The question for the contemporary reader is this: If we could transport a modern-day economist back to 1937, would he or she have made the same mistake? My suggested answer—admittedly somewhat hopeful—is no. I base this view on the fact that most economists today distinguish between the temporary movements in the consumer price index that stem from volatility in commodity prices and the movements that reflect fundamental inflation pressures. Hence a modern economist most likely would have identified the price rise in 1936 and 1937 as a temporary upswing in commodity prices that did not signal a significant increase in overall inflation.
Maybe competent economists won't make the same mistake, but our political elites clearly have. Expect the continuation of this:
The Mistake of 1937 was to relinquish the benefits of reflation and to set all policy levers in reverse. The Fed and key administration officials hinted at interest rate hikes and endorsed austerity in fiscal policy; the key concern now was containing inflation rather than sustaining recovery.
The effects of this policy reversal on prices and production are evident in the charts below. The top chart tracks the consumer price index (CPI) and the wholesale price index (WPI) over the period 1927-41, while the bottom chart plots the movements in industrial production over the same period. In both charts, the first vertical line marks the point at which FDR became president and announced a policy of reflation, while the second vertical line marks the Mistake of 1937. What we see in the top chart is that at the time in 1937 when the administration started warning that inflation was too high, the price level had not yet reached the pre-depression levels that had previously been the administration’s goal. Following this policy reversal, both prices and industrial production tumbled. The line indicating the “reversal of 1938” marks the point when the administration recommitted to inflating the price level to pre-depression levels. Significantly, this renewed commitment was followed by robust growth, as the bottom chart makes clear.
Austerity Now!
