In Gordon and Krenn’s 2010 NBER working paper “The End of the Great Depression 1931-1941: Policy Contributions and Fiscal Multipliers” the authors measure and compare the effects of monetary and fiscal policy in ending the Great Depression. Utilizing a VAR model in their analysis, the authors arrive at the conclusion that 89.1% of the economic recovery that occurred between the first quarter in 1939 and the last quarter of 1941 is due to fiscal policy innovations. The authors attribute 34.1% of the recovery to monetary policy innovations, and the remaining -23.2% to the VAR dynamic forecast and non-governmental factors.
A quick glance at these percentages alludes the reader to the main conclusion of the paper: The recovery from the Great Depression is largely due to changes in fiscal policy, with monetary policy playing a supporting role.
Throughout the course of the paper, the authors outline the contemporary evidence from newspapers and journal articles that illustrate the “explosion of Federal defense expenditures (that) began in 1940:Q2, the quarter in which France fell.” During this period the armament industry arose as the leading player in the U.S. economy, propelling actual output in key American industries well past potential levels.
My main question while reading this paper, however, remained, “What do the results of this study mean for our struggling recovery today in the absence of a 21st century blitzkrieg?” With the fiscal cliff taking a center role in political discussions and balancing the federal budget becoming a high priority, it is highly unlikely that we will experience any increases in government expenditures in the near future.
So where does that leave us? Most likely, we will continue to see a lot more quantitative easing. The recently passed QE3 is a clear indication of this trend. QE3 specifies that the Federal Reserve will buy $40 billion in mortgage-backed securities each month for the remainder of 2012 and maintain low interest rates until mid-2015. Furthermore, the Federal Reserve will continue the $40 billion a month purchases past 2012 if the economy has not shown significant improvement. The open-ended nature of QE3 signifies our nation’s current commitment to economic improvement through monetary policy innovation. However, the fact that the St. Louis Fed economic data reports that the M1 money multiplier has remained below one since the 2008 financial crisis and currently at .901, casts some doubt on whether quantitative easing measures can effectively spur the U.S. economy.