Delivering Growth while
Reducing Deficits:
Lessons from the 1930s
Nicholas Crafts
1930s: Relevance to Today
• Similar initial downturn
• First, fiscal consolidation, and then fiscal
stimulus at the ZLB
• Budget was balanced in 1933
• Double-dip recession in 1932 but 4% growth
from 1933-37
• NB: no banking crisis in UK
Real GDP (Quarterly)
1930q1-1938q1
Sources: Mitchell et al.
(2011); ONS
The 1930s Recovery: 1st Phase
• Started during fiscal consolidation which
reduced structural deficit by 4%GDP between
1930 and 1934
• Strong growth 1933-35 based on monetary
stimulus which offset negative impact of fiscal
policy: cf. the ‘foolproof way’ to escape the
liquidity trap
• Exit from gold standard plus cheap money;
housing investment led the recovery
Exchange Rates (1929 = 100)
Pound/Dollar
Pound/French
Franc
Average
Exchange Rate
1929
100.0
100.0
100.0
1930
100.1
99.9
99.6
1931
93.3
93.2
93.7
1932
72.1
71.9
75.2
1933
86.8
68.2
77.0
1934
103.8
62.0
75.4
1935
100.9
59.9
74.5
1936
102.3
66.9
77.7
1937
101.8
100.5
84.7
1938
100.7
137.6
86.9
Source:
Dimsdale (1981)
Medium-Term Implications of
Devaluation
• Permitted cheap money policy
• Nominal and ex-post real interest rates fell
• Fiscal sustainability improved as deflation ended
• International competitiveness improved; change
in net exports modest contribution to demand
growth during recovery
Quarterly Real GDP Estimates
(Mitchell et al. 2011)
19291
97.5
19311
93.6
19331
94.4
19292
98.9
19312
93.1
19332
96.0
19293
99.9
19313
92.8
19333
97.6
19294
99.9
19314
93.7
19334
99.1
19301
100
19321
94.0
19341
101.2
19302
99.1
19322
93.4
19342
102.6
19303
97.8
19323
92.9
19343
103.5
19304
95.9
19324
94.6
19344
104.0
Double-Dip Recession
• Quarterly GDP estimates reveal that after initial
recovery in late 1931/early 1932 there was
another recession in 1932 q2 and q3
• So, unlike the USA, devaluation did not signal
the turning point
• Adds weight to argument that devaluation was
not sufficient in USA but had to be part of bigger
package (the New Deal) that committed to future
inflation
The ‘Cheap Money’ Policy
• Was a coherent framework arrived at by mid-1932 with
HMT not B of E in charge
• Aim to raise the price level and to underpin this by
holding exchange rate at $3.40 then FFr. 88
• Short term interest rates kept at lower bound and real
interest rates fell
• Credible because it was clearly in HMT’s interests as a
route to recovery that did not open Pandora’s Box and
improved fiscal arithmetic
Treasury Bill Rate (%)(1930q1-1938q1)
Sources: Howson (1975); derived from Capie and Collins (1983)
House-Building in the 1930s
• They built a lot of houses by our standards
(293,000 in peak year)
• Building societies provided ample mortgage
finance
• Virtually no planning restrictions
• Strong demand in context of rising real incomes
and catching up 1920s shortfall
Houses Built (without state assistance),
Six Months Ending
Source: Stolper (1941)
The 1930s Recovery: 2nd Phase
• From 1935 onwards rearmament takes centre
stage
• Large exogenous fiscal shock with short term
interest rates held constant
• Suggests significant fiscal multiplier at ZLB;
conditions for government borrowing to improve
public finances may have been in place then
though not in 1931
Fiscal Policy
• Became ‘Keynesian’ only with rearmament
• Early 1930s tightening (over-riding automatic
stabilizers) - worries about fiscal sustainability
• Defence expenditure rose from £118 mn. in
1934 to £181 mn. in 1936 and £353 mn. in 1938
• Defence Loans Act (1937): £400 mn. deficit
finance over 5 years; multiplier about 1.6?
Public Finances (% GDP)
Net Public Debt
Budget Deficit
Structural Deficit
1929
158.4
0.7
-0.4
1930
159.2
1.4
-1.1
1931
169.8
2.2
-2.5
1932
173.6
0.5
-3.0
1933
179.2
-0.4
-4.2
1934
173.1
-0.5
-3.2
1935
165.0
0.3
-2.0
1936
158.7
0.7
-0.8
1937
147.2
1.5
0.1
Source: Middleton (1996)
The “Managed Economy” in
1930s UK
• Post-1932 policy package included capital controls,
devaluation, tariffs, cheap money and cartels
• Understandable as a short-term fix to raise prices at
ZLB at a time of high unemployment
• Regrettable long-term implications for productivity;
retreat from competition very hard to reverse
• Weak competition sustained bad management and
dysfunctional industrial relations
Lessons
• Fiscal consolidation does risk double-dip recession
• Conventional inflation targeting may be inappropriate
with fiscal consolidation at the ZLB
• Fiscal stimulus can help recovery when interest rates are
held constant if sustainability not an issue
• Severe recessions can risk bad supply-side policies that
can seriously damage long-run growth – perhaps the EU
and WTO are useful constraints