Thursday, January 26, 2012

What Hoover Should have Done in 1931

The tired and idiotic meme that Hoover tried a properly designed Keynesian stimulus in 1931 and 1932, and that this allegedly should have stopped the Great Depression continues to permeate the minds of various Austrians.

Robert P. Murphy quotes from his book The Politically Incorrect Guide to the Great Depression and the New Deal (2009) in a recent blog post:
“As with the evaluation of Hoover’s high-wages policy, his high-federal-budget policy can be usefully contrasted with the depression occurring at the end of Woodrow Wilson’s watch. With the conclusion of World War I, the U.S. government slashed its budget from $18.5 billion in FY 1919 down to $6.4 billion one year later. As the U.S. economy entered a depression at the turn of the decade, receipts fell. The Wilson Administration responded by cutting spending even more, down to $5.0 billion in FY 1921 and then following with a single-year slash of 34 percent, down to $3.3 billion in FY 1922. (Because of the fiscal/calendar year mismatch, it is debatable whether Wilson or Harding should be associated with the FY 1922 budget.)

So how do the two strategies stack up? We already know that Hoover faced 20+ percent unemployment after the second full year of his Keynesian stimulus policies. Wilson/Harding, on the other hand, was Krugman’s worst nightmare, taking the axe to federal spending in a way that would have given even Ron Paul the willies, and during a depression to boot! Yet as we already know, unemployment peaked at 11.7 percent in 1921, then began falling sharply. The depression was over for Harding, at the corresponding point when a desperate Hoover had decided to (try to) rein in his massive budget deficits” (Murphy 2009: 49).
Some basic facts should be stated first:
(1) In fiscal year 1930, Hoover actually ran a federal budget surplus, not a deficit. Federal policy was contractionary in this fiscal year.

(2) The Federal Reserve raised the discount rate in 1931.

(3) In fiscal year 1933, total federal spending was cut in relation to fiscal year 1932. Hoover introduced the Revenue Act of 1932 (June 6) which increased taxes across the board and applied to fiscal year 1932 and subsequent years. These were contractionary measures, and these two policies are the very antithesis of Keynesianism stimulus.
Murphy declares that Hoover engaged in “Keynesian stimulus policies.” If by this he means that the effect of federal government fiscal policy was weakly expansionary in 1931 and 1932 relative to the collapse of GNP, this is true enough. In 1931, for example, it is well known that fiscal policy was expansionary: one of the stimulative measures (passed over Hoover’s objections, however) included the Veterans’ Bonus Bill. The budget may have expanded demand by 2% of GNP in 1931 more than the 1929 budget, but this was not large relative to the collapse of GNP, which is the key (Temin 1989: 27–28). In 1931, GNP collapsed by 16.11% relative to its level in 1930, from $91.2 billion to $76.5 billion.

If by these words he means that Hoover engaged in the type of proper stimulative Keynesian fiscal expansion designed to halt the depression to restore growth, he is wrong, and contemptibly wrong.

In fiscal years 1931 and 1932, Hoover did indeed raise federal spending (especially in 1932), but it was woefully inadequate. In no sense do these miserable increases compared to the scale of the GDP collapse contradict Keynesian economics. Once you factor in state and local austerity and surpluses total federal spending increases was reduced.

In order to stimulate an economy back to its growth path and potential GDP, one has to do the following:
(1) calculate potential GDP and estimate how severely GDP is likely to collapse by,
(2) estimate the Keynesian multiplier and
(3) then design fiscal policy to expand demand by tax cuts and/or appropriate level of discretionary spending increases to hit potential GDP via the multiplier.
In 1931, US GDP collapsed by $14.7 billion dollars, in a debt deflationary spiral with bank failures and a collapse in consumption, employment and investment. If we assume a multiplier of 4 (which is very high), then Hoover’s federal spending increase of $257 million dollars in fiscal year 1931 might have generated at most $1.028 billion of GDP in fiscal year 1931 (the effect of state and local fiscal policy reduced this, however).

But GDP fell by $14.7 billion dollars, and it is the height of idiocy to seriously argue that Hoover’s increase in spending in fiscal year 1931 could have prevented the depression, to offset such a catastrophic fall in GDP. It could never have done any such thing.

To stop the downturn, Hoover needed to do the following:
(1) spend an additional $3.675 billion in fiscal year 1931 in stimulus;

(2) Hoover needed to at least stop fiscal contraction by states and local government, so some bailout of them was necessary to make (1) work.
He did no such thing. Not even close. $257 million dollars is not $3.675 billion. Hoover’s federal fiscal expansion was 6.9% of the sum required.

Of course, if Hoover had quickly stabilised the banking system in 1931, the GNP collapse would have been significantly reduced as well, and the scale of the needed stimulus would have been reduced too.

There is an easy empirical way to demonstrate that a Keynesian stimulus failed and that, moreover, something is wrong with Keynesian theory:
(1) in an economy experiencing a recession, calculate potential GDP, estimate the Keynesian multiplier and
(2) design fiscal policy to expand demand by tax cuts and/or appropriate level of discretionary spending increases to hit potential GDP via the multiplier, and if
(3) the stimulus is implemented and
(4) GNP continues to collapse, then you have empirical evidence that your stimulus failed, and that there are problems with your theory.
If in 1931, Hoover had designed a fiscal policy that stimulated the economy by an additional $3.675 billion, and US GNP had simply continued to collapse, then this would have been a failed stimulus. It would provide strong empirical evidence against Keynesian theory.

However, no such thing was ever done. Keynesianism did not fail, because Hoover never tried a proper Keynesian stimulus. Hoover’s fiscal policy in 1931 and 1932 was weak and feeble fiscal expansion, woefully inadequate.


Murphy, Robert. P. 2009. The Politically Incorrect Guide to the Great Depression and the New Deal, Regnery Publishing, Inc. Washington, DC.

Temin, P. 1989. Lessons from the Great Depression, MIT Press, Cambridge, Mass.


  1. You are obviously right that any fiscal expansion during the Hoover administration is not a great example of "Keynesian stimulus." You are not the first blogger to bring this up and you will probably not be the last -- because the spending meme will probably return --; but, amongst the more "educated" (I wouldn't read too much into that word, in case it brings up controversy) bloggers I think it's understood that the Hoover administration, like the Obama administration, practices what we can call a middle-of-the-road policy which neither entirely austerian or not entirely expansionist. On both sides of the field, what Hoover did was absolutely inadequate.

  2. Hoover was hardly a Keynesian in his policy response, but he was hardly a diehard advocate of laissez faire policy either. The fact is, he didn't know how to respond to what would become the Great Depression. Kuehn has a good post somewhere on his website, but I haven't been able to find it.

    P.S. Lord Keynes, please check your e-mail.

  3. Lord Keynes,

    Do you have a post anywhere explaining the dynamics of the Wilson years into the 20's? Seems it must have been private credit expansion which allowed for the growth. Do you have a good source for further reading? Thanks, Just discovered your site recently and have been enjoying it.

  4. Lord Keynes, This is off topic, but I just did a post on my blog claiming that fractional reserve leads to sub-optimum rates of interest. As someone who has given fractional reserve plenty of thought, your comments will be welcome. See:

  5. A friend has produced a dodgy T V statement by a USA professor, unknown to me or anyone, stating that "market forces could have ended the depression in two years if no political interference such as the New Deal had occurred." I thought it was garbage, propaganda and intentionally misleading. This site is far better.