At least if we are to believe modern Keynesians like Paul Krugman, who insist that the deep 1937-38 recession was produced by a tightening of fiscal policy.
In previous posts I’ve pointed out that there are all sorts of problems with the modern Keynesian explanation for 1937. The tightening was mostly in taxes and transfers, not government output. In contrast, modern Keynesians suggest that stimulus involving government output is far more effective than tax cuts.
The timing is also wrong. Investors were fully aware of fiscal tightening in early 1937, yet stocks were at very high levels. In contrast, my explanation of the deep recession (mostly a turnaround in the world gold market which led to deflation) correlates very closely with movements in the stock market. (I also think FDR’s high wage policy played a role in the recession.)
But who cares what I think. I’m more interested in Keynes’s views. Would he agree with me or Krugman?
Keynesians like to make a big deal of Keynes’s skill in investing, which is mostly (albeit not entirely) a myth. He lost lots of money in the 1920s and had to be bailed out by his father so that he could start over again. In the spring of 1937 he thought it was a great time to own US equities, indeed so much so that he purchased many on margin. How’d that work out? Here John Hussman:.
As biographer Robert Skidelski observes, “In the year of the ‘terrific decline’ which had started in the spring of 1937, he lost nearly two-thirds of his money.”
Keynes was fully aware of the fiscal tightening by this time. And he was fully aware that a steep recession would cause a sharp sell-off on Wall Street.
So which is it? Is the Keynesian theory wrong? Or did Keynes not believe his own theory?
I say the Keynesian theory is wrong. There was no reason for Keynes not to own stocks in 1937. The events that caused the severe recession also caused the stock market crash–and those occurred in the last half of 1937. EMH + market monetarism >>>>>> Keynesian theory.