Academic journal article Economic Perspectives

The Recession of 1937-A Cautionary Tale

Academic journal article Economic Perspectives

The Recession of 1937-A Cautionary Tale

Article excerpt

Introduction and summary

The U.S. economy is beginning to emerge from a severe economic downturn precipitated by a financial crisis without parallel since the Great Depression. As thoughts turn to the appropriate path of future policy during the recovery, a number of economists have proffered the recession that began in 1937 as a cautionary tale. That sharp but short-lived recession took place while the U.S. economy was recovering from the Great Depression of 1929-33. (1)

According to one interpretation, the 1937 recession was caused by premature tightening of monetary policy and fiscal policy prompted by inflation concerns. The lesson to be drawn is that policymakers should err on the side of caution. An alternative explanation is that the recession was caused by increases in labor costs due to the industrial policies that formed part of the New Deal--the policies of social and economic reform introduced in the 1930s by President Franklin D. Roosevelt. If a policy lesson can be drawn from this, it might have more to do with the dangers of interfering with market mechanisms.

The goal of this article is to present the relevant facts about the recession of 1937 and assess the competing explanations. Although overshadowed by its more dramatic predecessor, the recession of 1937 has received some attention before, in particular Roose (1954) and Friedman and Schwartz (1963). Then, as now, the competing explanations centered on fiscal policy, that is, the impact of taxation and government spending on the economy; monetary policy, or the management of currency and reserves; and labor relations policy, or more broadly government policy toward businesses.

The rest of this article is organized as follows. I first present the salient facts about the 1937 recession. I then review the competing explanations and finally provide a quantitative assessment of their likely contributions to the recession. I find that monetary policy and fiscal policy do not explain the timing of the downturn but do account well for its severity and most of the recovery. Wages explain little of the downturn and none of the recovery.

The recession

Before describing the salient features of the 1937 recession, I first take up the issue of its timing. The traditional National Bureau of Economic Research (NBER) business cycle dates put the peak of the recession in May 1937 and the trough in June 1938. Romer (1994) argues that there are inconsistencies in the way these dates were established over time, devises an algorithm that closely reproduces the dates of post-war business cycles, and applies it to the Miron and Romer (1990) industrial production series to produce new dates. In the case of the 1937 recession, Romer identifies August 1937 as the start of the recession. Cole and Ohanian (1999) implicitly use the same starting date when they state that industrial production peaked in that month. i will stick to the traditional date for several reasons. One is that Romer (1994) directs her argument mostly at cycles before 1927, when a shift in NBER methodology occurred. Another is that the NBER dating process considers a broader set of series than just industrial production. Roose (1954) lists the peaks of 40 monthly series and shows that 27 series peaked before August. Finally, industrial production as measured by the Board of Governors of the Federal Reserve System peaked in May 1937. There is no controversy over the end date of the recession, set by the NBER and Romer (1994) in June 1938.


Figure 1 plots real annual gross domestic product (GDP) per capita (population aged 16 years and older) over the twentieth century. The trend line follows that series' average growth rate over the periods 1919-29 and 1947-97, and is set to coincide with the series in 1929. This is the metric by which Cole and Ohanian (2004) show that the recovery after the Great Depression was weak, since the series does not return to trend until 1942. …

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