Tuesday, January 13, 2009

The New Deal Metaphor


The New Deal metaphor in wide circulation today is based on the illusion that, since New Deal interventions were effective in dealing with the Depression, they are the right medicine for dealing with today's financial crisis and economic slowdown. This illusion is driven by a deep misconception: that the market-oriented policies of the past quarter century were a great mistake and should be replaced by a more coordinated set of policies that (it is argued) will yield more stable growth and a fairer distribution of income. Thus the New Deal metaphor is now invoked as a call to overturn the free-market revolution of the 1980s, just as the New Deal threw overboard the Wall Street-favored policies of the 1920s. Such hopes are based on a fairy tale version of the New Deal and a highly ideological interpretation of recent history. In combination, they provide a shaky foundation for current policy and are a trap for Democrats.
The real causes of the Depression, on the other hand, are highly instructive for today's problems. Though economists and historians still debate the subject, several interconnected factors appear to have combined to turn a serious stock market correction in late 1929 into a full-scale depression by 1932: (1) an ill-advised tariff policy passed by Congress in 1930 to protect U.S. manufacturers but which had the unintended effect of shutting down international trade and U.S. exports; (2) a monetary policy adopted by the Federal Reserve, which raised the discount rate and allowed the money supply to shrink through 1931 even as the economy faltered; and (3) a cascade of bank failures which wiped out savings and credit for large swaths of the economy. The economic collapse was thus accelerated by policy errors from Congress, and especially by financial authorities who stood by as money contracted and banks failed. Such lessons seem foremost in the minds of financial authorities today who seem determined to stop any parallel sequence of falling dominoes lest we repeat the experience of the 1930s.

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