Economics, Pethokoukis

What austerity in 1946 tells us about the possible economic impact of the sequester

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In 1946, the US economy shrank by 11%. Back to the Great Depression, right? Yes — but only for government. Of that 11 percentage point drop, government spending accounted for a massive 29 percentage points. But the private-sector economy did just fine. Private-sector GDP, both consumer spending and business investment, added 7 points to GDP. As government spending fell by 66%, private investment rose by 156%.

How about unemployment? Well, as Russ Roberts reminds us:

Paul Samuelson, a prominent Keynesian who later won one of the first Nobel Prizes, worried that if the war ended suddenly and government spending contracted quickly, we would face “the greatest period of unemployment and industrial dislocation which any economy has ever faced.”

The jobless rate was 3.9% in 1945, 4.1% in 1946. Indeed, for all the talk of how Keynesian government spending ended the Great Depression, a look inside the GDP numbers reveals government exploding but the private-sector remaining in a funk. Roberts: “Government spending on the military didn’t stimulate private consumption—it crowded it out.”

I don’t want to overstate things. The macro situation in 1946 is not the same as in 2013. But I think this historical example provides a needed caveat to all those predictions of economic gloom if the sequester spending cuts take hold with full force.

7 thoughts on “What austerity in 1946 tells us about the possible economic impact of the sequester

  1. 1946 tells us nothing. The takeaway is the same as it has been. Boehner passed on attractive spending reduction offers made by Obama in 2011, betting that the Rs could reclaim the WH. He lost. Now he wants best 2 of 3 even though the Rs will take the fall again.

  2. Since the sequester doesn’t actually cut spending, but only reduces the amount by which government spending increases, we can look at the ‘increase that doesn’t happen’ as the functional equivalent of stimulus spending that doesn’t take place. Since there is no real economic growth from deficit-funded stimulus spending, consistency dictates that the absence of debt-funded stimulus spending should not have a negative impact on the economy.

  3. Is defense spending not stimulus?All of Reagens defense spending baseline increases from the 81 budget hit the economy in early 83 like a Keynesian style rocket.Look up the GDP archives from the early 1980′s.Defense spending in the late seventies was pretty weak didn’t add much to growth.Durable goods orders from defense added a lot of growth to GDP in Reagens first term.The Cold War was on,and Reagen wasn’t messing around.

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