THE ECONOMIC POLICIES of the 1930s are a continuing source of myth and confusion. Many people believe that capitalism caused the Great Depression and that Pres. Franklin Roosevelt helped to end it. The events of the 1930s influence economic policymaking today. Many people think that we need a big government to prevent, or reverse, recessions. Yet, the 1930s illustrate that activist policies increase, not decrease, economic instability. Government interventions reduce the flexibility that markets need to adjust to shocks and return to growth.
The Depression was a uniquely severe contraction. Real gross domestic product fell for four years before finally beginning to recover. Real output only regained its 1929 level in 1936, but then plunged again in 1938. The unemployment rate stayed persistently high at more than 14% from 1931-40. Government policies, meanwhile, prevented the economy from recovering. The following are some key mistakes:
Monetary contraction. The Depression was precipitated by a one-third drop in the money supply from 1929-33, which mainly was the fault of the Federal Reserve. Moreover, an overwhelming flood of bank failures in the early 1930s compounded the money supply shrinkage and heightened economic fears. A key problem was that most states restricted bank branching, which prevented banks from diversifying their portfolios across jurisdictions. By contrast, Canada allowed nationwide branching and did not surfer a single bank failure during the Depression.
Tax hikes. In the early 1920s, Treasury Secretary Andrew Mellon ushered in an economic boom by championing income tax cuts that reduced the top individual rate from 73 to 25%. Yet, these lessons were forgotten as the economy headed downward after 1929. Pres. Herbert Hoover signed into law the Revenue Act of 1932, which was the largest peacetime tax increase in U.S. history. It upped the top individual tax rate from 25 to 63%. After his election in 1932, Roosevelt imposed further individual and corporate tax increases. These hikes killed incentives for work, investment, and entrepreneurship at a time when they were sorely needed.
International trade restrictions. In 1930, Pres. Hoover signed into law the infamous Smoot-Hawley Trade Act, which raised import tariffs to an average of 59% on more than 25,000 products. Over 60 countries retaliated by slapping new restrictions on imports of U.S. products. By 1933, world trade was down to just one-third of the 1929 level.
Keeping prices high. The centerpiece of FDR's New Deal was the National Industrial Recovery Act of 1933. It created "codes" or cartels in more than 500 industries in order to limit competition. Businesses were told to cut output and maintain high prices and wages. Businessmen who cut prices were cajoled, fined, and sometimes arrested. Fortunately for the country, NIRA was struck down by the Supreme Court in 1935. The Agricultural Adjustment Act of 1933 similarly restricted production to keep prices high. …