Keynesian fallacies and the Great Depression: or how Australia left Roosevelt eating her dust

Gerard Jackson

This post is a response to a Keynesian reader.

 If the 1931 spending cuts deepened Australia’s depression, as is alleged, then the rate at which unemployment had been rising would have accelerated. In fact, the reverse happened as shown by the chart below. In the year 1928-29 unemployment leapt by 74 per cent and 42 per cent in the following year. For the year ending 30 June 1931 Commonwealth spending peaked at £68,585,546, after which it fell and the Commonwealth began to accumulate surpluses until war broke out. According to Keynesianism this policy should have been an economic disaster. However, as we can clearly see from the chart, not only did the rate at which unemployment had been increasing slow down significantly, rising by only 5.8 per cent, it then began to quickly drop even though the Commonwealth increased its surplus by 277 per cent and cut spending even further.

budgetsdepressionpic3

Manufacturing was extremely important with respect to the demand for labour and accounted for 43 per cent of unemployment. If Nottrampis were right then Commonwealth spending cuts should have caused manufacturing to cut output further and fire workers. Rather than contracting manufacturing employment and output stayed flat for the year 1931-32 after which it rapidly expanded.

Irrespective of what Nottrampis thinks the GDP estimates are telling him the cuts did not deepen the depression in any measurable way. Informed Keynesians know this and that is why they generally avoid the point that Nottrampis thinks he is making. The best that Keynesians and post-Keynesians can up with is the argument that the cuts were deflationary1. (Spending cuts are no more deflationary than deficits are inflationary).

That national income figures can be an unreliable indicator is a fact that every economist understands, even Keynesians. For example, the 1955 Economic Report of the President states that from 1945 to 1946 the economy contracted by 2 per cent and then rapidly expanded (p. 137). However, Historical Statistics of the United States from Colonial Times to 1970 calculated that from 1945 to 1947 the economy contracted by 12 per cent (p.229). Even better, the National Income and Product Accounts of the United States 1929-1976 reported that from 1944-1947 GNP dived by 17.4 per cent (p. 6).

The last figure exceeds the first two years of the Great Depression while the second figure is almost as bad as the severe 1932 contraction! If this keeps up we will eventually find that the American economy actually disappeared after peace was declared. Joking aside (and that’s a tough thing for me to do when looking at figures like these) the problem is not the deflators that these later statisticians used but the rather obvious fact that they chose not to look at the real economy. Nottrampis has made the same choice. Another point is that it doesn’t pay to treat figures in isolation.

Nottrampis states that “once inflation arrived at last courtesy of the devaluation real wages fell.” Completely wrong. (In fairness to Nottrampis we find Sinclair Davidson and Julie Novac making the same mistake). To begin with the massive drop in imports occurred before the deflation and was brought about by deflation2. Recovery didn’t start until some 15 months after the devaluation which was in January 1931. This is just a little too long3. Moreover, the devaluation was not followed by inflation. The next chart shows the relationship between the real factory wage4 and the demand for labour.  As the real factory wage fell the demand for labour rose. Now according to the devaluation argument the demand for labour rose because the increase in prices cut real wages. Never happened.

realwagedepressionpic4

To begin with wholesale prices didn’t start rising until 1934, when the recovery was already underway. But what is particularly interesting is that instead of manufacturing prices rising they fell through 1934 to 1935, flattened out and then started to rise in 1937 while metals and coal prices continued to fall until 1936 after which they too started rising in 1937. (I think I should point out that imports also started to increase in 1934). This is some five years after factory employment started to steeply rise, and continued to do so while the real factory wage, though not the real wage itself, fell. As inflation is usually defined as rising prices it cannot in this instance be responsible for falling unemployment. The main driving force was not devaluation or rising prices but lower costs of production — even though about 75 per cent of capital goods were imported along with a considerable amount of other inputs — combined with greater efficiency in production. In other words, recovery was production-driven, just as it was in America after WWII.

It should be made clear that there is nothing Keynesian about devaluations. Nothing at all. Devaluation is not a deliberate depreciation of the currency in order to export unemployment but a downward correction of an overvalued currency. At one point the premium on the Australian currency against the British pound was 30 per cent. And this was when the pound was also overvalued, indicating that the Australian exchange rate was seriously out of balance with other currencies.

Any classical economist would have advised the Australian government of the time that it was absolutely necessary to adjust the currency downwards in order for the exchange rate to reflect purchasing power parity. Therefore, even if the devaluation was responsible for the recovery it would still not be a Keynesian success story.

On a far less than final note, Nottrampis declared in another comment that “Australia had a weak recovery!!!!!!” I confess to being at a complete loss as to the nature of his logic. Australian unemployment fell from a peak of 30 per cent to about 8.5 per cent in 1938. It peaked at 25 per cent in America and stood at 19 per cent in 1938. In addition, there was never any hidden unemployment in Australian factories (the working week never dropped below 44 hours) while in Roosevelt’s America widespread underemployment in manufacturing was the order of the day.

Making the comparison even worse is the fact that in 1938 Australian manufacturing employed about 25 per cent more labour than it did in 1928. Then there is the little known fact that America also endured capital consumption while Australia did not5. Yet Nottrampis declares that Roosevelt’s phony recovery was superior to Australia’s effort merely on the basis of grossly misleading GDP figures. This is the same technique that would have us believe that there was a Great Depression in 1946 but nobody noticed.

Let me further emphasise again the fact that Keynesians categorically state that a policy of cutting spending and running surpluses during a depression or a recession would create an economic disaster. The above charts show this to be nonsense. Australian governments cut spending significantly and ran surpluses right up to WWII. The result was an economic recovery that left Roosevelt eating dust.

Facts don’t speak for themselves: as a rule they have to be interpreted, those charts just might be the exception that proves the rule.

* * * * *

1C. B. Schedvin, Australia and the Great Depression, Sydney University Press, 1988. p. 252

2L. F. Giblin, The Growth of a Central Bank, Melbourne at University Press, pp. 72, 80.

3This was noted by Schedvin who argued that manufacturing did not exploit the opportunities that devaluation created. This is an implicit admission something else must have been at work (Ibid. 302-303)

4The real factory wage is the ratio of the factory to the value of factory output

5Arthur Lewis calculated that from 1929 to 1938 net capital formation plunged by minus 15.2 per cent (W. Arthur Lewis, Economic Survey 1919-1939, Unwin University Books, 1970, p. 205). Benjamin M. Anderson estimated that in 1939 there was more than 50 per cent slack in the economy. (Benjamin M. Anderson, Economics and the Public Welfare: A Financial and Economic History of the United States 1914-1946, LibertyPress, 1979, pp. 479-48).

 

 

20 thoughts on “Keynesian fallacies and the Great Depression: or how Australia left Roosevelt eating her dust”

  1. You’re dead right Sarah but nottrampis will just resort to his usual tactic of ignoring facts and parroting figures he does not even understand.

  2. Gerry you cannot compare the USA in 1938 and Australia in 1938 apart from both having stimulatory policy. In 1937 you had the greatest change in fiscal policy under Roosevelt. The Structural budget went into a strong structural surplus. this and monetary policy meant the economy weaken. After having GDP rise at almost double digits the previous FOUR years and unemployment fall dramatically despite an incredibly stupid wages policy.

    In Australia Unemployment was around 20% until the very stupid fiscal policy which gave us deflation and meant Real wage increases. This lead Unemployment to around 30% if you believe the trade Union stats.

    We had the 1931 budget which should have given us strong growth BUT what did we get. Negative growth.
    We got unemployment start falling with the devaluation reducing real wages..
    This also meant monetary policy started to work again as real interest rates were lower.

    A devaluation is a great policy not to boost demand but to boost inflation and is why Hawtrey was a great supporter of it.
    you are putting to much influence on just manufacturing.

    We had recession levels of unemployment until WW2 started then it miraculously fell to 4%. Amazing what occurs when aggregate demand is increased!
    Germany was the only country to reach full employment until WW2. The USA would have got there in 1936 as well IMHO if they cut real wages.

    the IMF put out a very good paper on the myth of expansionary austerity. Daniel Leigh was one of the authors .You should read it.

    most countries experience a contraction after a war. Pent up demand means it doesn’t last. in the USA it occurred after both world wars!

  3. I’ve been waiting for gerry’s response and he didn’t disappoint me. You would think that after this beating Nottrampis would be too embarrassed to come here again. Gerry knows his stuff and nottrampis knows nothing. It’s clear from his comments that he’s only quoting from Keynesian sites.

  4. Nottrampis, you are pathetic. Gerry’s current post and his other posts on the great depression completely refute you. You are an absolute idiot. Gerry proved that the 1931 budget did not damage the economy and all you can say is blah blah blah blah. HE PROVED IT YOU MORON. And why didn’t the economy completely collapse when the government ran surpluses and cut spending as Keynesians predict? You just bloody well ignore that. Gerry also explains why he focuses on manufacturing you blithering idiot. And you ignored the fact that the unemployment rate slowed after the 1931 budget. Gerry pointed out that if you right it should have increased

    You ignore America’s unemployment and its capital consumption and just blather on about gdp. You cant eat gdp you twit. Then you whine when gerry compares Australia’s record with Rooosevelts. It ain’t fair, it ain’t fair, it ain’t fair. What a whinger.

    Inflation! What inflation??? Prices didnt rise until after the recovery started and unemployment began ot fall. What’s the matter with you? Cant you read? And Gerry also pointed out that real wages never fell throughout the depression!!!!!

    Gerry’s article on America’s 1937 depression completely destroyed that myth you are peddling. I gerry got it wrong then prove you loudmouth. You never debate gerry, you just mindlessly mouth what keynesians say. You did it again with the IMF paper.

    You are a really aggravating person. The only reason your Keynesian mates don’t come over here is because gerry would murder them and they know it.

  5. As I expected, nottrampis just resorted to his usual tactic of ignoring facts, parroting figures and referring to papers he does not even understand.

  6. I don’t blame Sarah for getting mad at Nottrampis. The man is hopeless and he is panicking. Gerry destroyed him and all he can do in response is desperately parrot what Keynesians write. Look, Gerry points out that inflation didn’t start until the recovery was well underway and notrampis responds by ignoring it. He mindlessly rabbits on about the non-existent inflation creating jobs. It’s as if he has been programmed. Anyhow, he is short-circuiting and there is no reasoning with him. Facts just don’t matter.

  7. Your right, Nick, about nottrampis ignoring facts he finds awkward. That comment of yours about the wages and inflation remined of gerry’s post on the 1937 depression where fingered rocketing real wages as the culprit. Nottrampis completely ignored that. and that reminds me that he also ignored gerry’s figures on government spending even though they .came from official sources and destroyed the keynesian argument

  8. I have to admire Gerry’s patience because Nottrampis is truly trying person. He’s a “true believer” and it doesn’t matter how many times gerry demolishes him or how many facts Gerry presents Nottrampis and his Keynesian mates will just come up with another rationalisation no matter how stupid. And that’s what he did again.

  9. l Loved the way Gerry used GDP figures to show that notrampis doesn’t know what hes talking about but it still made no difference the guy.

  10. Ref: Nottrampis

    Have just read your comment. I won’t be back until very late tonight but expect another post tomorrow. Incidentally, I have read Expansionary Austerity: New International Evidence by Jaime Guajardo, Daniel Leigh, and Andrea Pescatori. I am not at all impressed though I am a little amused. I shall get around to their paper at a later date.

  11. Now that I’ve calmed down I can look forward to Gerry’s response which is bound to be very informative. Thinking about Nottrampis’s non-refutation made me realise that this is the only site where there is a real debate about Keynesianism. I went over to Catallaxy and there is absolutely nothing. Steve Kates and Sinclair Davidson present themselves as Australia’s leading anti-Keynesians but when it comes to Keynesians like nottrampis they disappear. Gerry is actually presenting a vigorous and detailed anti-Keynesian case while Davidson and Kates just huff, puff and blow.

  12. Sarah,

    you and other appear unable to read.

    If a balanced budget lead to growth then why did it not lead to GDP growth.
    We had a very large devaluation ( Two authors Messrs Bernanke and Parkinson said it was massive .It was larger than In the USA. yet Gerry wants to believe inflation did not rise here whilst it did in the USA?
    It did not have to be large. But inflation would mean real wages declining and monetary policy could then work.
    Real interest rates would fall in a huge way given the deflation we had.
    Moreover somehow despite inflation not rising real wages in manufacturing fell???

    By the way the deficit rose to about 4% of GDP merely on the weakness of the economy. it wasn’t because of government measures.

    if GDP rose in 1933 then ipsofacto the recovery started some time in 1932.

    the 1937 recession in the USA came about principally because of fiscal policy but monetary policy was also assisting there. Funny how it created a recession and it was far more restrictive fiscal policy there then here!
    You ignore this and you are a fool.

    Real wages was an article of faith in the USA ever sine the 1920s. Hoover and Roosevelt both agreed on it. If Roosevelt had adopted real wage cuts as he should in 1932 then the USA would have had full employment in 1936 just like Germany.
    Australia never even got close.
    What Gerry fails to make clear is Australia , like the UK ,never got to full employment in the 1920s. It never got close after the Depression but somehow got there once the war started???

  13. You are parroting again and just making assertions. Gerry showed that prices did not start rising until 1936 So where was the inflation? He also showed there was no drop in real wages. I think you had better wait until tomorrow before you embarrass yourself any further.

  14. You are at it again nottrampis. You provide no evidence to support your opinions. You complained that Gerry focuses on manufacturing. I think your real complaint is that Gerry shows that real wages in manufacturing did not fall after the devaluation. If this is so then this means you lost the argument. I contacted Gerry and asked him to clarify this point once and for all. I also asked him to produce figures for prices. So let us wait and see what happens.

  15. I don’t know if he did it on purpose or not but Nottrampis confused us with a misdirection. He goes on about devaluation but ignores that Gerry had said that “there is nothing Keynesian about devaluations. Nothing at all.” Nottrampis ignored that. Then Gerry said that any classical economist would have advised it. Nottrampis ignored that one too. If there is nothing Keynesian about the devaluation then Nottrampis does not have a Keynesian argument. What the real argument would seem be is whether it was the devaluation or something else that caused the recovery. All that Gerry is saying is that the devaluation does not account for the recovery but he did admit that it contributed. Nottrampis has put the whole recovery down to rising prices caused by a devaluation, an explanation Gerry showed is not even Keynesian. Gerry said prices continued to fall while real wages in manufacturing stayed the same. If Gerry can show that prices did continue to fall after the devaluation while unemployment was also falling then Nottrampis must do the decent thing and admit that he is wrong.

  16. Sherlock,
    Keynes actually favoured a devaluation ahead of government spending for the same reasons Hawtrey did.

    Just for everyone’s benefit all statistics for this period are not of the highest standard. We simply do not know enough about the current account for example. Trade Unions collated the unemployment statistics which most people think are too high.

    To suggest a massive devaluation in Australia had no effect on inflation in Australia whilst a smaller one did in the USA doesn’t pass the laugh test.

    Moreover according to Gerry real wages have fallen given inflation hasn’t fallen ( real wages is merely nominal wages less inflation) but hey presto they have fallen with deflation. Again this doesn’t stand the laugh test.
    If deflation was still occurring until 1936 then real wages were increasing

    A devaluation assisting the recovery does this in two ways which for whatever reason Gerry always seems to miss.
    it reduces real wages and it enables monetary policy to work again as it did.
    It enabled a weak if not feeble recovery. It was the reduction in real wages that led to unemployment falling.

  17. Nottrampis has now decided to move the goal Posts. If Gerry provides statistical evidence in support of his case Nottrampis will just reject it as inaccurate. Knowing Gerry’s record I am confident that any statistical evidence he produces will be absolutely conclusive.

    In one of his articles regarding another subject Gerry wrote that “cultists are impervious to facts”. He could have been talking about Nottrampis.

  18. What the hell is nottrampis talking about? Gerry never said real wages fell. He said there was a huge deflation but real wages stayed flat. Even I know that means money wages must have fallen far enough to stop real wages from rising and Im no economist.

    Sarah is right, Nottrampis is trying to move the goal posts. He’s attacking any statistics gerry might use even before he uses them. This is pretty rich coming from a guy who never produces a single statistic to prove his argument. If the devaluation caused inflation then the statistics would show it. So where are Notrampis’s statistics?

  19. Nottrampis inability to provide any statistics to support his argument would get him laughed off any other site.

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