The Effect of New Deal Policies Revisited

What is it about?

The New Deal, a set of policy measures implemented by President Roosevelt during the Great Depression, is often cited as a model for addressing deflation and low nominal interest rates in modern times. These measures, which included policies such as increasing the market power of firms and unions, limiting goods production, and other supply-side reforms, were implemented in order to stimulate economic activity during a period of severe economic downturn. According to macroeconomic models, there are two possible equilibria when the economy reaches the zero lower bound (ZLB): Type 1 equilibrium, in which the aggregate demand (AD) curve is steeper than the aggregate supply (AS) curve, and Type 2 equilibrium, in which the AD curve is flatter than the AS curve. In both cases, the AD curve slopes upward. The effects of supply-side policies differ in these two cases, being expansionary in Type 1 equilibrium and contractionary in Type 2 equilibrium. Eggertsson (2012) uses a new Keynesian model and pre-New Deal data to demonstrate that the predicted path accurately tracks the data when the New Deal was implemented. However, the main point of this paper is that multiple equilibria are connected to the ZLB, and that Type 1 equilibrium is not predetermined. In order to determine whether the New Deal was expansionary, it is necessary to discard the current theoretical framework and let the data speak for itself. To investigate the slope of the AD and AS curves during the Great Depression, I applied Blanchard and Quah's (1989) long-run restriction method to measure the slopes of these curves. My findings confirm an upward-sloping AD curve and a very steep AS curve, implying Type 2 equilibrium during this period. This suggests that the New Deal was likely contractionary, rather than expansionary, as Eggertsson argued. It is important to note that this conclusion is based on a single study using a specific econometric method, and further research is needed to fully understand the effects of the New Deal on the economy. However, these findings do suggest that supply-side policies such as the New Deal may not always be effective in stimulating economic activity, and that the appropriate course of action in a given economic downturn may depend on the underlying equilibrium.

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Photo by Zwaddi on Unsplash

Photo by Zwaddi on Unsplash