trump is not the first president to urge an America-first policy: Roosevelt was of a similar mind after he replaced Herbert Hoover in 1933. Nor is this the first time there has been such a wide gulf between Wall Street and the rest of the country. The loathing of the bankers in the 20s hardened into a desire for retribution in the 30s.
According to Lord Robert Skidelsky, biographer of John Maynard Keynes: “We got into the Great Depression for the same reason as in 2008: there was a great pile of debt, there was gambling on margin on the stock market, there was over-inflation of assets, and interest rates were too high to support a full employment level of investment.”

There are other similarities. The 20s had been good for owners of assets but not for workers. There had been a sharp increase in unemployment at the start of the decade and labour markets had not fully recovered by the time an even bigger slump began in 1929. But while employees saw their slice of the economic cake get smaller, for the rich and powerful, the Roaring Twenties were the best of times. In the US, the halving of the top rate of income tax to 32% meant more money for speculation in the stock and property markets. Share prices rose sixfold on Wall Street in the decade leading up to the Wall Street Crash.

Inequality was high and rising, and demand only maintained through a credit bubble. Unemployment between 1921 and 1929 averaged 8% in the US, 9% in Germany and 12% in Britain. Labour markets had never really recovered from a severe recession at the start of the 20s designed to stamp out a post-war inflationary boom.

Above all, in both periods global politics were in flux. From around 1890, the balance of power between the great European nations that had kept the peace for three quarters of a century after the battle of Waterloo in 1815 started to break down. The Ottoman and Austro-Hungarian empires were in decline before the first world war; the US, Germany and Russia were on the rise.

More importantly, Britain, which had been the linchpin of late 19th-century globalisation had been weakened by the first world war and was no longer able to provide the leadership role. America was not yet ready to take up the mantle.

Stephen King, senior economic adviser to HSBC and author of a forthcoming book on the crisis of globalisation, Grave New World, says: “There are similarities between now and the 1920 and 1930s in the sense that you had a declining superpower. Britain was declining then and the US is potentially declining now.”

King says that in the 20s, the idea of a world ruled by empires was crumbling. Eventually, the US did take on Britain’s role as the defender of western values, but not until the 40s, when it was pivotal in both defeating totalitarianism and in creating the economic and political institutions – the United Nations, the International Monetary Fund, the World Bank – that were designed to ensure the calamitous events of the 30s never happened again.

“There are severe doubts about whether the US is able or willing to play the role it played in the second half of the 20th century, and that’s worrisome because if the US is not playing it, who does? If nobody is prepared to play that role, the question is whether we are moving towards a more chaotic era.”

Deflationary Disaster
There are, of course, differences as well as similarities between the two epochs. At this year’s meeting of the World Economic Forum in Davos, Switzerland, held in the week of Trump’s inauguration, members of the global business elite found reasons to be cheerful.

Some took comfort from technology: the idea that Facebook, Snapchat and Google have shrunk the world. Others said slapping tariffs on imported goods in an era of complex international supply chains would push up the cost of exports and make it unthinkable even for a country as big as the US to adopt a go-it-alone economic strategy. Roberto Azevêdo, managing director of the World Trade Organisation said: “The big difference between the financial crisis of 2008 and the early 1930s is that today we have multilateral trade rules, and in the 30s we didn’t.”

The biggest difference between the two crises, however, is that in the early 1930s blunders by central banks and finance ministries made matters a lot worse than they need have been. Not all stock market crashes morph into slumps, and one was avoided – just about – in the period after the collapse of Lehman Brothers.

Early signs from data for industrial production and world trade in late 2008 showed declines akin to those during the first months of the Great Depression. Policymakers have been rightly castigated for being asleep at the wheel while the sub-prime mortgage crisis was gestating, but knowing some economic history helped when Lehman Brothers went bust. In the early 30s, central banks waited too long to cut interest rates and allowed deflation to set in. There was a policy of malign neglect towards the banks, which were allowed to go bust in droves. Faced with higher budget deficits caused by higher unemployment and slower growth, finance ministers made matters worse by raising taxes and cutting spending.

The response to the Crash, according to Adam Tooze in his book The Deluge, was deflationary policies were pursued everywhere. “The question that critics have asked ever since is why the world was so eager to commit to this collective austerity. If Keynesian and monetarist economists can agree on one thing, it is the disastrous consequences of this deflationary consensus.”

At the heart of this consensus was the gold standard, the strongly held belief that it should be possible to exchange pounds, dollars, marks or francs for gold at a fixed exchange rate. The system had its own automatic regulatory process: if a country lived beyond its means and ran a current account surplus, gold would flow out and would only return once policy had been tightened to reduce imports.

After concerted efforts by the Bank of England and the Treasury, Britain returned to the gold standard in 1925 at its pre-war parity of $4.86. This involved a rise in the exchange rate that made life more difficult for exporters.

What the policymakers failed to realise was that the world had moved on since the pre-1914 era. Despite being on the winning side, Britain’s economy was much weaker. Germany’s economy had also suffered between 1914 and 1918, and was further hobbled by reparations. America, by contrast, was in a much stronger position.

This changing balance of power meant that restoring the pre-war regime was a long and painful process, and by the late 20s the strains of attempting to do so were starting to become unbearable in just the same way as the strains on the euro – the closest modern equivalent to the gold standard – have become evident since 2008.

Instead of easing off, policymakers in the early stages of the Great Depression thought the answer was to redouble their efforts. Peter Temin, an economic historian, compares central banks and finance ministries to the 18th-century doctors who treated Mozart with mercury: “Not only were they singularly ineffective in curing the economic disease; they also killed the patient.”

Skidelsky explains that in Britain, the so-called “automatic stabilisers” kicked in during the early stages of the crisis. Tax revenues fell because growth was weaker while spending on unemployment benefits rose. The public finances fell into the red.

Instead of welcoming the extra borrowing as a cushion against a deeper recession, the authorities took steps to balance the budget. Ramsay MacDonald’s government set up the May committee to see what could be done about the deficit. Given the membership, heavily weighted in favour of businessmen, the outcome was never in doubt: sterling was under pressure and in order to maintain Britain’s gold standard parity, the May committee recommended cuts of £97m from the state’s £885m budget. Unemployment pay was to be cut by 30% in order to balance the budget within a year.
The severity of the cuts split the Labour government and prompted the formation of a national government led by MacDonald. Philip Snowden, the chancellor, said the alternative to the status quo was “the Deluge”. Financial editors were invited to the Treasury to be briefed on measures being taken to protect the pound, and when one asked whether Britain should or could stay on the gold standard, the Treasury mandarin Sir Warren Hastings rose to his feet and thundered: “To suggest we should leave the gold standard is an affront not only to the national honour, but to the personal honour of every man or woman in the country.”

The show of fiscal masochism failed to prevent fresh selling of the pound, and eventually the pressure became unbearable. In September 1931, Britain provided as big a shock to the rest of the world as it did on 23 June 2016, by coming off the gold standard.

The pound fell and the boost to UK exports was reinforced six months later when the coalition government announced a policy of imperial preference, the erection of tariff barriers around colonies and former colonies such as Australia and New Zealand.

Britain was not the first country to resort to protectionism. The now infamous Smoot-Hawley tariff had been announced in the US in 1930. But America had a recent history of protectionism – it had built up its manufacturing strength behind a 40% tariff in the second half of the 19th century. Britain, as Tooze explains, had been in favour of free trade since the repeal of the corn laws in 1846. 

“Now it was responsible for initiating the death spiral of protectionism and beggar-thy-neighbour currency wars that would tear the global economy apart.”

Britain’s 1931 exit from the gold standard meant it secured first-mover advantage over its main rivals. For Germany, the pain was especially severe, since the country’s mountain of foreign debt ruled out devaluation and left Chancellor Brüning’s government with the choice between default and deflation. Brüning settled for another round of austerity, not realising that for voters there was a third choice: a party that insisted that national solutions were the answer to a broken international system.
The reason borrowing costs were slashed in 2008 is that central bankers knew their history. Ben Bernanke, then chairman of America’s Federal Reserve, was a student of the Great Depression and fully acknowledged that his institution could not afford to make the same mistake twice. Interest rates were cut to barely above zero; money was created through the process known as quantitative easing; the banks were bailed out; Barack Obama pushed a fiscal stimulus programme through Congress.

But the policy was only a partial success. Low interest rates and quantitative easing have averted Great Depression 2.0 by flooding economies with cheap money. This has driven up the prices of assets – shares, bonds and houses – to the benefit of those who are rich or comfortably off.

For those not doing so well, it has been a different story. Wage increases have been hard to come by, and the strong desire of governments to reduce budget deficits has resulted in unpopular austerity measures. Not all the lessons of the 1930s have been well learned , and the over-hasty tightening of fiscal policy has slowed growth and caused political alienation among those who feel they are being punished for a crisis they did not create, while the real villains get away scot-free . A familiar refrain in both the referendum on Brexit and the 2016 US presidential election was: there might be a recovery going on, but it’s not happening around here.

Authoritarian solutions

Internationalism died in the early 30s because it came to be associated with discredited policies: rampant speculation, mass unemployment, permanent austerity and falling living standards.

Totalitarian states promoted themselves as alternatives to failed and decrepit liberal democracies. Hitler’s Germany was one, Stalin’s Soviet Union another. While the first era of globalisation was breaking up, Moscow was pushing ahead with the collectivisation of agriculture and rapid industrialisation.

What’s more, the economic record of the totalitarian countries in the 30s was far superior to that of the liberal democracies. Growth averaged 0.3% a year in Britain, the US and France, compared with 3.1% a year in Germany, Italy, Japan and the Soviet Union.

Erik Britton, founder of the consultancy Fathom , says: “The 1920s saw the failure of liberal free-trade, free-market policies to deliver stability and growth. Alternative people came along with a populist stance that really worked, for a while.”

There is, Britton says, a reason mainstream parties are currently being rejected: “It is not safe to assume you can deliver unsatisfactory economic outcomes for a decade without a political reaction that feeds back into the economics.”

Economic devastation caused by the Great Depression did eventually force western democracies into rethinking policy. The key period was the 18 months between Britain coming off the gold standard in September 1931 and Roosevelt’s arrival in the White House in March 1933.

Under Hoover, US economic policy had been relentlessly deflationary. As in Germany – the other country to suffer most grievously from the Depression – there was a dogged insistence on protecting the currency and on balancing the budget.

The Great Depression ushered in isolationism, protectionism, aggressive nationalism and totalitarianism

That changed under FDR. Policy became both more interventionist and more isolationist. If London could adopt a Britain-first policy, then so could Washington. Roosevelt swiftly took the dollar off the gold standard and scuppered attempts to prevent currency wars. Wall Street was reined in; fiscal policy was loosened. But it was too late. By then, Hitler was chancellor and tightening his grip on power. Ultimately, the Depression was brought to an end not by the New Deal, but by war.

King says the world is already starting to become more protectionist in terms of movement of capital and labour. Trump has been naming and shaming US companies seeking to take advantage of cheaper labour in the emerging countries, while Brexit is an example of the idea that migration needs to be controlled.

The US supported the post-war global instutional framework: the UN, IMF and European Union, through the Marshall Plan. “It tried to create a framework in which individual countries could flourish,” King adds. “But I don’t see that [happening again] in the future, which creates difficulties for the rest of the world.”

So far, financial markets have taken a positive view of Trump. They have concentrated on the growth potential of his plans for tax cuts and higher infrastructure spending, rather than his threat to build a wall along the Rio Grande and to slap tariffs on Mexican and Chinese imports.

There is, though, a darker vision of the future, where every country tries to do what Trump is doing. In this scenario, a shrinking global economy leads to shrinking global trade, and deflation means personal debts become more onerous. “It becomes a vicious, self-fulfilling cycle,” Britton says. “People seek answers and find it in authoritarianism, populism and protectionism. If one country can show it works, there is a strong temptation for others to follow suit.”

This may prove too pessimistic. The global economy is growing by around 3% a year; Britain and the US (if not the eurozone) have seen unemployment halve since the 2008-09 crisis; low oil prices have kept inflation low and led to rising living standards.

Even so, it is not hard to see why support for the policy ideas that have driven the second era of globalisation – free movement of capital, goods and people – has started to fracture. The winners from the liberal economic system that emerged at the end of the cold war have, like their forebears in the 20s, failed to look out for the losers. A rising tide has not lifted all boats, and those who do not consider themselves the beneficiaries of globalisation have grown weary of hearing how marvellous it is.

The 30s are proof that nothing in economics is inevitable. There was eventually a backlash against the economic orthodoxies and Skidelsky can see why there is another backlash happening today. “Globalisation enables capital to escape national and union control. I am much more sympathetic since the start of the crisis to the Marxist way of analysing things.

“Trump will be impeached, assassinated or frustrated by Congress,” Skidelsky suggests. “Or he will remain popular enough to overcome the liberal consensus that he is a shit of the first order. After all, a lot of people agree with what he is doing.”

The Guardian

The Protectionist Who Nearly Wrecked America – Gil Troy. 

When Utah Senator Reed Smoot moved to Washington in 1903, he endured an even harsher welcome than Donald Trump’s.

This Mormon apostle, elevated in 1900, and first LDS senator had to battle anti-Mormon prejudice for four years until President Theodore Roosevelt bullied Republican senators into seating him formally. Smoot inspired what became a classic headline – “SMOOT SMITES SMUT” – with an anti-obscenity crusade that prompted the poet Ogden Nash to mock “Smoot of Ut.”

This priggish protectionist co-sponsored the 1930’s destructive, ultra-nationalist, anti-Free Trade, Smoot-Hawley Tariff. So, with apologies to Nash, because he wasn’t economically astute, “Smoot of Ut” made the Depression more acute.

In 1929, as the economy tanked, Smoot spearheaded the fight that would blacken his legacy—and cost him his Senate seat. Smoot pushed a puritanical, patriotic, protectionist tariff—with Sec. 305 banning the importation of obscene material. Smoot spent Christmas vacation reading “obscene” novels imported by foreigners, returning with a stack of “smutty” quotations. “In the classic manner of purity champions,” the historian Paul Boyer gibes, “he could not resist sharing the filth.” When Smoot proposed presenting his findings to a closed Senate session, reporters anticipated a “Senatorial stag party.”

Smoot and his co-sponsor Congressman Willis C. Hawley, the chairman of the House Ways and Means Committee, wanted to “throw their arms of protection” around American industry too. If the government made foreign goods more costly, they reasoned, Americans would buy American, boosting the economy. In words that sound familiar, Smoot said tariff opponents were spreading “propaganda from un-American and international sources.” He insisted: “No foreign country has the right to interfere.” Stirring America’s isolationist paranoia, he refused to “surrender our national prestige and power on the altar of internationalism.” Smoot did not “want to see any American industry swamped by foreign competition,” nor did he “wish to build a wall around this country so high as to practically shut off importation of foreign products… or unduly restrict the exportation of American products.”

The economic misery sharpened the tariff battle. One thousand and twenty eight economists signed a letter denouncing the bill. The banker Thomas Lamont, recalled “I almost went on my hands and knees to beg Herbert Hoover to veto the asinine Hawley-Smoot Tariff. That act intensified nationalism all over the world.”


The Smoot-Hawley Tariff became law on June 17, 1930, raising taxes on 20,000 imported goods. Its obscenity provision defined “the moral sense of the average person” as the standard for determining exclusion, although there were exceptions for classics.

Thirty-three countries protested formally. France, Australia, India, even Canada, retaliated. European governments now struggled to get the gold they needed to pay off their World War I debts to America. In two years “U.S. imports dropped more than 40 percent,” the historian Amity Shlaes reports; unemployment jumped 16 percent. Beyond the specific damages, the bill rattled markets and confidence globally, suggesting, the MIT economist Charles Kindleberger noted, that “no one was in charge.” While some economists question whether the higher tariffs were that damaging, the economic and historic consensus is that the act proved that if you raise tariffs too high, retaliatory trade wars will choke American exports.

Franklin Roosevelt’s New Deal tidal wave of 1932 swept away Protectionist Republicans, sending Smoot back to Utah. Smoot died in 1941. By then, World War II had jumpstarted America’s recovery from this Great Depression exacerbated by the mainstreaming Mormon whose cultural Yahooism, narrow nationalism, and economic illiteracy upstaged his fight for religious freedom.

The Daily Beast