Spending And The Great Depression or ‘No, World War 2 Didn’t End The Depression’

There’s a common myth out there that goes, “the Great Depression was finally ended by World War 2“. It has some slight variations, such as “the Great Depression lasted 15 years” or even “the market didn’t recover until govt spending stopped“.

Image from http://en.wikipedia.org/wiki/File:US_GDP_10-60.jpg

All of these are complete misunderstandings of history if not outright lies.

While there may not be as accepted a definition for depression as for recession, there’s a good bit of consensus along the lines of these two criteria for an economic depression:

  1. real GDP decline beyond 10%
  2. period of decline lasting more than three years
Year 2005 Real GDP
1929 977,000
1930 892,800
1931 834,900
1932 725,800
1933 716,400
1934 794,400

Real GDP declined every year from 1929 through 1933. By 1934, the economy had been pushed back into growth again. There you have it: the end of the Great Depression. It was 1929-1933, far short of 15 years. One can not be in a depression and have real GDP growth because a depression is defined by GDP decline. One can note other factors peculiar to depression, such as deflation. But a depression only exists while there is a declining economy as measured by real GDP. One can debate what ended the Great Depression, whether it was a combination of monetary and fiscal policy, deficit spending alone, monetary policy alone, or some other set of factors. But there is no reasonable debate that the Great Depression ended years before World War 2 when the economy returned to growth.

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Some effects of the Great Depression — though mostly diminished — did linger somewhat until World War 2. That much is true. Although unemployment had been drastically reduced before the war, it was still high until the war. Yet while it took quite a while to achieve full recovery, it did not take all that long to achieve renewed growth. Unemployment peaked in 1933. By 1936, the New Deal had kicked the economy into rolling again and — though unemployment was still high — the main economic indicators were back in gear. In early 1937, industrial production reached a level above that of 1929. But then pressure picked up to balance the budget, and FDR and Congress cut back spending. Although unemployment had been dramatically reduced from its peak, it was still too high for the economy to be self-sustaining. With the fiscal and monetary tightening of 1937, production dropped and unemployment went back up. Seeing the mistake, they stoked spending back up in 1938 and the recovery resumed.

Unemployment remained problematic throughout the 1930s and into the start of the 1940s. But even that measure declined every year that the New Deal was fully in force. The recession of 1937-1938 showed the effect of govt cutbacks pushed by Republicans overzealous to balance the budget at the wrong time. The cuts interrupted the full weight of the New Deal to push the economy forward. The unemployment rate continued to drop right up until the start of the war. We were already growing towards full recovery before the war. Admittedly, the massive increase of spending for the war — far beyond that of the New Deal — did push unemployment to very low levels far more rapidly than we would likely have achieved without the focus of a war effort. But the war boom runs quite the opposite of a case against spending. The extreme, focused spending for the war effort rocketed our economy higher. It was a finale to the New Deal, like a burst of fireworks at the end of a good 4th of July show. It couldn’t be further from the truth to say that “the market didn’t recover until govt spending stopped”. When govt cut spending while the economy was still weak, the economy suffered. Except for the disastrous cut-backs that brought us the recession of 1937-1938, government didn’t stop spending until the markets had recovered.

Originally posted at http://thoughtstate.blogspot.com/2011/09/no-world-war-2-didnt-end-depression.html.

Updates:

Some would argue that a depression should be measured by unemployment rather than GDP. However, both measures had roughly the same trajectory for the years in question. For the period and points discussed, the two are close enough to interchangeable.

Some would argue that we might have settled at a lower employment level had it not been for the war effort and that the last lingering effects of the Great Depression might not otherwise have been erased. While one can not absolutely prove what would have happened either way, the trajectory prior to the war was towards recovery and growth. There’s no clear evidence that the trajectory would have stopped at a worse level without the war than it did with the war. It is, however, near certain that eliminating the last of the effects would have taken longer without the war effort.