Was the New Deal expansionary?

What is it about?

The New Deal, a set of initiatives implemented by President Franklin D. Roosevelt during the Great Depression, has long been the subject of debate among economists. While some, like Eggertsson (2012), argue that the New Deal was effective in reducing the severity of the Depression by increasing inflation expectations, stopping deflation and its expectations, and lowering real interest rates when nominal interest rates were zero, our research suggests that these conclusions may be flawed due to two main weaknesses in the argument. First, Eggertsson failed to consider the role of wage stickiness in the effectiveness of the New Deal. When wages are sticky, meaning they are resistant to decreases, the purchasing power of consumers and the marginal cost of firms may be reduced due to reduced real wages, leading to decreased prices and effectively neutralizing the inflation caused by the New Deal. This can make it difficult for the policy to achieve its intended effects, particularly if wage stickiness is high. Second, Eggertsson's argument relies on the assumption that the public's expectation of the duration of the New Deal is identical to that of zero nominal interest rates. However, our simulations show that this may not necessarily be the case. If the public expects a shorter duration for the New Deal than for zero nominal interest rates, the New Deal may actually exacerbate the severity of the Great Depression, rather than reducing it. This highlights the importance of taking into account both wage stickiness and the expectation of policy duration when evaluating the effectiveness of policy interventions, particularly in the context of a liquidity trap like the one experienced by many countries following the global financial crisis of 2008. In light of these findings, policymakers should be cautious about adopting New Deal-style interventions. Instead, they should carefully weigh the various factors that can affect the effectiveness of such policies, including wage stickiness and the expectations of the public, before implementing any such strategy. Given the low nominal interest rates that have persisted in many developed countries following the Great Recession, it is particularly important for policymakers to consider these factors before implementing a policy akin to the New Deal. By taking a more nuanced approach to economic stimulus policies, policymakers can ensure that they are making informed decisions that have the best chance of success in helping to alleviate economic downturns.

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Photo by Zwaddi on Unsplash

Photo by Zwaddi on Unsplash