Did the 1936 fiscal stimulus help the economy?

Joshua Hausman has a very good paper on the 1936 veterans’ bonus, in the AER.  This was a payment of $1.8 billion to about 3.2 million WWI veterans.  The benefits were originally supposed to be in the form of a pension, but Congress bowed to public pressure and voted to make immediate lump sum payments to the veterans (in the form of bonds).  FDR viewed the bill as irresponsible, but it passed over his veto.

Hausman provides lots of pretty convincing evidence that the bonus payments boosted consumption, at least by those who received the payments.  He estimates a MPC in the .60 to .75 range.  One telling fact is that 80% of the bonds were cashed in during 1936, despite the fact that they paid an above market rate of interest (3%).  I imagine that after 7 years of depression, lots of the veterans were liquidity constrained and we were not in a Ricardian equivalence world.  Nonetheless, I’m skeptical that the bonus program was effective, not surprisingly for monetary offset reasons.

The bonus bill was passed in January 1936, and the payments went out to veterans in late June 1936.  As a bit of background, the recovery had temporarily stalled under the NIRA, indeed from July 1933 to May 1935 there was no increase in industrial production.  After the NIRA was ruled unconstitutional in May 1935, industrial production started rising rapidly, and continued doing so into early 1937, when growth slowed.  In late 1937 and early 1938, industrial production plummeted, as the US entered one of the most severe depressions of the 20th century.  So the bonus payments came part way through a period of strong growth.

I do believe that 1936 GDP was higher than it would have been without the bonus program, but I don’t think the overall effect was expansionary.  Less than a month after the payments were distributed, the Fed embarked on a major anti-inflation program.  On July 15, the Fed voted to raise reserve requirements sharply.  By itself, this action probably had only modest effects, not enough to offset the fiscal stimulus.  But then in December 1936, the Treasury began sterilizing gold inflows.  In March 1937, reserve requirements were raised again, and then again in May 1937.  By this time the reserve requirements had doubled from the levels of early 1936.

In my book on the Great Depression, I suggested that other factors largely explain the severity of the 1937-38 slump, especially higher labor costs in early 1937 combined with a bout of gold hoarding in late 1937.  This gold hoarding was a dramatic turnaround from the gold panic of late 1936 and early 1937 (which involved gold dishoarding).  Nonetheless, the various contractionary monetary policies were probably enough to offset the bonus payments, which were about 2.1% of 1936 GDP.

There are three possibilities, anyone of which seems plausible.  The monetary policy tightening might have offset, more than offset, or less than offset the bonus payments.  We don’t know, and given the “game theory” aspects of this problem, we will never be able to know for sure.  But it’s worth noting that 1936 was an almost ideal time to do fiscal stimulus:

1.  Generally speaking, monetary policy was quite passive during the period after 1934, with the monetary base tending to rise along with the monetary gold stock.  Under a gold standard regime, monetary offset is less likely to occur, and indeed the constraint of the gold standard is one reason why I was skeptical of the effectiveness of the various contractionary monetary policies in 1936-37.

2.  FDR had allies at the Board of Governors.

3.  Interest rates were near zero, which is generally assumed to be a condition where monetary offset is less likely to occur.

Thus I find it interesting that 1936-37 looks like an almost classic example of monetary offset.  There was a very specific, highly visible fiscal stimulus.  It occurred during a period of rising (wholesale) prices, and inflation seemed to accelerate further after the bonus was paid.  Then policymakers take not one but four steps to restrain AD and slow inflation, with the first occurring less than a month after the bonus payment.  And then the economy slows and eventually falls sharply. Admittedly that’s all circumstantial, but it’s almost a textbook example of what you’d expect monetary offset to look like.

Interestingly, Hausman doesn’t focus on monetary offset (his study uses cross sectional data, as well as survey data).  But he does allude to possible fiscal offset:

As is customary, I consider the multiplier for the bonus ignoring any political economy affects of the bonus’ passage on other spending and taxing decisions. The veterans’ bonus was itself deficit financed, but its passage led to political pressure for higher taxes. Thus the veterans bonus contributed to the enactment of the undistributed profits tax (the Revenue Act of 1936) in June 1936 (Romer and Romer 2012). This bill imposed taxes on undistributed corporate profits and also raised taxes on dividends. It did not affect other personal taxes. The political dynamic through which the veterans bonus contributed to the passage of this tax increase can be compared to the way the American Recovery and Reinvestment Act (the Obama stimulus) may have contributed to later spending cuts.

PS.  Just to be clear, I think the bonus program was expansionary during 1936.  My skepticism has to do with the effects of monetary offset on the economy in 1937 and 1938.  And my skepticism about the bonus as fiscal stimulus doesn’t mean I necessarily think it was a bad program.  I certainly have sympathy for WWI veterans, although I also understand the reasons why FDR vetoed the program.



31 Responses to “Did the 1936 fiscal stimulus help the economy?”

  1. Gravatar of Jerry Brown Jerry Brown
    5. April 2016 at 09:21

    I doubt that it was your intent, but I think you make a good case for restricting Fed independence here. I mean- monetary offset to expansionary fiscal policy during the Great Depression?? What was wrong with those people at the Fed?

    They definitely needed a NGDPLT then.

  2. Gravatar of AL AL
    5. April 2016 at 09:28

    To me this suggests, under the inflation targeting regime, that no one can credibly promise to be “irresponsible” — not central bankers, and not legislatures, either. The system won’t allow it.

    That last quote is particularly depressing, because it ties past and present together so nicely.

  3. Gravatar of Britonomist Britonomist
    5. April 2016 at 09:55

    There wasn’t just a monetary offset, there was also a fiscal offset in 1937 where FDR decided he needed balanced budgets after all.

  4. Gravatar of Ray Lopez Ray Lopez
    5. April 2016 at 10:46

    As Britonomist says, there’s other stuff going on besides monetary offset. But consider this episode with two priors: (1) money is largely neutral (3.2% to 13.2% out of 100%), and, (2) the Keynesian fiscal multiplier is less than one. If you consider these priors, it shows the expansion and contractions in the Great Depression were largely due to chance alone. And BTW arguably we’re in a ‘depression’ now. Except for bank failures not being present, and a higher base, how are we not in depression now? Recall that during the Great Depression real GDP did not fall all that much after the initial shock of 1929-1933, indeed, it was higher at the end of the 1930s than the end of the 1920s, see: http://www.investmentpostcards.com/2011/08/23/faqs-about-the-great-depression-and-the-great-recession/ (also other parallels with today’s “Great Recession”. Note for example unemployment was roughly about 16% in the 1930s–high, but not the end of the world, as 84% were working. Compare with today’s ‘underemployed’ / ‘not looking for work but want to work’.)

    Bottom line: the economy is nonlinear, chaotic, with a slight upward trend over time, and both monetarism and fiscal policy are ex post sops used by economists to ‘explain’ something they don’t understand, to impress clients and fools. Is that you?

  5. Gravatar of Indy Indy
    5. April 2016 at 11:23

    In 1932 that “bonus army” of veterans marched on Washington D.C. and camped in Anacostia. Hoover had AG Mitchell order them to disband, and when they refused he instructed the Army to break them up (posse comitatus does not apply to the district.) MacArthur, Eisenhower, and Patton all took part in the operation, during which they deployed Adamsite (“DM”, an arsenic-based, vomit-inducing, riot-control agent) on the veterans and the accompanying family members.

  6. Gravatar of james elizondo james elizondo
    5. April 2016 at 11:42

    Scott I’m considering reading your book

    Monetary Lessons from the Not-So-Great Depression

    I see that it was written in 2008. In hindsight any modifications you would consider to the book?

  7. Gravatar of Benjamin Cole Benjamin Cole
    5. April 2016 at 16:01

    Great post.

    My takeaway echoes Jerry Brown: independent central bankers have proven themselves to be dangerous policymakers in times of depression or recession.

    I suspect the fix is administrative, not theoretical. No matter how much better NGDPLT is, central bankers will jibber-jabber about inflation.

    Sheesh, I cannot imagine the US Fed even adopting an inflation band target of 2 to 3%, as does the Reserve Bank of Australia.

    What would be wrong with placing the central bank into the Department of Treasury and having policy made by the President?

  8. Gravatar of Alexander Hamilton Alexander Hamilton
    5. April 2016 at 16:37

    @Benjamin All the same things that were wrong with government control of monetary policy in the seventies. Why would they jibber-jabber about inflation if they had an NGDPLT? Central bankers are civil servants. They’ll target what they are told and if they don’t fire them.

  9. Gravatar of bill bill
    5. April 2016 at 17:16

    Congress could pass a law updating the dual mandate to mean 5% NGDPLT.

  10. Gravatar of ghirlandaio ghirlandaio
    5. April 2016 at 18:14

    New readers will enjoy this related article by our host circa 2013.


  11. Gravatar of ghirlandaio ghirlandaio
    5. April 2016 at 18:59

    Just for fun…

    The Veterans bonus in 1936 was about $550.

    Average per capita income $535.

    Least expensive ford (model 48 standard roadster) $510.

    2016 per capita income, $53,000

    2016 Ford fiesta $14,900

    I am very sympathetic to the Austrian’s and I love Hayek, but all of this belly aching about the loss of purchasing power…..come on

  12. Gravatar of Major.Freedom Major.Freedom
    5. April 2016 at 20:45

    “In my book on the Great Depression, I suggested that other factors largely explain the severity of the 1937-38 slump, especially higher labor costs in early 1937 combined with a bout of gold hoarding in late 1937. This gold hoarding was a dramatic turnaround from the gold panic of late 1936 and early 1937 (which involved gold dishoarding). Nonetheless, the various contractionary monetary policies were probably enough to offset the bonus payments, which were about 2.1% of 1936 GDP.”

    I bet a million dollars there is no explanation anywhere for why the demand for money holding increased.

    What explains these periodic bouts of cash preference? Why was there no large scale rise in cash preference over the course of 2015 that was as high as 2008-2009? Why is the Fed NOT in a position today of having to print more money to have the spending outcomes that exist today?

    Of course this question is illegal and must be treated with utter silence, for it leads to dangerous and dark places that monetarists and keynesians of all types dare not tread. Shhhhhh!

  13. Gravatar of ssumner ssumner
    5. April 2016 at 21:02

    James, My book came out last year, and it was on the Great Depression, not the Great Recession. I am currently working on a book on the Great Recession.

  14. Gravatar of Benjamin Cole Benjamin Cole
    5. April 2016 at 21:04

    Alexander Hamilton:

    Check out real growth rates in the 1970s. It was not stagflation. In fact, real GDP expanded by 20% in the four years after 1975-6 recession. I would love that now.

    The Fed was much more under the thumb of the White House (think wars, cold wars, and more serious concerns than inflation) in the 1950s and 1960s, and those were times of rapid per-capita GDP growth (then called GNP).

    Another oddity: Looking at the PCE, did you know that on an annual basis, the PCE never got into double-digits in the 1970s and 1980s? By the Fed’s preferred measurement, we were in single digits in the great inflation era.

    So, in the intervening years, the 1970s has been fashioned by pundits into a decade of stagnant growth (not true) and runway inflation (actually sub-double digits).

    I prefer NGDPLT, so I am not calling for double-digit inflation. I could happily live with 3% real growth and 3% inflation, which is a reasonable goal I think. The other option is 1% real growth and 1% inflation, and constant threat of deflationary spirals and liquidity traps.

    Was central banking better in the 1970s or now? Close call.

    I would say central bankers are independent now, within broad guidelines. No, they cannot deliver deflation and recession for 20 years and get away with it…well, maybe not.

    I prefer democracy. Clear channels of accountability to voters. If I today think the most important economic tool, monetary policy, is way too tight, how do I vote?

  15. Gravatar of Benjamin Cole Benjamin Cole
    6. April 2016 at 15:58

    “There’s no doubt Donald Trump has energized and excited a great many people. And I’m grateful to him for doing so. The issues that brought those voters into the political world, the need to secure our border, stop illegal immigration, stop the failed immigration policies that have driven down wages and taken away jobs from struggling Americans.The need for a common-sense trade policy that doesn’t continue to ship jobs overseas and force Americans to compete on an unfair playing field.”‘-Ted Cruz interview Time magazine today.

  16. Gravatar of E. Harding E. Harding
    6. April 2016 at 17:41

    Ben, it was stagflation. In terms of real wages, even worse than today. It was the size of the labor force that helped keep production soaring in an age of stagnant productivity. We don’t have that now. Just the stagnant productivity.
    And regarding your Econlog post
    “Another factor that may have contributed to stable economic growth during the First Great Moderation was the sustained downward trend in U.S. import tariffs beginning during the early 1830s and running until 1860.”


    No, trade was more restricted than usual, not less. You were good on American history in your book, Sumner, why are you starting to forget it now?

    “I occasionally see economic historians argue that America’s industrial revolution was aided by high tariff rates during the 19th century.”

    -It was:
    But it probably would have happened in the long run, anyway.

  17. Gravatar of Ray Lopez Ray Lopez
    6. April 2016 at 21:10

    OT- paging Dr. Sumner, x3…do you have any thoughts on the so-called New Monetarist theory of Lagos-Wright? Notice they excoriate sticky prices as a pillar for fiscal theory (and by implication for Old Monetarism). Further one of their models allows for money neutrality. Sound x3 –RL

    https://research.stlouisfed.org/publications/review/10/07/Williamson.pdf (2010 paper on New Monetarism: “A more obvious illustration of New Monetarists worrying relatively more about the soundness and consistency of economic theories may be the reliance of the entire Keynesian edifice on a foundation of sticky prices, which are not what we would call microfounded, even when—especially when—appeal is made to Calvo (1983) pricing or Mankiw (1985) menu costs. we offer as food for thought two New Monetarist models that speak to the issue. …The other model uses search theory to get nominal rigidities to emerge endogenously, as an outcome rather than an assumption. This model is consistent not just with the broad observation that many prices appear to be sticky, but also the detailed micro evidence discussed by Klenow and Malin (forthcoming) and references therein. Yet it delivers policy prescriptions very different from those of New Keynesians: Money is neutral. “)

  18. Gravatar of Benjamin Cole Benjamin Cole
    6. April 2016 at 23:45

    Speaking of the Great Depression, there is a 1936 Japanese film entitled “Mr. Thank You” about a bus driver and the lives of people along his rural route, all influenced by the Great Depression on that side of the Pacific. Not a great movie but a wonderful view into that time. On youtube.

    “When a family has a baby today you don’t know whether to send congratulations or condolences.”

    Tojo came next.

  19. Gravatar of Ray Lopez Ray Lopez
    7. April 2016 at 06:47

    @B. Cole – thank you for Mr. Thank You, a nice ‘slice of life in rural JP’ movie (@41:10 mark, bus driver offers to give geisha girls a ‘chess lesson’ lol; also note dirt roads). However, by 1936 the Japanese were well on their way to imperialism, after all they invaded Korea in 1910 and Manchuria in 1931. Further, going off of gold (the gold standard) in 1932 hardly affected the Japanese economy (see this graph: http://www.analysis.williamdoneil.com/Great_Depression_Facts_Figures.htm), which was already on an upward path, compare to Brazil, Argentina, Germany and Hungary, whose economies worsened after going off of gold. That said, the data is patchy. Only two countries, the USA and the UK, clearly benefited going off of gold; the rest only indirectly benefited and with a lag. If going off of gold was that great, why did Argentina, the first country to go off of gold, well before all others, in 1928-9, suffer such a decline? Something Sumner has never answered.

  20. Gravatar of ssumner ssumner
    7. April 2016 at 06:54

    Harding, We would have industrialized faster without the tariffs.

  21. Gravatar of E. Harding E. Harding
    7. April 2016 at 09:11


    -What’s the reasoning behind your conclusion?

  22. Gravatar of E. Harding E. Harding
    7. April 2016 at 10:32

    Also, Sumner, the progressive will surely respond by pointing out that you can’t easily transfer low-level agricultural and service jobs to another state, while you can easily transfer most manufacturing jobs, and that all the manufacturing jobs that could be transferred to another state have already been transferred. He might use this graph as evidence:

  23. Gravatar of Jerry Brown Jerry Brown
    7. April 2016 at 11:16

    What E. Harding said. An assertion like “we would have industrialized faster without the tariffs” really could use some historical examples or at least a little explanation of the reasoning behind it.

  24. Gravatar of Alexander Hamilton Alexander Hamilton
    7. April 2016 at 12:17

    Benjamin, I don’t really see what real output has to do with central bank independence but in the UK growth was stagnant for nearly two years in the seventies with inflation rates of 16% and 24%. Government controlled monetary policy leads to one thing: very high inflation. Given this fact it just seems like throwing the baby out with the bathwater to remove central bank independence when there is a much easier solution available.

  25. Gravatar of Carl Carl
    8. April 2016 at 09:01

    Jerry Brown:
    How about the East Asian miracle? Japan, the four tigers et al. had lower tariffs rates than other poor regions that fared far worse. (rest of Asia, South America, sub-Saharan Africa…). How well less protected industries (cars, electronics…) fared in Japan versus how poorly protected industries (services …) fared.
    There were, of course, other differences between East Asia and the other regions.

  26. Gravatar of ssumner ssumner
    8. April 2016 at 16:19

    Harding, You asked:

    “What’s the reasoning behind your conclusion?”

    Countries with freer trade tend to grow faster. The US grew faster during the first Great Moderation.

    I don’t see the point of the graph you attached.

    You said:

    “Also, Sumner, the progressive will surely respond by pointing out that you can’t easily transfer low-level agricultural and service jobs to another state”

    Actually, you can.

  27. Gravatar of E. Harding E. Harding
    8. April 2016 at 17:05

    “Countries with freer trade tend to grow faster. The US grew faster during the first Great Moderation.”

    -You said “industrialized faster”, not grown faster. This is changing the subject. The U.S. grew fastest between 1933 and 1973, when trade as a percentage of GDP was quite low.

    “I don’t see the point of the graph you attached.”

    -It shows that Alabama auto manufacturing unemployment as a percentage of Michigan auto manufacturing unemployment has been stagnant over the past half-decade.

    “Actually, you can.”


  28. Gravatar of ssumner ssumner
    9. April 2016 at 07:06

    Harding, OK, they industrialize faster.

  29. Gravatar of E. Harding E. Harding
    9. April 2016 at 11:30

    Korea, Mexico, Brazil, and Taiwan did not have free trade when they industrialized, Sumner.

  30. Gravatar of ssumner ssumner
    10. April 2016 at 05:38

    Harding, Korea and Taiwan had freer trade than Mexico and Brazil, and industrialized faster. That’s a famous study in economic development.

  31. Gravatar of E. Harding E. Harding
    10. April 2016 at 14:09

    “That’s a famous study in economic development”

    -Too many independent variables here. For example, Mexico liberalized trade with NAFTA, and its economy continued to stagnate harder than that of Japan (per working-age person), even as its exports increased and diversified. And Japan industrialized with about as large a quantity of exports as a percentage of GDP as Brazil.

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