US Fiscal Policy During the Great Depression

Before the Great Depression, the idea that government should use its fiscal policy to moderate the business cycle was far from the focus of political and economic debate. In the past, the government borrowed during wartime as wars were very expensive. Borrowings were large relative to the size of the economy and a balanced budget was hardly discussed. Upon entering the Great Depression in 1929, president Herbert Hoover was an important representative of belief in the application of social thought into social programs. Similarly, President Franklin Delano Roosevelt preceded Hoover and shared many of Hoover’s beliefs in the application of thought into social programs. Both Hoover and Roosevelts fiscal policies in the Depression era were the catalyst of the various fiscal policies practiced today. This paper outlines the numerous fiscal policies pursued by Herbert Hoover and FDR during the Great Depression and examines the positive and negative effects of these policies.

Hoover confronted the Depression with an abundance of attitudes, which even today sound modern. Hoover accepted the need for social action and confluence to prevent and correct the current state of unemployment. The acceptance of this social conglomerate did not mean the central government would be elevated to the role of managing the economy entirely. Rather, it was an acceptance to a more cooperative system in which the elements of society- businesses, individuals, state and local governments-worked together to achieve the goals of society. The cooperative system required a leader that would point society in a direction that was in their best interests but would not give the central government responsibilities that were otherwise separate from those of the other elements of society. Hoover’s inaugural address on March 4th, 1929, included voluntary cooperation as one of the main themes in achieving a solution to the national problem and called on numerous branches of government to collaborate in assisting businesses and individuals:

There is an equally important field of cooperation by the Federal Government with the multitude of agencies, State, municipal, and private, in the systematic development of those processes which directly affect public health, recreation, education, and the home. We have need further to perfect the means by which Government can be adapted to human service.

Hoover was the leader in the movement to organize businesses in trade associations to cooperate with each other and the government in order to prevent and alleviate the growing unemployment. Hoover warned against excessive reliance upon the federal government and believed that the cooperative system would reduce unemployment.

Shortly after the stock market crash in October 1929, Hoover extended the reach of the Federal Farm Board (FFB) to make government funded loans to farm cooperatives to keep prices up, with a stabilization fund of $500 million. The FFB had two major responsibilities: strengthening farm cooperatives and direct prize stabilization within the $500 million fund made available. Unfortunately, the subsidies given to farmers encouraged them to increase production until the deflation could not be countered and the appropriated funds were eventually exhausted.

Following the disastrous attempt to aid farmers, President Hoover proposed a “limited revision” of the tariff on agricultural imports to raise rates and boost sagging farm prices. This in turn brought tariff debates to the forefront and Representatives Willis Hawley and Reed Smoot were encouraged to further tariff hikes. After months of debate and numerous warnings from economists, Hoover, unable to break from his own party’s congressional leadership, signed the tariff in 1930. As a result, the high tariff proved to be a major mistake as U.S. trade partners began retaliating by increasing their tariffs, temporarily freezing international trade.

Similarly, to maintain wage rates and enlarge private investment and public work expenditures, Hoover invited major business leaders to discuss keeping wages constant in the face of rising unemployment and asked labor leaders not to strike or request higher wages.

I have, therefore, instituted systematic, voluntary measures of cooperation with the business institutions and with State and municipal authorities to make certain that fundamental businesses of the country shall continue as usual, that wages and therefore consuming power shall not be reduced, and that a special effort shall be made to expand construction work in order to assist in equalizing other deficits in employment.

Hoover believed that high wages causes prosperity and argued that if major firms cut wages then workers would not have the purchasing power needed to buy the goods being produced. Non-union industry leaders complied with Hoover’s request out of implicit protection from unions. In 1931, Hoover signed the Davis-Bacon Act which established the requirement for paying locally prevailing wages on public works projects. A year later, Hoover signed the Norris-LaGuardia Act which removed certain legal and judicial barriers against organized labor unions. The act declared that members of labor unions should have full freedom of association undisturbed by employers.

Not surprisingly, the impact of high wages on profitability caused concern among industry leaders as they could no longer keep wages higher than the market clearing level. As a result, unemployment continued to rise. In 1929, unemployment was at 3.2% and rose to 8.7% in 1930. In 1931-1932, unemployment rose to 15.9% and 23.6%. (See Table 1) After Hoover’s conference, nominal wages rose, and unemployment fell resulting in rapid unemployment between 1929 and 1932. By late 1931, the Hoover administration began moving towards stimulating real investment by restoring confidence and allocate funding for capital projects.

To increase real investment and confidence, the Hoover administration focused on fighting deflation through stimulating lending and spending by creating the Reconstruction Finance Corporation (RFC). The agency was established by Congress to provide financial aid to railroads, financial institutions, and business corporations. After a few months of its creation, “the Treasury Department purchased the capital stock of the RFC for $500 million and announced it would borrow up to $3.3 billion. Although only the capital infusion affected the budget at that time, the expansion of the government’s borrowing authority alarmed investors.” Although this open-market program was to achieve confidence and reassurance, investors were still alarmed by the growing deficit and high unemployment.

Another priority of Hoover’s was to balance the budget because it emphasized the importance of preserving confidence in the credit of the government. Attempting to control the growing deficit, Hoover passed the Revenue Act of 1932 and was criticized because increasing taxes during a recession is contractionary. According to Keynesian Theory, fiscal deficits may stimulate an economy in the short run by increasing aggregate demand, but numerous forces could counteract this expansion.

Hoover inherited a budget of $3.1 billion in 1929 and increased spending to $3.3 billion in 1930, $3.6 billion in 1931, $4.7 billion in 1932, and $4.6 billion in 1933. (see Table 2). Hoover increased spending over four years by about 48%, yet this increase was hindered by the numerous fiscal policies created by the Hoover administration. According to Herbert Stein, Hoover’s decision to raise taxes was made in a condition of rising interest rates, falling bond prices, increasing bank suspensions, and large gold outflow. In response, foreigners predicted that the U.S. would devalue the dollar and began converting their dollar holdings to gold. To maintain the dollars strength and slow the outflow of gold, the fed raised interest rates.

The administrations attempt at an open-market policy was unable to increase confidence as activity within the financial markets indicated that the country was in a high level of uncertainty. The index values in graph 1 shows that uncertainty and risk reached their highest levels within 1932, down 86% being the lowest the country has ever seen since the beginning of the Great Depression.

On March 4th, 1933, Franklin Delano Roosevelt was hurled into the height of the Great Depression. Bank runs had reached epidemic proportions, interest rates had risen, and gold was flowing out of the country again. Both Roosevelt and Hoover were faced with the problem of working within these unfavorable conditions, however, these conditions were most unfavorable to Roosevelt as he pursued an expansionary policy of increasing budgetary deficits. Roosevelt won the election by promising to take the necessary steps to end the Great Depression. He introduced Keynesian economic theory and pursued policies that increased government spending.

FDR promised to balance the budget for similar reasons to Hoover. Roosevelt believed that a balanced budget was important to instill confidence in consumers, business, and the markets, which would thus encourage investment and economic expansion. FDR’s first step in balancing the budget was to close banks to stop foreign investors from depleting America’s gold deposits because Britain had just reverted to the pound. FDR declared a national bank holiday, ordering commercial banks to exchange their remaining gold reserves for Federal Reserve notes and credits and to submit lists of persons who had withdrawn gold or gold certificates since February.

In conjunction to the bank holiday, FDR suspended the convertibility of dollars into gold for domestic citizens and suspended the export of gold until the value of the dollar in gold had been reduced by 40%. Dollars were no longer tied to gold and the US was now entirely off the gold standard. While the value of the dollar declined internationally, the policy allowed more money to become available to Americans, stimulating the economy. FDR had deliberately achieved domestic and monetary freedom.

On March 9th, 1933, within the first 100 days of FDR’s presidency, congress enacted many of the programs in FDR’s New Deal. It passed the Emergency Banking Act, which allowed banks to reopen once they prove they are solvent. Within three days, over one thousand banks reopened and raised the nations confidence exponentially. In the same day, Secretary of Treasury William Wooden said:

The emergency banking legislation passed by the Congress today is a most constructive step toward the solution of the financial and banking difficulties which have confronted the country. The extraordinary rapidity with which this legislation was enacted by the Congress heartens and encourages the country.

Before the Emergency Banking Act, the Depression caused many people to run on the bank and store their money at home. This Act provided confidence and security to the American people and slightly improved the economy.

Within the following months, Congress passed numerous acts proposed by the New Deal. With unemployment nearing 25%, congress passed the Federal Emergency Relief Act, which provided immediate grants to states for relief projects. Simultaneously, congress passed the Agricultural Adjustment Act, which restricted farmers production and paid farmers to not till their land. It was an effort to restore agricultural prosperity by curtailing farm production, reducing export surpluses, and raising prices. This was a direct improvement of Hoover’s attempt to subsidize farmers. Had Hoover enacted a production limit similar to FDR, a surplus of agricultural products wouldn’t have occurred, and the $500 million allocated fund wouldn’t have been exhausted.

Over the course of FDR’s presidency, congress signed an abundance of acts that created and improved social programs such as organized labor, Social Security Act, Revenue Act, Neutrality Act, and numerous others. In the mid 1930’s, FDR had established his reputation and established confidence amongst the American people. Upon taking office in 1933, unemployment was at a staggering 24.75% (see Table 3) In just one year the unemployment rate fell to 21.6% and by 1939 it fell to 17.05%. Although unemployment was still high, FDR’s New Deal and Keynesian policies had increased government expenditure which lowered unemployment.

With a strong financial system and cooperative monetary policy, there was no danger that a large deficit would cause a financial crisis and FDR used federal spending to provide relief and not to achieve full-employment. When FDR took office the budget for 1933 was $4.6 billion and increased to $6.4 billion in 1934. By 1939 it increased to $9.1 billion as Europe entered WWII. (See Table 2)

In conclusion, the Great Depression brought about new revolutionary ways of fiscal policy that required cooperation from monetary forces. Hoover pioneered the benefits of a social conglomerate in which the government and societal forces work together in achieving stability. Hoover’s presidency is regarded as a failure due to his inability to balance the budget by significantly increasing it. Hoover also demonstrated many folly’s such as subsidizing farmers without a production limit and setting a high tariff on foreign countries, causing interest rates to sky rocket and gold to flow out of the country. Yet, regarding much of these failures, Hoover’s inability to stabilize the economy provided FDR with the necessary information to correct the instability. FDR followed many of Hoovers practices and they both believed that society must come together in times of crisis in order to improve the nation. FDR subsidized farmers but set a production limit to reduce export surpluses and increase prices and directly implemented Keynesian theory throughout his presidency.

Although FDR increased government expenditure by running a budget deficit, the increase in spending was not enough to shift aggregate demand to the right. It wasn’t until the start of WWII did the government deficit skyrocket and unemployment neared zero percent.