Created 10/7/1996
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Fiscal Policy in the Shadow of the Great Depression

J. Bradford De Long

University of California at Berkeley, and National Bureau of Economic Research

October 1996


Before the Great Depression the U.S. government borrowed in time of war, and ran peacetime surpluses to pay off war debt. The use of the government deficit as a tool of macroeconomic management was rarely considered, and if considered rejected as inconsistent with international exchange rate arrangements.

The Depression broke this pattern: both Hoover and Roosevelt wished to maintain surpluses, but both recoiled at the austerity required in the midst of the Depression. So the political nation made a virtue of necessity: it concluded that deficits in time of recession helped alleviate the downturn.

The generation after World War II moved toward the CED view of fiscal policy: set tax rates and expenditure plans so that the high-employment budget would be in surplus, but do not take any steps to neutralize "automatic stabilizers" set in motion by recession.

But the American political system cannot hold more than one idea in its mind at a time. The idea that "cyclical" deficits in recession could be good has weakened the belief that "structural" deficits that permanently reduce the national savings rate are a bad idea; and fear of "structural" deficits has undermined the support for allowing the fiscal "automatic stabilizers" to work smoothly.


Created 2/21/1996
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Associate Professor of Economics Brad De Long, 601 Evans
University of California at Berkeley; Berkeley, CA 94720-3880
(510) 643-4027 phone (510) 642-6615 fax