Wednesday, January 28, 2009

 

Keynesian Stimulus and World War II

Professor Barro had a good WSJ op-ed recently on the historical evidence for the USA for fiscal policy. WW2 is the big example-- maybe the only example of where people say it had an effect. He doesn't think much of that as evidence. If WW2 is not a good example, then maybe there aren't *any* good examples of the Keynesian effect.

Data from the Ec. Rep. of the President is at http://www.gpoaccess.gov/eop/2009/B79.xls . The Deficit/GDP ratio rose to 5.9% in 1934 (first year of the data there), to 30.3% in 1943, to 4.2% in 1976, to 6% in 1983, to 4.7% in 1992, to 3.6% in 2004, and was estimated at 2.7% for 2008 (I suppose this estimate is from January 2008).

A stimulus extra of $400 billion per year would add about 2.9% to the budget deficit for 2009. That would take it up to 2.7+2.9= 5.6% if we use the pre-recession estimate of tax intake and GDP for 2009. We'd reach the 1934 and 1983 levels of budget deficit. Is that enough to take us out of a recession? I'd always heard that the New Deal spending was *not* enough to have much of a Keynesian effect. In that case, the best the stimulus package could hope for would be to mildly helpful-- it's not big enough to get us out of a recession.

But was the WW2 spending helpful? It was certainly big enough--30% of GDP in 1943. I thought I'd look at the WW2 experience in a very simple way. The first diagram shows the unemployment rate from 1923 to 1940. What would you expect to happen in the 1940s?

Here's what it looks like to me. The normal unemployment rate is around 4%. If the 1938 recession (was that the "Capital Strike"?) hadn't hit, it would have been reached in 1939. WIthout WW2 it would have been reached in 1944.

Here's what actually happened:

It is worth mentioning that there was a massive government jobs program in the 1930's, which affected unemployment. Below I graph both the civilian unemployment rate that I used above and an adjusted, higher, rate which is (Unemployed people + people in emergency govt. jobs)/(labor force). The picture is similar.

Mark Wieczorek has a graph of the Deficit/GDP ratio 1940-2007: References:

  • Cowen: Did World War II end the Great Depression?
  • Paul Krugman,January 23, 2009, Spending in wartime
  • Cowen on Barro and Krugman
  • Rasmusen on World War II as a test of Keynesian stimulus and Robert Barro.
  • Mark Wieczorek, The National Budget, Debt & Deficit . Graphs and numbers.

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