Perhaps the most important lesson to take from the Great Depression is that policymakers should follow the Hippocratic Oath: First, do no harm.Economic history

Stephen Slivinski

English

Research Papers in Economics

40 Region Focus • Fall 2008
E
conomic analysis is, at its core, a form of storytelling.
When you strip away the math and the jargon, what
you’re left with is a tale about how people respond
to the world around them and how their actions influence
everything else. And economists do indeed have a variety
of stories they like to tell. Yet the one that seems to be
told most — and nowadays with increasing frequency —
is the one about the Great Depression. 
This story, while consisting of the same basic facts, can
have a different tone depending upon who tells it. Some say
that between 1929 and 1933, a sudden decline in expectations
about the future of economic growth led to a collapse in 
consumer and investor demand that could not be quickly
corrected by the market. 
This school of thought suggests that government policy
provides a way around this shortcoming. The policies that
supporters of this thesis propose 
are aimed at increasing weak
demand in a variety of ways, particu-
larly through government spending
and employment programs. This
would serve, in the former case, to
prop up demand and, in the latter,
prop up employment and wages. 
A competing explanation comes
from the neoclassical school of
thought. Proponents of this view
argue that what the economy really
suffered from wasn’t an inherent weakness. Instead, it was
impaired by the shock of policy missteps, particularly those
of the Federal Reserve which severely contracted the money
supply and choked off economic activity. The neoclassical
economists think that over time the economy can right itself
in the absence of shocks without widespread government
direction. Instead, the remedy is to reverse the misguided
policies that weigh the economy down.
Both schools acknowledge that policy has the power to
shape economic growth. Yet the forms those policies take
are important. Those that are aimed at “fixing” a perceived
shortcoming of the market are by nature intended to keep
the market from the opportunity to correct itself on its own.
Still other policies can be geared to helping the market cor-
rect itself by assisting the mechanisms of self-correction.
This could include the lowering of barriers to competition.
So, one way to arbitrate this dispute would be to deter-
mine whether the activist fixes succeeded in helping achieve
a higher growth path for the economy. That begs a question:
Why did the Great Depression last as long as it did? After
all, by 1939 — 10 years after the start of the downturn —
employment and output were well below their 1929 levels. 
The best example of this line of inquiry is the work of
economists Harold Cole and Lee Ohanian, both of the
University of California at Los Angeles. They start by look-
ing at some fundamental economic data. 
For instance, the ability of the economy to produce goods
more efficiently — illustrated by the substantial increase in
“productivity” after 1933 — should have increased economic
output midway through the decade. But it didn’t. Wages and
prices should have gone down as a result of the reduced out-
put, but that didn’t happen either. “These data contrast
sharply with neoclassical theory, which predicts a strong
recovery [from the Great Depression] with low real wages,”
write Cole and Ohanian in their 2004 article in theJournal of
Political Economy. 
They suggest that what was hindering the labor adjust-
ment process was President Roosevelt’s New Deal labor and
industrial policies. The National
Industrial Recovery Act of 1933
(NIRA) actually had the effect of
limiting entry of competitors into
the market, mainly in manufactur-
ing. It also allowed incumbent
firms to set minimum prices in
exchange for raising worker wages.
When the Supreme Court ruled
that the NIRA was unconstitu-
tional in 1935, the National Labor
Relations Act of that year carried
on several of the NIRA goals directed at limiting competi-
tion in the labor market and, consequently, inflating wages.
So, in short, the New Deal policies artificially inflated prices
and wages. That kept the market’s self-correcting forces
from working and made it tougher for the economy to
recover from the Great Depression.
While there is still debate about whether this is a robust
explanation of what prolonged the Great Depression, it
helps us understand the assumptions economists use when
they describe the Great Depression. Those who argue that
federal policies during that era helped bring the United
States out of the economic doldrums have to assume that
policymakers, all of whom are fallible and under pressure
from a variety of interest groups, were able or willing to craft
sensible policy under economic and political duress. This is
a tall order, even for the best-intentioned policymaker.
So, perhaps the most important lesson to take from all
the competing renditions of the Great Depression story is
that policymakers should follow the Hippocratic Oath:
First, do no harm. And more often than not, that means
avoiding the temptation to intervene and, thus, intruding on
the market’s self-correction mechanisms. RF
BY STEPHEN SLIVINSKI
OPINION
Why the Great Depression Matters
Perhaps the most important
lesson to take from the
Great Depression is that 
policymakers should follow
the Hippocratic Oath: 
First, do no harm. 

Opinion : Why the Great Depression matters

http://www.richmondfed.org/publications/research/region_focus/2008/fall/pdf/opinion.pdf

Opinion : Why the Great Depression matters

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