The UK case may be an interesting point of comparison. The Great Depression in the UK was much shorter and less severe than in the US. In the UK however as in the US expansionary fiscal policy was not used. The 'Treasury view' prevailed and the first 'Keynesian budget' had to wait until 1941 and then it was used to check inflation and not to stimulate demand (readers with access to JSTOR can read Alan's Booth 1983 paper here). Monetary policy drove the recovery by sparking a boom in the construction industry. Private investment in the new industries boomed. The relationship between this housing boom and the interest rate is evident from this diagram from Broadberry and Crafts (1992).This appears to support the view that fiscal policy was not necessary for a quicker recovery than America actually experienced in the 1930s. In comparison note that private investment in America in the 1930s was stagnant as Robert Higgs shows. [...]
Expansionary fiscal policy is actually quite limited in what it can do. If the fiscal expansion is in the form of tax cuts then the multiplier will be quite low due to (weak form) Ricardian equivalence because when a tax cut is funded by borrowing, tax payers consume less out of the cuts because they anticipate future tax rises in order to pay off the debt. If the fiscal expansion is in the form of long run infrastructure projects then the multiplier effects are greater but in order to be effective these projects must be on a large enough scale so as to constitute an intrusion of the state into the private market place. In other words central planning must replace the decentralized price syste in large parts of the economy. This is what occurred in Germany in the 1930s and though it occasioned a swifter initial recovery, it severely impeded the long-run capacity of the economy as Adam Tooze documents.
Thursday, 13 November 2008
Fiscal policy and ending the depression
Mark Koyama, at Oxonomics, writes about the effectiveness of fiscal policy in bring about an end to the depression in the UK. Koyama writes,