roger sandilands - galbraith. the new deal and domesticated keynesianism

7/27/2019 Roger Sandilands - Galbraith. the New Deal and Domesticated Keynesianism

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© 2001 Michael Keaney, selection and editorial matter; individual chapters,the contributors

12 The New Deal and‘domesticatedKeynesianism’ in America

Roger J.Sandilands

John Kenneth Galbraith has held up the ‘almost unique unreadability’ and‘fascinating obscurity’ of much of John Maynard Keynes’s General Theory of Employment, Interest and Money as a major reason for its success. It created a needfor translators and proselytizers to explain its deep meaning to governmentofficials, students and the public at large; and ‘as with the Bible and Marx,obscurity stimulated abstract debate’ (Galbraith, 1971:44).

Unlike much of the preceding theoretical literature on depression economics,Keynes’s General Theory was not a theory of the business cycle but rather a theoryof the chronic tendency of the free-enterprise economy to depart from fullemployment, with no automatic tendency, under realistic institutionalassumptions, to return to full employment. It is a general theory of disequilibriumor, rather, it explains why there is a multiplicity of possible equilibria, most of them suboptimal, and each one prone to unpredictable shift through the vagariesof businessmen’s ‘animal spirits’. It called for the visible hand of government tosupplement the invisible hand of the market Though a difficult book, Keynes’sGeneral Theory is a model of clarity compared with modern ‘general equilibrium theory’ that purports to explain how ‘free’, fully flexible markets unencumbered

by government may keep the economy close to a unique, optimal full-employmentequilibrium. Perhaps for this reason exegesis of the latter now easily displacesKeynesian theory in prestige and classroom time.

Where does this leave Galbraith? His vision of the proper role of governmentis to sustain not merely high and rising levels of output and employment but a ‘better’ composition of that output between private consumption and publicinvestment, and to ensure that it be equitably distributed among social classes. Inthis sense he is an unreconstructed New Dealer Mark I and Mark II. The formerembraces theVeblenian activism of the early (Mark I) New Deal, 1933–36, withits focus on the countervailing power of the state to tackle abuses of monopolyand monopsony. The latter (Mark II) New Deal followed hard on the shock of the 1937–38 recession (after several years of sustained recovery). This galvanisedsupport for ‘Keynesian’ fiscal activism against the orthodox view that an economycannot be in balance unless the government’s budget is also in balance.

Galbraith’s own transparent style leaves less scope for the army of professionalinterpreters and obscurantists that has sustained and formalized Keynesianism




and anti-Keynesianism. Furthermore, discussion of power relations, the ethics of advertising, and judgments on the respective value of bullets, butter and ballet—other than as revealed in their market price—smacks too much of elitism and toolittle of formal science to be safe subjects for economics classes or journals. ButGalbraith can look back with satisfaction at the impact he has had on theeconomic, political, social and cultural life of our world through his fearless

iconoclasm. He has stood out as an inter-disciplinarian who, in the rich Americaninstitutionalist tradition, has not shirked a duty, as scientist and citizen, to engagein the great issues of our times and expound his view of democracy and thesocial interest.1 For this his books are read with profit by a wide public audienceand, somewhat furtively and uncomfortably, by many academic economists too.Few economists are entirely content with the increasing formalism and abstractionof our discipline, and a weekend with Galbraith offers escape from unreality

Never was there a greater need to question orthodoxy than when Galbraith

was starting out as a student of economics in the early 1930s. Some of Galbraith’srecollections of these years are recorded in his interview with David Colanderand Harry Landreth in The Coming ofKeynesianism to America (1996) and in hisautobiography, A Life in Our Times (1981). As a Ph. D. student at Berkeley, 1931–34, he was fed the mainstream view that the Depression was an exceptionallysevere manifestation of the business cycle, that it would correct itself in time, andthat activist government policy, especially a deliberate unbalancing of the budget,would be unsound, even immoral.2 But other voices did intrude. He read Veblenwho held that business was chronically repressed by the type of control exercised

by profit-minded managers rather than technically minded engineers. He wasalso introduced to pre-General Theory Keynes. And there was the view thatDepression was caused by the monopolistic practices of Big Business and should

be tackled through more vigorous enforcement of anti-trust laws and a restructuring of the business corporation.

Armed with his Ph. D. and a dissertation on the economics of bee-keeping Galbraith found a summer job in Howard Tolley’s office at the AgriculturalAdjustment Administration, an emergency New Deal agency within theDepartment of Agriculture under Henry Wallace. His work involved advice,unfortunately largely unheeded, on how tax-reverted land could usefully be keptin the public domain. In the autumn of 1934 he entered Harvard as an instructorin agricultural economics under John D.Black’s direction but retained his linkswith the Department of Agriculture, a regular commuter between Boston andWashington.

As recounted by Galbraith, in the summer of 1936 he was hired by theunorthodox businessman, Henry Dennison, to help with the manuscript of a

book on the causes of the Depression. Dennison held that depression was caused by the non-spending of income. Galbraith held that it was due to the prevalenceof Chamberlinian monopolistic competition that was restricting output andraising prices, Dennison was told that his ideas were unsound. No reputableeconomist would endorse them. Shortly thereafter, Keynes’s General Theory fellinto Galbraith’s hands. To his consternation Galbraith realised that Dennison




had an ally in the greatest of modern economists. His task then was to restoreDennison’s dented self-confidence. Dennison went on to serve as an adviser tothe National Resources Planning Board in 1938.

‘By the autumn of 1936’, wrote Galbraith (1981:67), ‘Keynes had reachedHarvard with tidal force’. A majority of the prominent American Keynesiansinterviewed by Colander and Landreth were connected with Harvard at that time

or slightly later. Three of them—Robert Bryce, Lorie Tarshis and Walter Salant—had spent some time in Cambridge, England where they had attended Keynes’slectures on a Monetary Theory of Production, which became the General Theory.On their arrival at Harvard (or, in Tarshis’s case, to nearby Tufts) in 1935 theyorganized an informal seminar series on Keynes’s economics for graduate studentsand younger faculty (including Galbraith). Paul Sweezy was a prominent member.He had taken his B. A. at Harvard (1932) and then spent a year at the LondonSchool of Economics (LSE) before returning to Harvard. Sweezy and Walter Salant

had both studied Keynes, Dennis Robertson and Ralph Hawtrey’s views on moneyand the cycle in John Williams’s popular class in Money and Banking.

Williams’s assistant was Lauchlin Currie, and his students included Sweezy,Walter and William Salant, Emile Despres, Albert Hart, Martin Krost and MosesAbramovitz, all of whom were to play a role in New Deal and/or wartimeWashington. Paul Sweezy’s older brother Alan, a history major, had been toCambridge on a fellowship and on his return to Harvard in the early 1930s

began graduate work in economics. Later he recalled that

Currie had already been advocating expansionary monetary and fiscalpolicies in his writing and teaching as an economics instructor at Harvard

before coming to Washington in the summer of 1934… Like Keynes,Currie was impatient with the negative attitude of so many of hisprofessional colleagues. Early in 1934 he persuaded five of us who werethen instructors in economics at Harvard to join him in sending an openletter to President Roosevelt endorsing the main features of the New Dealrecovery program.

Sweezy (1972:117) This letter coincided with the publication of The Economics of the Recovery Program (Brown et al., 1934) that several of Harvard’s senior faculty, the ‘Seven WiseMen’, had put together and which offered no support for Roosevelt’s policies.This may explain why Currie’s letter stated that ‘we wish to single out for specialcommendation that which has received more criticism perhaps than any other atthe hands of our professional colleagues—namely, your monetary policy’. Theletter praised the departure from the gold standard as essential for Roosevelt’sexpansionist policies—‘one of the rare occasions since the war when a government

both foresaw danger and took action to avoid it’—and warmly supported thepolicy of increased government expenditures. Unsurprisingly, none of thesignatories received tenure. The chairman of the department, Harold Burbank,had already sharply reprimanded Currie for straying into the field of fiscal policy




in his classes on money and banking. When Treasury Secretary HenryMorgenthau Jr requested that Harvard extend Currie’s summer leave of absenceto become Jacob Viner’s assistant, the request was refused.

Galbraith describes the fuss when Alan Sweezy and Raymond Walsh (bothsignatories of the 1934 letter to Roosevelt) were singled out for termination in1937. One of their main rivals was Seymour Harris. Paul Samuelson recalls

(Colander and Landreth, 1996:155) that when he asked his Chicago professorsin 1935 which graduate school he should attend, he was warned by Lloyd Mintsthat at Harvard Seymour Harris was an inflationist. ‘This is interesting’, saidSamuelson, ‘because if you read The Economics of the Recovery Program, 1934, you’llsee that Harris, not yet having tenure at Harvard and still under the influence of Harold Hitchings Burbank, is a stout reactionary. Lloyd Mints must have hadsome keen sense of smell, because after Harris did get tenure he became a flaming Keynesian’. Currie later remarked sourly that he converted only when it was

safe to do so. As Galbraith (1977:220) put it: ‘In economics one should not beright too soon. The shrewd scholar always waits until the parade is passing hisdoor and then steps bravely out in front of the band.’ When Galbraith wasseeking tenure in 1939 he was interviewed for a post at Princeton, confident thiswould be a catalyst to promotion at Harvard. Instead, at dinner in the home of the chairman of the Princeton economics department he was handed a telegramfrom Burbank. It stated that he had just come from a meeting with president

James Bryant Conant; that his Harvard prospects were very dim; and that hewould be advised to take any post that was offered by Princeton.

Returning to Paul Sweezy’s role in what Galbraith has described as the coming of Keynes to America by way of Harvard (and, as we shall see, by way of theFederal Reserve Board also), it should be noted that despite his exposure to JohnWilliams’s undergraduate class he had been more heavily influenced by GottfreidHaberler. Thus when he arrived at the LSE in 1932 he was initially veryimpressed (as was his friend Abba Lerner) by the Austrian theory as expounded

by Hayek and Robbins. But the LSE radicalised him. On his return to Harvardin 1933 he had Joseph Schumpeter as his supervisor and was his teaching assistantfrom 1935 to 1937. Though Schumpeter was intensely jealous of Keynes andabhorred Marxism, Sweezy was receptive to the activist Keynesian message thatRobert Bryce brought over from Cambridge in 1935, as well as to the Marxisttheory for which he would later be a famous exponent. His close friend RichardGoodwin claimed (Sandilands, 1990:26–27) that he and Sweezy (both from

banking families) were the models for Schumpeter’s prognosis, in the famous‘crumbling walls’ chapter in Capitalism, Socialism and Democracy (1943): thatcapitalism was (regrettably) doomed because the sons of the bankers andentrepreneurs upon whom the system depended, would, while enjoying thecomfort and security their fathers had provided, be rebels seeking differentchallenges. Capitalism would be a victim of its own success.

But a simpler explanation for the embrace of socialism during the 1930s, inHarvard, in Cambridge, England and elsewhere (notably at Berkeley, Galbraith’sother alma mater3), was not the success but the very evident breakdown of the




free enterprise capitalist system, the misery caused by that breakdown, itspervasiveness and persistence, and the absence of convincing explanations andsolutions from the economics establishment.

At Harvard the Austrian School was powerfully represented by Haberler andSchumpeter. Schumpeter had been the Austrian finance minister at a time of hyperinflation. Perhaps chastened by that experience he now sided with Hayek and

Robbins in the ‘neutral money’ doctrine that welcomed declining prices as a reflectionof rising productivity. The exceptional deflation of 1929–33 (when the general priceindex fell by around 25 percent) was held mainly to reflect and compensate for theirresponsibly inflationist policies of the ‘roaring’ 1920s. These had producedmisleading price signals that encouraged excessive, speculative investments andassociated ‘maladjustments’. Deflation was a necessary, unavoidable purgative. Somerelief, however, might be afforded by greater wage flexibility.

Galbraith has remarked that Schumpeter’s ‘political and business

misfortunes had left him with a deep distaste for practical affairs, and hecondemned as intellectually debased economists who presumed to advise onpractical questions’.4 Lauchlin Currie, who was also Schumpeter’s assistant inthe early 1930s, recalls that he did once put his theories into practice: believing in wage flexibility as a cure for depression he supported Harvard’s decision tocut the wages of the support staff. Professors’ salaries were not altered and asprices fell Schumpeter enjoyed a rising real income. This accorded with hispronouncement that ‘a gentleman cannot live on less than $50,000 a year’(Sandilands, 1990:25–6).

Currie was later to play a leading role in bringing Galbraith back toWashington. First, in 1938, as chief technician on the fiscal and monetarycommittee of the National Resources Committee under Frederic A.Delano (withGalbraith’s old friend Henry Dennison also on the board), Currie arranged forGalbraith to direct a large review (with Griff Johnson, an assistant of Currie’s atthe Federal Reserve Board) of the impact of public works expenditures from theearly days of the New Deal to the present (Galbraith, 1975:230). This meant thatGalbraith could again commute between Washington and Harvard whereKeynes’s General Theory was now the centre of attention. In 1937 Alvin Hansenhad been appointed to a chair at Harvard. Though he had previously been highlysceptical, by 1938 he had revised his opinion of the General Theory and becameone of its most vigorous champions. Galbraith and a galaxy of bright studentsand eminent visitors from Washington attended the famous fiscal policy seminarthat Hansen had organized with John Williams, and it was now in full swing (Salant, 1998). From this seminar group Currie recruited not only Galbraith butalso Richard V.Gilbert, George Jaszi and Emile Despres for work in Washington.5

In fact Currie was soon running a one-man recruitment agency for Keynesianeconomists from the White House, having been appointed as a Roosevelt aide in

June 1939 after five years as assistant to Marriner Eccles at the Federal Reserve.In a session at the 1971 American Economic Association meetings organised byGalbraith (the Association’s president that year), Currie (1972:141) recorded:




By 1939 I had become the first economist in the White House and we were becoming a formidable group. I had recruited Dick Gilbert and his group—V.L.Bassie, Rod Riley and the rest—for Harry Hopkins at Commerce,which gave support to Bob Nathan, long a lone outpost in hostile territory.I had turned my post at the Federal Reserve over to Emile Despres. I was,I am happy to say, responsible for bringing Ken Galbraith to Washington

and for getting Gerhard Colm placed in the Bureau of the Budget, nowmoved to the Executive Office of the President Waiter and Bill Salant, Griff

Johnson, Alan Sweezy, Arthur Gayer, Malcolm Bryan, George Eddy, AlbertHart and Martin Krost were my former students or associates and wereoccupying key posts. Our position in the Treasury was getting stronger asHarry White [Currie’s Harvard classmate6] gained influence, and we hadclose working relations with Gardiner Means and Tom Blaisdell in theNRPB and the members of the Board, and with [Mordecai] Ezekiel and

Louis Bean in Agriculture, with Isador Lubin in Labor and, of course, withLeon Henderson and Jerome Frank in the SEC. Hansen was winning converts outside. We didn’t sleep much, but when we did, the General Theory kept working. With the Works Financing Act of 1939 and our long discussions on a major revision of the Social Security System, Rooseveltfinally acquired a firm grasp of the theory. I think, therefore, that even if the war had not intervened, victory was assured.

The second occasion on which Currie recruited Galbraith for work inWashington was in the summer of 1940, a few days after the fall of France. LeonHenderson had just been placed in charge of prices in the National DefenceAdvisory Commission, but was more prominent as a trust-busting (‘Mark I’)than a Keynesian (‘Mark II’) New Dealer. Currie wanted a reliable disciple to beon hand. Galbraith fitted the bill and went on to assume wartime responsibilityfor price control.

Currie had been impressed by the work of Galbraith and Griff Johnson forthe National Resources Committee on the impact of public works expenditure.Their eventual report (published late 1940) conceded that ‘the view thatdepressions will correct themselves if left alone is by no means dead’. But theyexpressed grave doubt that this view was likely to become again the basis of public policy. The tone of the report was unmistakably Keynesian: ‘Unemployedmen and materials are the normal or equilibrium situation in the moderneconomy… [T]he construction of public works, so financed as to offset otherwiseidle saving, represents one of the devices for escaping a persistent low level of private investment and a persistently high level of unemployment’ (Galbraithand Johnson, 1940).

This was very much in accord with the rationale given by Currie in his draftof the 1939 Works Financing Bill, on behalf of his then boss, the activist chairmanof the Federal Reserve Board, Marriner Eccles. The bill was presented toCongress in July by Senator Alben Barkley. It was framed in such a way that a major spending programme would be financed outside of the regular budget




of the money supply and spending. In fact the money supply did contractdrastically, by about a third between late 1929 and mid-1933. At the same timethe perceived loss of financial wealth, following the collapse of stock and realestate prices, had increased the propensity to save as households and businessesattempted to increase their liquid balances.

The demand for money (cash plus demand deposits) rose as a percentage of

declining income. This measured decline in income velocity aggravated theimpact of monetary deflation. Temin (1976) emphasized that in real terms themoney supply was rising slightly because prices were falling faster than the moneysupply during the first two years of Depression. But it makes little sense to regardmonetary conditions during this period as ‘easy’ when it was these very declinesin prices that were so discouraging to business and that were persuading consumers to delay purchases. The fall in output was accompanied by a fall inincomes, and the adverse income and expectations effect on spending

considerably outweighed any positive real balance effect from falling prices orstimulus to investment from the fall in interest rates (nominal terms only).

This was evident to Currie from his reading of Keynes’s Treatise on Money andHawtrey’s monetary theory of the cycle (Hawtrey, 1929, 1932), both of whomdrew activist monetary conclusions from the American experience after 1929(Laidler, 1999:225). Hawtrey in particular believed it possible to arrest andreverse the contraction with monetary policy alone, had it been vigorous enough,

but did not eschew fiscal deficits as a vehicle for achieving the requisite expansionof money. Much of this was reflected in Currie’s Harvard Ph. D. thesis (1931)and in his classes as Williams’s assistant.

In January 1932 Lauchlin Currie, P.T.Ellsworth and Harry Dexter Whitewrote a thirty-three page memorandum from Harvard (see note 6) that began bynoting that the Depression had already cost the American people more than theGreat War and had engendered a loss of confidence in American leadership andAmerican institutions that was becoming more marked as the Depressionlengthened. They deplored the failure of the monetary authorities to provide thereserves the banks needed to get out of debt, following the loss of reserves due toa flight into cash. Furthermore, whenever individuals or corporations saved bypurchasing bonds or paying off a loan to the banking system their deposits werenot re-lent and spent, but were, instead, used to reduce member bankindebtedness (currently $800 million) to the reserve banks. Thus, more and morepurchasing power (means of payment in the form of demand deposits) was being wiped out and banks were closing. It was urgent that this purchasing power beput back into the system through a vigorous (billion dollar) open-marketpurchasing policy.8

They also advocated fiscal deficits. These should be financed by borrowing not from individuals, but from the reserve and other banks, in order to usedeposits that have been newly created and not diverted from individuals. In thisway a net increase in spending would be achieved, both directly and throughsecondary and subsequent rounds of spending which ‘would stimulate recoveryin other lines in ever widening circles’ They urged the relaxation of gold reserve




would in due course become associated with Keynesian economics, and soto a degree would the second, though it is worth noting that Currie’sparticular version of the case for deficit finance bore a closer resemblanceto the possibility which Hawtrey (1925) had broached, albeit briefly andpurely hypothetically, as a means for breaking a credit deadlock that wouldnot succumb to open-market operations, than to anything that Keynes

would propose in the 1930s. As Simon Kuznets, Willard King and Morris Copeland’s early estimates of U.S. national income became available, Currie was able to conduct the firstestimate of the income velocity of circulation of the nation’s money stock(previous estimates were of the transactions velocity which was much lessrelevant, indeed misleading, for policy). He was also the first to compute a money supply series, defining money as means of payment—currency plus

checkable demand deposits now known as M1). His calculations of themovement in income velocity showed that it rose fairly steadily from 2.82 in1921 to 3.48 in 1929. It fell thereafter, seriously aggravating the effects of thedecline in the money stock.9

Prior to Roosevelt’s inauguration on March 4, 1933, a new crisis developed.The resources of the Reconstruction Finance Corporation, established in 1932,were inadequate to prevent more and more bank failures in the absence of morevigorous open market purchases by the reserve banks. When Roosevelt assumedoffice in March 1933 he immediately declared a bank holiday. More than 3000

banks never opened their doors again and while their reserves remained frozenyet more of the nation’s money supply, hence monetary expenditure, wasextinguished.

Thereafter the first phase of Roosevelt’s New Deal began. His original ‘brainstrusters’, Rexford Tugwell, Raymond Moley and Adolf Berle of Columbia University, concentrated on the abuses of big business and attempted to curbprofiteering through price and quantity regulations, profits taxes, and movestowards comprehensive national planning. The ill-starred National IndustrialRecovery Act (NIRA) was signed into law on June 16, 1933 but struck down asunconstitutional in May 1935 by a Supreme Court that had no sympathy for thestructuralist measures that the National Recovery Administration (NRA) had

been promoting. A positive short-term effect of the NRA was that work-sharing provisions caused nearly two and a half million workers to be re-employed

between June and October 1933 (Barber, 1996:4). Other measures included‘codes of fair competition’ submitted by trade and industrial associations,minimum wage laws, output restrictions and price fixing. Similar schemes infarming were instituted through the Agricultural Adjustment Administration.There were bitter disputes, both inside and outside the administration, betweenthose who favoured price ceilings (to help consumers) versus those who wantedprice floors (to help business); and between those who favoured higher wages tohelp labour versus those who argued that this would raise costs above prices,squeeze profits and hinder recovery.




On the macroeconomic front Roosevelt had campaigned in 1932 on a budget-balancing platform but in office pushed hard, on pragmatic andhumanitarian grounds,10 for appropriations for the Works ProgressAdministration. The NIRA included a peacetime record appropriation of $3.3

billion, to be allocated at the discretion of the WPA administrator. Though a record figure, this was still very modest in relation to need. As Currie

(1978:545) later remarked, ‘It took too little to keep people alive’; and Barber(1996:37) remarked that ‘Honest’ Harold Ickes, the WPA administrator, ‘stoodfirm against authorizing projects before their long-run social utility had beenclearly demonstrated. These qualities were not well calculated to produce timelyaction. Ickes’s posture, however, was congenial to a president who was thennot persuaded that public works spending could be a pump primer and whostood for budget balancing in the normal operations of government’. TheBudget Director, Lewis W. Douglas, emphasized that these expenditures were

of an extraordinary and emergency character and that the administration’scommitment to budget-balancing would not be compromised. And he insistedthat soundness required new revenues, from taxes on business, to cover theservice charges ($220 million per year) on the debt issued to finance the publicworks programme. The ubiquitous Yale monetary theorist Irving Fisherproposed a self-liquidating ‘stamped scrip issue’ to finance the annual servicecharges, but his proposal was rejected.

Fisher was no fan of public works as a re-employment device. He preferredto see the private sector creating jobs, and believed this could be accomplishedvia monetary stimuli to counteract ‘debt deflation’ (the burden on debtors asprices fell) that he thought was at the root of the Depression. He was one of thevoices, along with Cornell agricultural economist George Warren, who hadargued for a rise in the price of gold through a gold purchase programme. Thiswas implemented between September 1933 and January 1934 and the price of gold rose from $29 to $35 an ounce. The aim was to increase the money supplyand so raise commodity prices to their pre-Depression levels. However, despitestrong monetary growth over the next four years (further boosted by flight of gold from a troubled Europe to a haven in the United States) prices recoveredrelatively little (from an index of 75 in 1933 to about 83 in 1937, with1929=100). Galbraith (1975:210–1) remarked that another of Warren’s aimswas that

by manipulating the gold price he believed that a great deal of other publicand reformist action, including most of the New Deal farm program, could

be avoided. He was one of the first in a long line of monetary reformersextending to Professor Milton Friedman…who have hoped that theirchanges would make other and more comprehensive government actionunnecessary. They are monetary radicals because they are politicalconservatives.

The same is probably true of Irving Fisher.




As Barber (1996:50) has observed:

The designs of both the structuralists and the monetarists shared a priceorientation in their diagnoses of and prescriptions for the economy’s ills.The structuralists were preoccupied with price behavior in specific sectors:Thus, AAA’s policies sought to raise the prices of farm outputs deemed to

be ‘basic’, and the NRA codes sought to stabilize the prices of manufacturedgoods and to banish ‘destructive’ price wars. The gold purchase program,on the other hand, was intended to raise the general price level.

There was much tension between the supporters of these two strands of the earlyNew Deal, but neither was ‘Keynesian’ in the sense of offering a coherentintellectual (as opposed to humanitarian) rationale for deficit spending to maintainthe flow of aggregate demand at the full employment potential level of output.

The structuralists were pre-occupied with relative prices to achieve fullemployment through allocative efficiency; the monetarists thought all this could

best be achieved through the stabilisation of the general price level at its pre-Depression level. However, by the time Roosevelt had assumed office it had

become clear to some that though monetary policy (and traditional monetarytheory) may be relevant in normal times and normal cycles, the times now werefar from normal. Monetary measures alone would therefore now have very weakeffects. From the end of 1933 the expansion of money coincided with a big increase in commercial banks’ holdings of reserves in excess of their legalrequirements. They were scarred by the wave of bank failures and were alsoexperiencing difficulty finding credit-worthy customers in the depressed privatesector. Interest rates were falling to unprecedentedly low levels.

Faced with what Ralph Hawtrey had diagnosed as a rare ‘credit deadlock’—what Keynesians refer to as a ‘liquidity trap’11—the most articulate champions of deficit finance were to emerge from a surprising quarter. Galbraith (1971:48) hasremarked that ‘Not often have important new ideas entered a government byway of its central bank. There is not the slightest indication that it will everhappen again’. In June 1934 Eugene Black resigned as governor of the FederalReserve Board and President Roosevelt was looking for a successor. Earlier in1934 Marriner S.Eccles, an unorthodox millionaire Mormon banker from Utahhad joined the U.S. Treasury as an adviser to the newly appointed TreasurySecretary Henry Morgenthau Jr. On the urging of Rexford Tugwell and otherleading members of the Roosevelt administration who were impressed by Eccles’s

bold advocacy of deficit spending, Morgenthau was persuaded, against his ownconservative instincts and despite the evident clash of personalities that was toworsen over the years, to appoint him as a special adviser in the re-organisationof the Treasury Department.

Most bankers shared Morgenthau’s strong commitment to ‘fiscalresponsibility’ without which, they claimed, there could be no businessconfidence, hence no recovery. Eccles challenged these nostrums. Thoughuntrained in economics he was a very successful practical banker and




a New York banker and sometime consultant to the administration in 1933,was out-spokenly hostile. He rejected the theory underlying the structureof the bill, which he characterised as Curried Keynes, ‘for it is in fact a half-cooked lump of J.Maynard Keynes—the well-known British economistwhose theories find more support in this country than in his own—liberallyseasoned with a sauce prepared by Prof. Laughlin [sic] Currie’.

During the turbulent months during which the Banking Act, signed in August1935, was passing through Congress the economy was beginning to recoverfrom the depths of the Depression. But there was a long way to go beforeoutput and employment could recover their 1928–29 levels. A combination of shell-shock from earlier failures and sluggish demand for loans meant that

banks were accumulating substantial excess reserves rather than seeking potential investors as gold flowed in from Europe. Interest rates were at

historically very low levels and since there were still fears that inflation couldresume (prices rose by 8% in 1936), with nominal interest rates following suit,it was understandable (even before Keynes presented his formal analysis of the‘speculative motive’ for holding idle balances) that banks would be reluctant toexploit their full ability to increase their earning assets.13 Under thesecircumstances Eccles and Currie realised that greater emphasis would need to

be placed on measures to stimulate public and private spending through directfiscal means, even though this meant a turf war with the Treasury and repeatedclashes with Secretary Morgenthau whose main prescription for recovery was‘to boost confidence’ by balancing the budget.

The power given by the 1935 Banking Act to vary reserve requirements wasto prove highly controversial. As excess reserves piled up there was widespreadanxiety (shared by John H.Williams, Lauchlin Currie, Irving Fisher and others)that as the economy continued to recover there would be an increase in loandemand, interest rates would pick up from the current floor, and banks would

be able to expand deposits without check.14 The required reserve ratio wasincreased by 50 percent in August 1936. This reduced excess reserves by $1.5

billion, but this still left nearly $2 billion excess. There was no adverse effect oninterest rates, money supply continued to increase, and the economy continuedits upward course.15 But there were worrying developments arising from a growing tendency to mark up commodity prices following increasedunionisation and associated wage increases. Wholesale prices rose by about 7percent in 1936. This, together with anticipation of labour market strife andfurther wage increases, was encouraging large inventory accumulations thatposed a danger of recession if sales did not keep pace and excess stocks wereworked off at the expense of current production. Nevertheless, in January 1937the Board announced a second increase in reserve requirements, effectiveMarch 1, followed by a final increase on May 1. Excess reserves remained high

because of a continuing inflow of gold, though the Treasury sterilised much of this in late 1936. The rapid growth in the stock of money slowed, and halted inMarch. These measures were all designed to be ‘precautionary’ rather than




restrictive. It was believed that since excess reserves were ‘redundant’ orsuperfluous, the mopping up would have no effect on recovery.

However, beginning around June 1937 recovery turned rapidly into a deeplyalarming recession. Real GDP would fall by 18% over the next thirteen months(Meltzer, 2000:125). At the time few people blamed the monetary measures,though the slight increase in bond yields, from an all-time low of 2.46 percent in

early March to 2.8 percent in early April (after which they declined again), hadangered Treasury Secretary Morgenthau (though it was the Treasury that tookthe decision to sterilise gold inflows from December). His main concern was thata rise in interest rates would increase the financial cost of the deficit, and he keptpressing Roosevelt to trim government spending and balance the budget Ecclesagreed that higher interest rates were undesirable and he supported the FederalOpen Market Committee’s decision in April to engage in compensatory openmarket purchases.

There is no evidence that the banks were suddenly denying requests for loans by business or government, or imposing stricter conditions as a result of theincreased reserve requirements. Thus the almost exclusive modern focus on a supposedly inept monetary policy as the cause of the sharp downturn in 1937seems misplaced (e.g. Steindl, 1995, in support of Friedman and Schwartz’sinfluential 1963 study). Meltzer (2000), however, offers a more eclecticexplanation, and another exception is Romer and Romer (1989:131–2) whoemphasise two non-monetary forces acting to decrease output in 1937: the fiscaldownturn and the way in which the Wagner Act led to large inventoryaccumulations in anticipation of labour market strife that did indeed occur in1937, coinciding with an end to inventory accumulations. They also note that the

behaviour of reserve holdings ran counter to Friedman and Schwartz’sinterpretation, in that there was no discernible change in the behaviour of reservesas a fraction of deposits until December 1937, seventeen months after the firstincrease in reserve requirements was announced and after the declines in moneyand industrial production were largely complete.

In a note to the writer, August 2, 1988, Currie admitted that probably thereserve requirements would not have been raised if the recession of 1937 had

been accurately forecast But he wrote that ‘this is a different matter than holding the raising responsible for the recession. For that the very sharp, even drastic,reduction in the fiscal cash deficit is the more convincing explanation of the sharpdecline in the rate of growth in sales and the consequent piling up of inventories’.He also noted that ‘few theorists would expect an immediate impact on incomesand sales to result from the small decline in deposits that took place, especially asthere is such an other more convincing explanation of the causation of the rise inaggregate demand’.

By the fall of 1937 it was clear to all that the economy was in decline.Morgenthau infuriated Eccles (a tireless advocate of public spending) by declaring that this was proof that deficits cause recessions through their adverse effect on

business confidence. He placed his faith in the driving force of private enterprise.By contrast, Barber (1996:111) states that the recession was a conversion




experience for Alvin Hansen who had reacted adversely when the Keynes’sGeneral Theory first appeared. In a paper to the Academy of Political Science,November 1937, before the depth of the recession could be fully appreciated, he

began to rethink his position. He wrote:

We are currently witnessing a rapid shift in income-creating expenditures

both public and private. The props which have been lifting the level of consumption are being withdrawn. The automobile boom has tapered off.We are moving toward a saturation point in installment sales. Thegovernment stimulus to consumption is in the process of being completelywithdrawn in a dramatic reversal from a plus of three billion to a minus of four hundred million dollars within a single year. The full force of this suddenchange upon our recovery has perhaps not been adequately appraised.

(Hansen 1938:66)

In fact the fiscal stance had been subjected to detailed and continuous scrutinyfor its net income-creating effect ever since 1934. While still at the Treasury, andencouraged by Jacob Viner, Lauchlin Currie began work with Martin Krost, a

brilliant student whom he had brought with him from Harvard, to develop a monthly series initially known as a ‘pump-priming deficit’. These figures adjustedthe government’s official budget statement of revenues and expenditures to reflectthe varying effectiveness of different categories on the circular flow of incomeand expenditure, making allowance for those expenditures that were for currentlyproduced goods and services and those that were merely transfers, or that merelychanged savings.

In a memorandum entitled Federal Income-Increasing Expenditures, 1933–35,written in late 1935 (reprinted in Currie, 1978), Currie and Krost reported thatany similarity between the ‘net contribution’ and the reported cash deficit waspurely coincidental. The reported budget could be in balance while the netcontribution was in heavy deficit. Thus, there was no necessary conflict betweenthose who wanted a balanced budget in the official sense and those who wantedthe federal government to provide a big stimulus to business: ‘By selecting income-increasing types of expenditure and non-income-decreasing methods of raising revenue, it is conceivable that a balanced budget could be maintained and at thesame time a considerable stimulus given to business’. Investment subsidies, forexample, could have a powerful stimulatory effect while a tax on undistributedprofits might have only a small negative effect But there was no doubt in Currie’smind that the conditions prevailing in the mid-1930s called for much more thana balanced expansion of taxes and spending. The size of the required deficit,whether in its explicit or ‘net contribution’ form, was calculated according to thesize of potential, full-employment income (based on 1928 with adjustments forpopulation and productivity growth) and the size of the leakages from that incomethat would need to be offset

The 1935 Currie—Krost memorandum can be seen to have anticipated notonly the full-employment budget concept but also a rudimentary version of the




‘balanced-budget multiplier’ idea. However, Currie never thought that thealgebraic version that was later developed as a theorem had any relevance forpolicy purposes (Sandilands, 1990:74–8). The theorem assumed a constantmarginal propensity to consume and given money supply. This implies thatvelocity adjusts passively to support higher incomes. But if individuals and firmsare subject to higher taxes their initial portfolios are disturbed. When they get

their money back (in practice not immediately) they may use some of it to restoretheir depleted cash balances. Thus the marginal velocity (corresponding to themarginal propensity to consume) could fall in the next round and reverse theinitial stimulus.

The net impact on spending would in any case be much smaller than if increased government spending were financed by borrowing. So even if therewere a positive balanced-budget multiplier effect, the economic boost required inthe 1930s would have called for a non-feasible tax-and-spend package. Samuelson

(in Colander and Landreth, 1996:166–7) hails the balanced-budget theoremwithout addressing its realism. In this respect Currie’s adherence to period orsequence analysis of pre-General Theory monetary theory, and his detailed studiesof the demand for and supply of money in explaining the flow of aggregateexpenditure was superior, for policy purposes, to Keynes’s instantaneousmultiplier analysis. Patinkin (1976:1101) noted that Currie was one of the firsteconomists to subject Keynes’s investment multiplier to empirical test, finding that it was highly variable in the short term. But Blaug (1991:174) has maintainedthat it was precisely the rigour and simplicity of Keynes’s static, single-periodequilibrium approach that explains the appeal of the General Theory and why theKeynesian revolution took hold so quickly.

Due to the intense passion aroused at that time by the very word deficit, theterm ‘pump-priming deficit series’ was soon dropped in favour of the ‘Federalnet income-increasing expenditures series’. It was also realised early on that inthe prevailing conditions, more than a one-shot priming of the pump would berequired and that deficits would probably need to be sustained for some time.According to Alan Sweezy (1972:118–19) the new title was ‘a semantic triumphof the first magnitude. It brought out the common element in all thegovernment’s fiscal operations. No one used to thinking in terms of the netcontribution could advocate promoting recovery by increasing public worksspending while at the same time cutting government salaries and raising taxrates’. The figures were never published (the Federal Reserve Board’s directorof research, E.A.Goldenweiser, blocked this and similar publications on thegrounds that ‘it might cause trouble’16) but mimeographs circulated widely inNew Deal circles.

The income-increasing expenditure series was to assume considerablesignificance in diagnosing the causes of the 1937–38 recession. The outlines of what Barber (1996:125) has called a ‘domesticated Keynesian’ analysis of recovery and relapse was contained in a prescient pre-General Theory memorandumto Eccles from Currie, April 13, 1935, entitled ‘Recovery! The stress is on theimportance of contra-cyclical fiscal measures to combat a ‘deadlock’, with




monetary policy assuming a passive role at such times.17 After analysing theprospects in various fields, Currie concluded that

[I]n each important outlay for construction and equipment expenditureswhich we have considered, the conclusion is the same: increased expenditureswait on increased demand and increased demand waits on increased

expenditures… The most feasible way in which this deadlock may be brokenis for the Government through its expenditures to increase incomes, andhence demand for goods, sufficient to create conditions making it profitableto increase the production of new capital. This, very simply, is the theory of pump-priming operations… As incomes and the demand for goods increaseit is to be expected that the operations of one industry after another willapproach a point where it appears profitable to invest in new plant andequipment Similarly, in one town after another the rise in rents will make it

profitable to build houses. The ideal, which it is admittedly difficult for a government to achieve, would be to vary the rate of expenditures in such a way as to insure a steady and uninterrupted growth in demand. This, morespecifically, would require a slower rate of expenditure during the inventory

buying upswings we have been experiencing in recent years, and then a greatly accelerated rate of expenditure when such buying decreases. Whennon-federal expenditure for equipment and construction increase, theGovernment may taper off its expenditures.

As economic recovery faltered in 1937 it became evident that ‘pump-priming operations’ had not been sufficiently vigorous or steady. Fiscal policy was nowoperating in a perverse direction and Currie began to send increasingly urgentmemoranda to Eccles. In February he condemned the 1937 Social Security Act

because of the deflationary implications of building up a large reserve fund,18

especially when in 1937 there was nothing to replace the large pay-out of veterans’ bonuses (passed by Congress over the president’s veto) in 1936. Inhis memorandum ‘Comments on Business Prospects’ (September 28, 1937)Currie emphasised the rapid advance in building costs (hourly wages in theconstruction industry had increased by 16 percent in little over a year, and

building materials prices by 13 percent) relative to the increase in rents, andresidential contracts awarded had been declining since June. In ‘The Decline inthe Federal Contribution to the Growth in Community Expenditures’ (October19), he showed that in the three years 1934–36 the net federal contribution had

been $3.2 billion, $3.1 billion, and $4.0 billion. These were sizable fractions of the growth of national income in those same years: $7.8 billion, $5.4 billion and$8.8 billion respectively. In the nine months to September 1937, the Currie-Krost series showed that the net contribution had fallen to only $810 million($90 million a month and still falling) compared with $3,080 million ($342million a month) in the same period of 1936. He warned that the government’scontribution to buying power, already insufficient to offset the slowdown inprivate expenditures, may well turn negative in the near future.




On a Keynesian interpretation of the downturn in 1937–38, this fiscal reversalwas a crucial causal factor. By comparison, variations in the degree of excessliquidity in the banks were of secondary importance. By cutting the federal deficitthere was a fall in the supply of safe earning assets that the banks had previouslyrelied on. They could not easily or quickly replace them with private sector lending,for the decline in government spending and the increase in tax and social security

receipts were depressing demand for private sector output. This naturally reducedprivate sector loan demand. These factors, rather than the raising of reserverequirements, may account for some diminution of demand deposits and thecontinued high level of excess reserves. That the Fed resumed the purchase of government securities after April 1937 gives some credence to this view.

On November 8 WPA administrator Harry Hopkins and his economicadviser Leon Henderson, together with Lauchlin Currie and Isador Lubin,Commissioner of Labour Statistics met with the president in an unprecedented

four-hour session (Lash, 1988:317–27). The New York Post reported the next daythat ‘the four advisers minced no words in giving Roosevelt a hard-boiledreview of economic conditions and with equal bluntness and vigor they toldhim that a disastrous recession can only be averted by a resumption of big-scaleGovernment spending’. The group laid a report before the president thatshowed how, for the first time since 1931 the government took more out of theincome stream than it poured back in. ‘If the Government takes taxes awayfrom workers or corporations and uses these in bookkeeping items, such as oldage reserve accounts, gold purchases, debt retirement, etc., and the amountexceeds what is paid for men and materials, then there is a deficit That is whatis happening now.’

It is noteworthy that here they used the term ‘deficit’ to refer to a deficit of overall spending, not the budget deficit. The deficit in the income stream had to

be reduced by increasing the federal contribution; that is, by increasing the budgetdeficit.19 But in a speech the very next day (November 10) Secretary Morgenthaudeclared that the latter deficit was excessive. A balanced budget was needed torestore business confidence.

As Stein (1969: Chap. 6) put it, the Keynesians and the budget-balancers werenow locked in a furious ‘struggle for the soul of FDR’. The report that theKeynesians placed before the president stated that if the government continuedto take out more than it puts in then’ (1) prices will not adjust quickly enough, (2)

budget balancing will be pursued too far and deflation will result, (3)unemployment will increase, (4) buying power will be impaired, and (5) thingswill get out of hand’. The large increase in production in 1936 should have led toa vigorous increase in retail business in 1937. Instead, a combination of cost-induced (as distinct from demand-induced) price increases and cuts ingovernment spending meant that the large increase in production could not betaken off the market because purchasing power was not large enough. Costadvances in the key construction sector were also highly damaging and neededto be offset by reduced financing charges. The report continued:




A part of the deficit was filled by increase in installment buying, which merelymeans that future buying power is already spent. All this talk aboutproduction creating its own purchasing power is absurd when prices increase.Then inventories pile up and real purchasing power stays the same.

Some experts believe this is merely a lull, catching up with the franticinventory buying which took place when prices were going up last winter

and that when these stocks are worked off, business will resume as usual. Itis far from certain that the matter is so simple as just overloading of inventories.

It is difficult to see where additional purchasing power is to come from,that is, large and effective quantities of it, such as are needed if we are tomove forward vigorously. Farm income is at its peak. Steel will hold its pricesup too long. Automobiles will run into sales difficulties. There is little hopefor big volume in textiles. Men’s clothing and all garment selling is having

trouble. Rayon yarn production for the first time in months is being reduced.Auto tire companies and many others are slowing down production.

Regardless of whether this decline is temporary or whether it is the beginning of a major depression, there is urgent need to keep a close watchon things.

In fact the economy was in a tail spin. In a speech to Congress a few days after his‘Keynesian’ seminar, he asked: ‘What does the country ultimately gain if weencourage businessmen to enlarge the capacity of American industry to produceunless we see to it that the income of our working population actually expandssufficiently to create markets to absorb the increased production’. But Rooseveltinitially sided with Morgenthau. Disaster followed (Brinkley, 1995:28); and notuntil April 14, 1938, after the worst period of his long tenure in the White Houseand after a strong letter from Keynes in February, did Roosevelt at last ask Congress(over the continuing objections of the Secretary of the Treasury) for more than $3

billion of spending or lending in the immediate future for relief, public works,housing and assistance to state and local governments (Barber, 1996:114).

Shortly afterwards, Roosevelt delivered a ‘Monopoly Message’ to Congress,April 29, in which he proposed an appropriation of $500,000 to fund anexhaustive investigation into the concentration of economic power that led to thesetting up of the Temporary National Economic Committee (TNEC) that was togenerate some thirty volumes of testimony over the next three years. This inquiryhad been mooted for over a year. In a letter to Eccles, March 23, 1937, Curriewrote: ‘Friday I attended a meeting of the Industrial Committee of the NationalResources Committee… They are planning to recommend to the President thata national conference on productivity be called… Most of the emphasis wasplaced on the removal of restrictions on output of various kinds and I suggestedthat some emphasis be placed on the problem of securing full and continuousemployment, since our greatest waste of resources in the past has been attributableto depressions’ It was with this in mind that Currie arranged for Galbraith toconduct a review for the National Resources Planning Board of the impact of




public works (see above). He also persuaded Leon Henderson and Jerome Frankat the Securities and Exchange Commission (SEC), the main instigators of theTNEC, to include the study of macroeconomic policy as well as the study of monopoly and industrial concentration. Stein (1969:168; see also Brinkley,1995:128–136) observed that theTNEC hearings turned out to be mainly a showcase for Keynesian economics, with Lauchlin Currie and Alvin Hansen the

star witnesses, having teamed up, as ‘Mr Inside and Mr Outside’ (Tobin, 1976:33)to present complementary presentations in May 1939 of the theoretical andempirical case for compensatory fiscal policy.

Hansen used the occasion to elaborate on the ‘mature economy’ and ‘secularstagnation’ theme he had first presented as his presidential address to theAmerican Economic Association in December 1938. To theTNEC he registeredhis ‘growing conviction that the combined effect of declining population growth,together with the failure of any really important innovations of a magnitude

sufficient to absorb large capital outlays, weighs very heavily as an explanation of the failure of the recent recovery to reach full employment’. It was clear thatpublic investment on a very considerable scale would be needed to supplementprivate investment. To drive the point home, Currie (1939) then explained andpresented charts showing the ‘income-producing expenditures that offset savings’Barber (1996:124) summarises his argument thus:

As savings were withdrawals from the income stream, the economy wasdoomed to a chronic state of underemployment unless these withdrawalswere ‘offset’ by capital spending by business, outlays for residential housing construction, lending abroad, or loan-financed expenditures by government.As a shortfall in the private sector’s capital spending was expected,government’s role as a spender would be crucial. Under questioning, Hansenand Currie acknowledged that tax reductions might pay dividends instimulating private spending. But their central argument held thatgovernment could better manipulate aggregate demand by other means.

Barber concluded that the Hansen-Currie line of analysis amounted to a domesticated Keynesian perspective on the performance of the economy. It wasHansen’s belief, however, that it was the war rather than the 1937–38 recessionthat finally shifted opinion to accept the practical applications of Keynesianism interms of employment policy (Colander and Landreth, 1996:104–6). There wasviolent opposition to Hansen’s views on the public debt: ‘The Americaneconomists were all dead against it’, and he singled out Henry Moulton, thepresident of the prestigious Brookings Institution. ‘There was practically nobodyin the United States who accepted Keynesianism up to and as we got into thewar.’ (See also Evsey Domar’s interview in Colander and Landreth, 1996:187–8.) Currie too, in an unpublished memoir (1951:92), wrote:

Those of us who pioneered in the field of forecasting and in advocating policies of adjustment not only received little credit but actually were




subjected to a good deal of criticism and abuse. I was somewhat protectedfrom the latter by the fact that nearly all of my work was carried on insidethe Government, though I was regarded with suspicion by many of theacademic economists and certainly by many business men. Alvin Hansen,however, was abused and ridiculed and even accused of something likelack of patriotism for daring to suggest that there might be too much saving

or that there were limits to the possibilities of profitable private investmentsof savings. I doubt very much if he would have been offered a chair ineconomics in Harvard if those views had been known in advance. Keyneswas for years regarded as the Archpriest of economic unsoundness andfew people were the target of so much criticism from the professionaleconomists of the United States.

On the other hand, no criticism was meted out to those professional

economists who through this tragic decade betrayed their trust andcontinued to talk nonsense about balancing the budget and restoring confidence.

Such attitudes help explain the defeat, as late as 1939, of the Works Financing Bill even though this was framed in such a way that a major spending programmewould be financed ‘outside the budget’, in hopes of appeasing the budget

balancers. Nonetheless, Roosevelt was by then less reticent about spending as a way out of recession and the federal net contribution nearly doubled in 1939 toaround $3.6 billion.

The New Deal of course was about much more than the size of public spending.However, in the absence of macroeconomic balance relatively little could beexpected of microeconomic reforms. Gardiner C.Means continued to insist thatlaissez faire was played out and that detailed industrial planning was called for toeradicate the malevolent influence of administered prices and the output-suppressing propensities of producers with market power (Barber, 1996:126; Lee,1990). By 1938–39, however, the stress was on spending first, structural reformsecond. The spenders thought that monopoly was as much the consequence as thecause of Depression. Expansion of the market, domestic and foreign, would offeropportunities for greater competition from new firms and products.

In fact, the greatest expansion of markets would come from the demands of war. Yet, as Galbraith has emphasized, for the United States the Second WorldWar was the cheapest in history in terms of the squeeze it imposed on non-military production. So great was the slack in the system that it was possible,with substantially the same capital equipment as existed in 1940, to wage a mightywar on two fronts, equip the allies, put 12 million men in the armed forces, andat the same time increase the civilian standard of living. Nevertheless, the refusalof Congress to pass the 1939 Works Financing Bill, for example, meant that theUnited States entered the war with much less addition to railroad and electricitygenerating capacity and improved highways than, as the war showed, it wascapable of producing. Naturally, however, there were many specific bottle-necks




and shortages in the transition to a war economy. Also, too little was done toapply the logic of Keynesianism to wartime, and close an excessive deficit by raising taxes. It was left to Galbraith, in his capacity as the ‘czar of prices’, to subjectprice and wage advances to close scrutiny and to fight the profiteers.

The lasting legacy of the theoretical, empirical and practical experience of theDepression and war years was the February 1946 Employment Act and the

creation of the Council of Economic Advisers. Its passage through Congress wasstormy, and the original bill that Alvin Hansen drafted in August 1944 was muchwatered down. Nevertheless, a statute that affirmed governmental responsibilityfor ‘maximum employment, production and purchasing power’ was a significantadvance, for Keynesians, over the much more limited mandate for governmentthat, for example, was preferred by Irving Fisher and the Chicago School withtheir rules-based price stability goal for monetary policy, and with fiscal policyaimed at low-level balanced budgets. The war itself accustomed people to higher

and more progressive rates of taxation and government spending and these wereonly partially retrenched in peacetime. This introduced a much greater degree of

built-in stability by effectively reducing the savings rate at full employmentincome, relative to the offsets.

Nonetheless, with Roosevelt’s death in April 1945 the liberal establishment thathad surrounded him was rapidly replaced by a more conservative power elite, andthe potential peace dividend was squandered for forty years on a futile Cold Warand several nasty hot wars. Unlike in the 1941–45 war when vast underusedresources could be mobilised, in the era of full employment the military-industrialcomplex (Galbraith’s term) has sucked resources and talent away from education,health, housing and the arts. The challenge of the ‘mature economy’ has turnedout to be not Hansen’s stagnation thesis, but the challenge of public squalor, crimeand incivility amidst unprecedented but unequally distributed private affluence,much of it due to the unearned increments of land values and to inadequatecompetition and mobility. In the affluent society what matters for economic andsocial welfare is not the size of GDP but its composition and distribution.

Notes

1. See Mehrling (1997) for an excellent recent account of the Americaninstitutionalist tradition, as exemplified by Allyn Young, Alvin Hansen andEdward Shaw, in keeping alive an awareness of the ever anxious relations

between finance and democracy, between the money interest and the publicinterest Compare with Galbraith’s Economics and the Public Purpose (1973).

2. This was also the dominant view coming out of Harvard at that time, asDavid Laidler (1999:215–9) records. Gottfried Haberler and JosephSchumpeter based their policy nihilism on the ideas of the Austrian school:depressions were the natural and necessary remedy for the maladjustments,

built up during preceding periods of prosperity, between the production of consumer goods and increasingly ‘roundabout’ capital. This at least had a




semblance of theoretical coherence. Their nihilistic conclusions wereshared, but without any coherent theoretical support, by their Harvardcolleagues, Seymour Harris, Edward Chamberlin, Edward Mason andothers (Brown et al., 1934). All of them opposed monetary and fiscal easing,either because that would make matters worse, or at best be useless.

3. Galbraith (1981:23) noted that at Berkeley ‘we all looked up especially to

Gregory Silvermaster [a Berkeley Ph.D. in economics]…[who] later movedon to Washington and was much celebrated by Whittaker Chambers as a leader of the Communist underground in that city’.

4. Galbraith (1981:48).5. In 1949 he also recruited Richard Musgrave, another member of Hansen’s

seminar group, as the tax expert on a World Bank mission to Colombia.Currie teamed up with Alvin Hansen to present evidence on the impact of public spending before the Temporary National Economic Committee

(TNEC) in 1939. Musgrave records his experience at Harvard, 1934–42,in Colander and Landreth (1996).

6. White wrote his Harvard Ph. D. dissertation under Frank Taussig on theoperation of the international gold standard. He worked at the U.S.Treasury from 1934 to 1946, rising to Assistant Secretary. Like Currie hewas an early advocate of activist monetary and fiscal policy. See L.B.Currie,P.T.Ellsworth and H.D.White, ‘Memorandum’, January 1932. File 29, The Papers of Harry Dexter White, Seeley G.Mudd Library, Princeton University.This memorandum is discussed below.

7. Friedman and Schwartz were later criticised by Humphrey (1971), Patinkin(1981) and Laidler (1993) for ignoring the contributions of non-Chicagoeconomists, especially Currie, to monetary theory and statistics.Humphrey stated that ‘Currie was the only American monetary theorist inthe early 1930s to have held the Federal Reserve responsible forprecipitating the Great Depression’. Friedman later offered an explicit mea culpa (Laidler, 1993:1077–8).

8. When this little-known memorandum was brought to the attention of David Laidler by the present writer in November 1999, he was struck by itssimilarity to the famous Harris Foundation manifesto sent to PresidentHoover a few days later. That manifesto was drafted by John H.Williams(Currie’s Harvard Ph. D. superviser), Irving Fisher, Alvin Hansen, CharlesHardy, Henry Schultz and Jacob Viner. See also Laidler (1993:1091) for a note on Currie’s influence on John Williams at this time.

9. Friedman and Schwartz (1963:640) define ‘money’ to include timedeposits, or M2, but they calculate velocity for M1 and M2. Their chartshows M2 velocity falling slightly during the 1920s while it was rising forM1. Only the M1 measure is consistent with their claim that velocity tendsto move pro-cyclically. Interest-bearing time deposits would increase withan increase in the savings rate over time. Lending financed out of savingscan grow rapidly with no threat to inflation. Thus the narrower definition(means of payment) is a better series for the monitoring of total




expenditures (as opposed to their composition). In the 1920s the authoritiesonly monitored ‘credit’, or the quantity of bank loans and their ‘quality’(short-term versus long-term, ‘productive’ versus ‘speculative’).

10. These characteristics of FDR (and the even greater human qualities of hiswife Eleanor) have been affectionately portrayed by Galbraith in his mostrecent book (1999).

11. The term was first used by D.H.Robertson. For a discussion of the subtle but important distinction between a credit deadlock and a liquidity trap seeLaidler (1999:285–7). In the latter case a ‘speculative’ demand for moneyat low rates of interest on long bonds renders monetary policy impotentHawtrey (and Currie), however, doubted the existence of a speculativedemand for money—based on a desire for liquidity when long bonds are toorisky—because there are plenty of liquid assets (with capital-value certainty)other than ‘money’ proper that can satisfy demand for liquidity. Hawtrey

believed a credit deadlock—in which a loss of business confidence halts bank borrowing and destroys deposits—could usually be counteractedthrough vigorous open-market bond purchases; but he did not rejectmoney-financed deficits as a last resort

12. Some 9,000 banks, with $6.8 billion of deposits failed between 1930 and1933 (Wheelock, 1992:4). In 1936 Currie undertook a study of closed

banks as part of a WPA ‘make-work’ scheme for unemployed white collarworkers (Sandilands, 1990:80). The results revealed that the loss of deposits attributable to the panic withdrawal of small depositors was a negligible factor in causing bank suspensions. Before lines formed outside

banks it was typically the large depositors, well connected and informed by bank directors, who accounted for the bulk of withdrawals. The rise in thecash-deposit ratio and associated loss of bank reserves went largelyuncompensated by Federal Reserve action.

13. See Friedman and Schwartz (1963:454–5) for data on interest rates. In1936 interest rates continued to fall. This increased Eccles’s concern that if

banks did increase their lending they could suffer large losses in a futureinflation. This was a decisive factor in his decision in July 1936 to support a ‘precautionary’ increase in the reserve requirement ratio (Eccles, 1951:289;Meltzer, 2000: Chap. 6).

14. Friedman and Schwartz (1963:526) and Meltzer (2000) both make thereasonable point that if there were no desire to cause a current restrictiveeffect the authorities should have waited until there was such need. Theyargue that the effect was in fact highly restrictive, and that the availability of the reserve requirement instrument caused excess reserves to be reduced byfar more than the authorities would have dared to engineer via traditionalopen-market operations.

15. This view is shared by Cole and Ohanion (1999). They also doubt that the1933 bank failures could explain why the low level of lending relative toindustrial output persisted so long, especially in view of the reassurance given

by federal deposit insurance (effective July 1934). It can be argued that




increased output was spurred not by increased liquidity, but by the influenceof government spending on private incomes and spending. However, Coleand Ohanion ignore the fiscal position and blame the slowness of recovery onNIRA codes that encouraged cartelisation and high industrial wages that ledto a fall in labour inputs. Based on a neo-classical growth model, theycalculate the effect of this supply shock on output. The demand side is

ignored. The Keynesian revolution is far from complete!16. Letter, Lauchlin Currie to Jacob Viner, September 23, 1935, in Jacob Viner

Papers, Princeton University.17. This analysis calls into question Steindl’s (1998) view that the inattention to

data on money by almost all economists and policy makers (including Currie) after 1933 contradicts Kuhn’s hypothesis that old paradigms (inthis case a crude quantity theory) are only rejected when an alternativeparadigm has emerged. Steindl bases this judgment on the fact that the

General Theory was not published until 1936 and absorbed only some timelater. He considers Currie’s position particularly puzzling, because of thestress he had placed on money in his diagnosis of the 1929–32 contraction.But when the facts change a consistent focus has no merit. Also, see Laidler(1999) for an excellent survey of the pre-General Theory intellectualarguments for counter-cyclical public works.

18. Leon Keyserling states that pressure for this legislation originally camefrom Senator Robert F.Wagner (Colander and Landreth, 1996:223–4).

Currie states that it was not until April 1940, during lengthy discussions inWarm Springs on how to put social security on to a pay-as-you-go basis,that Roosevelt finally understood the fallacy of composition in moving from individual to national accounting (Sandilands, 1990:102; Stein,1969:129). Progress on these reforms was aborted as FDR moved from ‘Dr.New Deal’ to ‘Dr. Win-the-War’ (Lash, 1988:463).

19. Paul Samuelson and Tibor Scitovsky (in Colander and Landreth,1996:170, 211) highlight the important statistical work by Richard Gilbert,

Robert Nathan and Simon Kuznets in calculating potential GDP. In 1941people wanted to know if it was possible to have both guns and butter (Lash,1988:455). Samuelson records that while Keynes was in Washington in1941, Richard Gilbert, then at the Office of Price Administration, argued,controversially, that there was big room for expansion. Keynes was askedhis opinion. He asked how much higher was 1929 real output over 1913?He was given the numbers and said, ‘Well that was a 15-year period and it’s

been 12 years since 1929. So, let’s take 12/15 of that increment, and I think

that would be a reasonable goal for potential GNP’. This figure coincidedwith Gilbert’s calculation, and wartime GNP indeed matched it.

References

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roger sandilands - galbraith. the new deal and domesticated keynesianism

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