Pushing on a String

One for the footnotes: Timothy Taylor has tracked down the origin of the "pushing on a string" metaphor for expansionary monetary policy in a depressed economy.  It looks like we owe it to Maryland congressman Thomas Alan Goldsborough, who used it in a 1935 hearing with Fed Chairman Marriner Eccles.

Professor Keynes is Optimistic

An archive of British Movietone newsreels has been added to YouTube, including one of John Maynard Keynes commenting on Britain's departure from the gold standard in 1931: Another newsreel discusses leaving the gold standard and includes footage of Sir Josiah Stamp explaining the decision: This Telegraph article describes some of the correspondence between the bank and the government about the crisis.  Britain's exit - after painfully resuming the gold standard at its prewar parity in 1925 - was one episode in a series of sterling crises in the 20th century. Last year, I posted some newsreels from the 1949 and 1967 devaluations.  

Note: An earlier post from 2011 had a fragment of the same Keynes newsreel, but now we are fortunate to have it in full.

A Theory of Production

Economists often use the word "technology" to mean the relationship between output and factors of production such as capital and labor.  The Cobb-Douglas production function, which is a ubiquitous description of technology has its origin in a 1928 AER article, "A Theory of Production," by Charles Cobb and Paul Douglas.

Using C to denote capital, L for labor and P for production, the production function makes its first appearance:

Although the description of technology is a theoretical contribution, much of the article is empirical in nature, as they construct indexes of capital and labor in order to test their model.  They compare the production implied by their function and estimates of capital and labor, P', with a measure of actual production.

To a contemporary macroeconomist reader, the striking thing about the article is the extent to which it anticipates how we analyze business cycles today.  Cobb and Douglas, separate out cyclical and trend components (using 3 year moving averages) and show that the deviations of actual production and the production implied by changes in capital and labor are procyclical.

The article includes a chronology of business cycles which aligns with the NBER chronology; the NBER recessions during this period are

• June 1899 - Dec. 1900
• Sept. 1902 - Aug. 1904
• May 1907 - June 1908
• Jan. 1910 - Jan. 1912
• Jan. 1913 - Dec. 1914
• Aug. 1918 - Mar. 1919
• Jan. 1920 - July 1921

Cobb and Douglas' estimates are annual, but several of these do line up with points where P' (implied production) exceeds actual production, P.

Today these deviations of actual output from the amount implied by changes in factors of production are known as "Solow residuals" after work by Robert Solow in the 1950s and interpreted as measures of technological progress (i.e., our ability to wring more output out of given amounts of capital and labor).  Although Solow was mainly concerned with long-run growth trends, in the 1980's, Real Business Cycle theorists interpreted short-run fluctuations as "technology shocks".  In Real Business Cycle models these shocks drive economic fluctuations, and the same pattern identified by Cobb and Douglas - using postwar data and newer detrending techniques - was cited in support of this theory.  One weakness of this argument is that short run movements in the Solow residual are at least partly due to utilization - "factor hoarding" - rather than changes in technology.  This, too, was anticipated by Cobb and Douglas:

The index does not of course measure the short-time fluctuations in the amount of capital used.  Thus, no allowance is made for the capital which is allowed to be idle during periods of business depression nor for the greater than normal intensity of use int he form of second shifts etc., which characterizes the periods of prospertity.

Overall, this article would fit very well into a syllabus for a current course on business cycle theory.  Hmm...

Cassidy on Keynes and Reagan

Econ 302 midterm question 2(a):

The fiscal policies enacted by the Reagan administration included significant cuts in taxes and increases in (military) spending. Illustrate the effects of this fiscal policy using an IS-LM diagram. 

While my students were asked to work out the results in (Keynesian) theory, the data are consistent with its prediction:

The red line (right-hand scale) is GDP growth, which is negative in 1982, but strongly positive in 1983 and 84 ('Morning in America'), and the blue line is the federal deficit as a percentage of potential GDP, which shows the effect of Reagan's fiscal policy.

Apropos of this, John Cassidy has a nice post arguing that Reagan was a closet Keynesian:

In strict terms, Reagan’s neglect of the deficit wasn’t Keynesian. Keynes himself believed in letting the deficit rise in a recession and paying down debts in the good times. In America, though, Keynesianism has always been associated with stimulus programs, big government, and deprioritizing the deficit. In all of these ways, Reagan was a Keynesian. But a word to the wise: don’t waste your time trying to tell that to anybody in the Republican Party.

Sterling Crisis!

The British Pathe newsreel archive is now on youtube.  This is how they chronicled Britain's 1949 devaluation:

While floating exchange rates have day-to-day volatility, they don't provide the same drama as fixed exchange rates, which are prone to crises that are both political and economic.

The postwar Bretton Woods system fixed exchange rates with the dollar (and pegged the dollar to gold), but countries were allowed to make discrete changes in their parities.  Britain availed itself of  this in 1949 and 1967.

The Bretton Woods system ended in 1971 when the US announced that it would no longer redeem dollars for gold.

Sterling faced speculative pressure in the mid-1960's - "in a world of international finance, there is no sentiment; nations, whose currency is ailing must expect from the foreign dealers a kick in the moneybags"-

Which ultimately led to the 1967 devaluation:

Sterling crises were not unique to the Bretton Woods era.  Britain had left the gold standard in 1931 (after a very painful experience re-joining it in 1925).  In 1976, a plummeting pound led Britain to turn to the IMF for a loan, and, on "Black Wednesday" in 1992,  it was forced out of the European Monetary System.

Richard on Gold

The inclusion of a plank supporting a commission to study a return to the gold standard in the Republican platform has prompted a number of economists to explain (again) why it is a bad idea.

In an LA Times op-ed, my Wesleyan colleague Richard Grossman writes:

History provides ample evidence that the gold standard is a bad idea. After World War I, the major industrialized nations established the gold standard, which is widely seen as having contributed to the spread and intensification of the Great Depression. The gold standard tied the hands of monetary policymakers, forcing them to maintain high interest rates in order to maintain the price of gold, thereby making a bad economic situation even worse.

See also Paul Krugman.  My version of the case against gold is in this earlier post.

Hans-Werner Sinn is for Hanging Separately. Is Germany?

In a NY Times op-ed attempting to explain "Why Berlin is Balking on a Bailout" Hans-Werner Sinn writes:

Even a European nation, however, should not socialize debt, a lesson demonstrated by the United States in the 19th century. 

When Secretary of the Treasury Alexander Hamilton socialized the states’ war debt after the Revolutionary War, he raised the expectation of further debt socialization in the future, which induced the states to over-borrow. This resulted in political tensions in the early 19th century that severely threatened the stability of the young nation. 

Wow.  

Every American schoolkid learns that Ben Franklin said "we must all hang together or assuredly we shall all hang separately." The point is that the we succeeded by hanging together.  Sinn somehow manages to draw the opposite lesson.  Wow.

The more widely-held (until today, I would have said "universally") view is that Hamilton's plans - which faced a great deal of opposition at the time - helped establish the creditworthiness of the United States and provided a foundation for its financial and economic development. Bob Wright and David Cowen, in Financial Founding Fathers explain:

The positive effects of funding and assumption of the debt upon not only the country's credit standing but also its commerce were felt almost immediately. Writing from Hartford in 1791, Noah Webster, the "schoolmaster of America," boasted about the era of prosperity brought on by assumption. "The establishment of funds to maintain public credit," he noted, "has an amazing effect upon the face of business and the country." "Commerce," he continued, "revives and the country is full of provision. Manufactures are increasing to a great degree, and in the large towns vast improvements are making in pavements and buildings."

Moreover, Europe's capital markets magically opened to the United States. As early as March 1791, United States securities were selling from 1 to 40 percent above par in Europe. In November 1791, European-based broker John Fry assured Hamilton that American credit overseas was secure and that European funds would stabilize securities prices. "The American Funds," Fry claimed, "had inspired no Confidence in this market 'til they had acquired a high price at home & three months ago a sale of them must have been effected here with the greatest difficulty." "The Case is now so materially alter'd," he wrote, "that one friend of mine has bought & sold near a Million of Dollars." Fry noted that Europeans at that time had more money than local investment opportunities and were looking to employ their capital in the United States. In short, Americans were able to borrow money in Europe at between 3 and 6 percent and use it to fund projects that returned 10, 15, even 20 percent per year. 

That is, Hamilton's plan for the national debt mostly worked out pretty well and is a good example of something that was controversial at the time but vindicated by history.

I really hope Sinn's view isn't representative of German opinion.  If it is, we're in way more trouble than I realized.

Economic Pessimism in Historical Perspective

US industrial production (log scale), 1790-2011:

From Davis, QJE 2004 (1790-1915); Miron and Romer, JEH 1990 (1916-1918); Federal Reserve, 1919-2011.

J.M. Keynes (Economic Possibilities for Our Grandchildren, 1930):

The prevailing world depression, the enormous anomaly of unemployment in a world full of wants, the disastrous mistakes we have made, blind us to what is going on under the surface - to the true interpretation of things.  For I predict that both of the two opposed errors of pessimism which now make so much noise in the world will be proved wrong in our own time - the pessimism of the revolutionaries who think that things are so bad that nothing can save us but violent change, and the pessimism of the reactionaries who consider the balance of our economic and social life so precarious that we must risk no experiments.

Bartlett: Not the Time for "Reaganomics"

At washingtonpost.com, Bruce Bartlett writes:

Judging from the [Republican] candidates’ tax proposals, they seem to believe that the most Reagan-like candidate is the one with the biggest tax cut. But as the person who drafted the 1981 Reagan tax cut, I think Republicans misunderstand the premises upon which Reagan’s economic policies were based and why those policies can’t — and shouldn’t — be replicated today.

Although I am skeptical of "supply-side economics" in general, and I don't think that it should be considered a success in the 1980's (see this post, for example) I think Bartlett makes a reasonable case that it made more sense (or at least was less non-sensical) in 1980 than today:

When comparing Reagan’s policies with Republican proposals today, several things stand out. Inflation is low now. We are not looking at “bracket creep” or sharply rising taxes, as we were in the late 1970s. The top income tax rate is 35 percent, half the rate Reagan inherited. And federal revenue is at a 60-year low of about 15 percent of GDP, compared with a post-World War II average of about 18.5 percent.

These differences are essential to understanding why Reagan’s policies worked when they did — and why they are not appropriate today.

All of the evidence tells us that the economy’s fundamental problem today is not on the supply side but the demand side.

UK: Worse than the Depression?

On their blogs, Paul Krugman and Brad DeLong have both reproduced this graph (from here):

and cited it as evidence that the UK economy is now worse than the Great Depression.  I haven't been following the UK situation closely, but I'm instinctively inclined to agree with their criticisms of the Cameron government's austerity policies.

Having said that, I think the graph (and implied interpretation) is a little unfair because of how Britain's experience during the interwar period differed significantly from that of the US.

While the US economy went pretty suddenly from the "roaring 20's" to the depression, the UK economy was already in bad shape throughout the 1920's, which I believe can be primarily attributed to the attempt to resume the gold standard at the pre-war parity (the infamous "Norman [Montagu] Conquest of $4.86"/ "Economic Consequences of Mr. Churchill") and the 1930's was just a further deterioration of an already dismal situation.

So, while it may be the case that the deterioration from 2008 in Britain has been comparable in magnitude and will be worse in terms of persistence than the decline starting from 1930, saying that its worse than the depression that ignores that Britain in 1930 already had an unemployment rate of 16%.

For comparison, here's the US (red) and UK (blue) unemployment rates over the past several years:

Yes, things look like they're getting worse in Britain, but they're not exactly in "Road to Wigan Pier" territory yet...

*Since this is just a quick blog post, I haven't dug into the technical differences between various unemployment data series, but I'm pretty sure they would all show similar trends, if not exact levels.

Update (1/30): In his column today, Krugman writes:

O.K., about those caveats: On one side, British unemployment was much higher in the 1930s than it is now, because the British economy was depressed — mainly thanks to an ill-advised return to the gold standard — even before the Depression struck. On the other side, Britain had a notably mild Depression compared with the United States.

Cross of Stupidity

International contention over currencies and the Fed's announcement of another round of quantitative easing seem to have induced another bout of misplaced gold standard nostalgia.  In the Financial Times last week World Bank president Robert Zoellick called for a "cooperative monetary system" employing gold as "an international reference point."  Saturday's Times included an op-ed by James Grant which was even more direct:

Let the economists gasp: The classical gold standard, the one that was in place from 1880 to 1914, is what the world needs now. In its utility, economy and elegance, there has never been a monetary system like it.

I didn't gasp, I groaned.  Here is a plot of the US price level from January 1879, when the US rejoined the gold standard after relying on paper "greenback" money during the Civil War, through December 1913 (the gold standard collapsed around the outbreak of World War I 1914), normalized to 100 at the beginning.

Although the price level in the gold standard era lacked a long run trend, that doesn't mean it was stable.  While the change in the price level from Jan. 1879 to Dec. 1913 was modest (average annual inflation of about 0.5%), there were significant runs of high inflation, and even more perniciously, deflation.  Deflation raised the real value of debt burdens, which exacerbated the economic downturns of the time, which were frequent and severe (according to the NBER chronology, 189 out of 420 months were spent in recession).  Moreover, financial crises were a regular occurrence; the severity of the 1907 "panic" helped motivate the founding of the Fed, which Grant so dislikes, in 1913.  Its little wonder, then, that the gold standard was not universally liked at the time. The monetary system was one of the most bitterly contentious issues of the day, with the debate reaching its high point in the 1896 election, when William Jennings Bryan carried the south and west on a platform of freeing the US from the "cross of gold".

There are plenty of reasons to criticize the Fed and its management of the modern "fiat money" system, but even with all of its mistakes, its doing far better than the gold standard.

About That "Hastily Prepared Fiscal Blueprint"

In the Times, former Reagan budget director David Stockman writes:

This debt explosion has resulted not from big spending by the Democrats, but instead the Republican Party’s embrace, about three decades ago, of the insidious doctrine that deficits don’t matter if they result from tax cuts.

In 1981, traditional Republicans supported tax cuts, matched by spending cuts, to offset the way inflation was pushing many taxpayers into higher brackets and to spur investment. The Reagan administration’s hastily prepared fiscal blueprint, however, was no match for the primordial forces — the welfare state and the warfare state — that drive the federal spending machine.

Ahh, yes... three decades ago....

THE underlying problem of the deficits first surfaced, to Stockman's embarrassment, in the Senate Budget Committee in mid-April, when committee Republicans choked on the three-year projections supplied by the nonpartisan Congressional Budget Office. Three Republican senators refused to vote for a long-term budget measure that predicted continuing deficits of $60 billion, instead of a balanced budget by 1984.

Stockman thought he had taken care of embarrassing questions about future deficits with a device he referred to as the "magic asterisk." (Senator Howard Baker had dubbed it that in strategy sessions, Stockman said.) The "magic asterisk" would blithely denote all of the future deficit problems that were to be taken care of with additional budget reductions, to be announced by the President at a later date. Thus, everyone could finesse the hard questions, for now.

"Hastily prepared"?! To be fair, Stockman himself was an anti-government ideologue rather than a supply-side true believer, and the Reagan administration did change course and the tax cuts were partially reversed. But, nonetheless, three decades ago he entered into an alliance of convenience with the supply-siders and one can trace a pretty direct line between the policies he helped usher in and the nonsense he now laments. Of course, a return now to pre-Reagan Republican balanced budget dogma, as Stockman is calling for today, would be another kind of pernicious stupidity....

The quote above is from William Greider's famous 1981 Atlantic article "The Education of David Stockman." Stockman later wrote a book about his experience in the Reagan White House, which was reviewed by Michael Kinsley for the Times.

Update (8/6): Bruce Bartlett, who as a staffer for Congressman Jack Kemp also played a supporting role in the 1981 tax cuts, considers Stockman's "eclectic ideological journey."

Volcker Revisited

As bad as its been, it doesn't look like the current slump will match the postwar peak in the unemployment rate, 10.8% at the end of 1982. That recession was largely a result of the Volcker Fed's efforts to reduce inflation, which was quite painful - exactly as the Phillips curve implies. Since Paul Volcker seems to be back in vogue, Free Exchange asks a very good question:

The Fed began raising interest rates in 1977, and the American economy tipped into recession in 1980, at which point the central bank took its foot off the brakes. But inflation rates continued to rise, and so shortly after the economy recovered (briefly) in July of 1980, Mr Volcker orchestrated a series of interest rate increases that took the federal funds target from around 10% to near 20%.

What followed was an extraordinarily painful recession. Unemployment rose to near 11%. Manufacturing states were battered by the downturn; the near 17% unemployment rate in Michigan was worse than the state sustained in this latest recession. Mortgage lenders were devastated by high interest rates. The banking system was pushed to the point of insolvency. Things were quite bad. And while growth snapped back to trend rather quickly after the Fed took its foot offf the brake for good, there was considerable suffering through the recession, and the effects of unemployment, on health and earnings of sacked workers, persisted for years.

And yet, Mr Volcker is widely hailed as a hero for his total victory over inflation. This is understandable; inflation can be an extremely unpleasant phenomenon. It distorts consumption and investment decisions, and erodes faith in markets and government. But I found myself wondering yesterday whether the Volcker Recession was, after all, worth the pain. Was it a good decision to send the American economy into a debilitating recession for three years in order to whip inflation?

Their answer is worth reading. It leans heavily on the "supply shock" interpretation of the 1970s stagflation, suggesting that, in the absence of further oil shocks in the 1980s, inflation would have gotten at least somewhat better on its own. Hardcore believers in Milton Friedman's dictum that "inflation is always, everywhere a monetary phenomenon" would beg to differ.

Did JP Morgan Save the Dollar?

In the 1890s, the ability of the US to maintain a fixed exchange rate came into question and it was threatened by an international financial crisis similar to those experienced in recent decades by many "emerging markets." In this instance, the exchange rate peg was to the gold standard, which meant grinding deflation as money growth, limited by the pace of gold production, failed to keep pace with output. This hit debtors particularly hard as it raised real interest rates - imagine a farmer facing fixed interest payments while the price of his crops falls year after year. Populists and silver mining interests campaigned for the monetization - "free coinage" - of silver, which would have led to inflation and devaluation.

With the commitment to gold under threat in the 1890s, the Treasury faced a drain on gold reserves and US bonds carried a risk premium over UK gilts. Nowadays, a country in such a predicament might seek the aid of the International Monetary Fund. Since the IMF did not exist at the time, the US instead turned to JP Morgan.

At the American Heritage website, John Steele Gordon has an interesting description of JP Morgan's 1895 "bailout" of the US Government. He concludes:

Morgan’s rescue of the dollar, despite intense criticism from the Left, changed the country’s economic mood, and a strong recovery from the depression began. The next year the 36-year-old William Jennings Bryan would win the Democratic nomination with a promise that the moneyed classes “shall not crucify mankind upon a cross of gold.” It was one of the most famous speeches in American history, but his far less eloquent opponent, William McKinley, trounced him by running on a slogan of “sound money, protection, and prosperity.”

The election proved to be the start of the revival of Republican dominance in American politics that would last until 1932.

While the Morgan loan did give the Treasury some breathing space, if deflation had continued, no doubt populism would have continued to gain strength. What really did in the "free silver" movement was the end of deflation due to an increase in world gold supplies:

For academic studies, see Milton Friedman, "The Crime of 1873" (Journal of Political Economy, 1990 [JSTOR]) and Hallwood, MacDonald and Marsh, "Realignment Expectations and the US Dollar, 1890-1897: Was There a 'Peso Problem'?" (Journal of Monetary Economics, 2000).

Lessons of 1937

Bruce Bartlett reminds us that the "Great Depression" was actually two recessions, from 1929-33, followed by a recovery and then a second recession in 1937. This second recesssion was attributable to a tightening of monetary and fiscal policy. Bartlett writes:

In early 1937, Roosevelt was preparing his budget for the next fiscal year, which began on July 1 in those days. Strong growth in the economy and tax increases over the previous three years, especially the institution of a new payroll tax for Social Security, had caused tax receipts to almost double from 2.8% of GDP in 1932 to 5% in 1936. Projections showed that budget balance was within reach with only a modest reduction of spending.

Roosevelt was also concerned about the reemergence of inflation. After falling 24% between 1929 and 1933, the Consumer Price Index rose by a total of 7% over the next three years and signs pointed to even higher prices in 1937. Indeed, the CPI rose 3.6% that year.

Rather than viewing this as a sign of progress, which had caused the stock market to almost double between 1935 and 1936, Roosevelt and the inflation hawks of the day were determined to pop what they viewed as a stock market bubble and nip inflation in the bud. Balancing the budget was an important step in this regard, but so was Federal Reserve policy, which tightened sharply through higher reserve requirements for banks. Between August 1936 and May 1937 reserve requirements doubled.

During 1937, Roosevelt pressed ahead with fiscal tightening despite the obvious downturn in economic activity. The budget deficit fell from 5.5% of GDP in 1936 to 2.5% in 1937 and the budget was virtually balanced in fiscal year 1938, with a deficit of just $89 million.

While Bartlett believes the mistake is unlikely to be repeated, there are some "hawkish" rumblings coming from parts of the Fed.

I discussed a similar argument from CEA chair Christina Romer in a post last June. The lessons of 1937 were also the subject of a recent Paul Krugman column.

Pigou!

In the Journal, John Cassidy profiles A.C. Pigou, the Cambridge (UK) economist who pioneered the concept of externalities.

The Darkest Hour

is just before the dawn?

Perhaps, says David Leonhardt, who looks back at at the pessimism that prevailed in 1982:

In the fall of 1982, with a long recession ending but the unemployment rate heading toward 10 percent, The New York Times ran an article titled “The Recovery That Won’t Start.”

It quoted prominent economists who worried that “the recovery may amount to nothing more than a few quarters of paltry growth — and possibly not even that.” The economists, the article noted, had “growing doubts about whether the mechanisms of economic recovery will — or can — operate as they have in other postwar business cycles.”

Or as a classic song of the time put it:

And now you find yourself in '82
The disco hot spots hold no charm for you
You can concern yourself with bigger things
You catch a pearl and ride the dragon's wings

Of course, now we know that what came next were two years of very strong growth and soon it was "Morning in America:"



Perhaps the pessimists were just caught up in the heat of the moment, as Leonhardt suggests:

People tend to become overly pessimistic at the end of a recession, partly because they can see that the forces behind the last boom — housing and mortgage lending, in this case — won’t be around for the next one. If anything, the excesses from the last boom seem likely to hold back the economy for years to come. People are left to wonder where future growth will come from.

He has hope that we may indeed ride the dragon's wings to recovery:

For years, economists have been saying that China needs to consume more and the United States needs to consume less. Now it’s starting to happen.

The Chinese government has increased spending in the country’s impoverished countryside and made it easier for households to borrow money. Meanwhile, the global recession has caused China’s export sector to shrink.

However, Calculated Risk argues (seconded by Krugman) that today's situation compares unfavorably to that of 1982 because financial-crisis recessions generally tend to be longer, and because the Fed is out of room to lower interest rates.

Hmmm... only time will tell.

Melissa on Health Care

NPR asks:

If you want to understand how to fix today's health insurance system, you'd be smart to look first at how it was born. How did Americans end up with a system in which employers pay for our health insurance?

My Miami colleague Melissa Thomasson answers.

The Theory of the Blackberry Class

In the Times last week, Daniel Gross revisited The Theory of the Leisure Class, the most famous work of Carleton College's most famous alumnus, Thorstein Veblen. Though much of what Veblen wrote continues to be relevant today, Gross notes that conspicuous leisure no longer seems to be a preferred way for people to display their wealth. Indeed, quite the opposite:

In the contemporary money culture, to be at leisure, to be idle, is to be irrelevant. After Bank of America acquired Merrill Lynch, John Thain, the former chief executive of Merrill, was pushed out, in part because he insisted on going skiing at Vail over Christmas and wanted to attend the World Economic Forum in Davos amid the company’s continuing crisis. A great many people can afford not to work and could spend their time shuttling between multiple homes, eating fabulous meals and playing golf. Yet they continue to work around the clock. Of course, the private jet, the BlackBerry and the Internet allow people to do all of the above. But among Type-A, self-made members of the leisure class, there’s a sort of reverse prestige associated with leisure. At Davos, which is filled with conspicuous consumers, the only people who ski are the journalists.

Ezra Klein has an explanation: unlike in Veblen's era, when tycoons derived their income from capital, their contemporary equivalents - investment bankers, CEOs, professional athletes etc. - are the beneficiaries of increasing disparities in labor income. Klein writes:

Veblen, who died in 1929, saw a large overclass that earned most of its wealth through returns on capital. Essentially, their money made money for them. Which gave them time to hang about and conspicuously consume. In the period after his death, that overclass shrank substantially, first because the Great Depression battered them and then because the New Deal disadvantaged them. But by the start of the 21st century, they were back. At least in terms of wealth concentration. Their money, however, wasn't coming from capital returns. It was coming from wages and salaries. They were -- gasp! -- working.

Keep the (Fiscal) Pedal to the Metal

And the thing to the floor...

The stimulus bill passed in February was somewhat a watered-down compromise at the time, and the recession has since proven even worse than expected. Brad DeLong amended a chart made by CEA chair Christina Romer and Biden economic advisor Jared Bernstein during the stimulus debate. He writes:

So my first point is that the Obama administration's federal fiscal stimulus programmes are on the low side of what is appropriate by a substantial margin. This is the largest economic downturn since the Great Depression and the standard tools of expansionary monetary policy are tapped out and broken right now.

My second, related point is that the need for federal-level fiscal expansion is reinforced by what state governments are doing right now. The federal government's discretionary actions are expanding aggregate demand by about $400 billion over fiscal year 2010, but state governments are right now cutting their spending and raising their taxes in order to offset this federal fiscal expansion more or less completely. On net, the government sector will be on autopilot as far as discretionary policy moves to stimulate the economy are concerned: federal-level expansion is offset and neutralised by state-level fiscal contraction. This is not an appropriate macroeconomic policy stance: this is the largest economic downturn since the Great Depression.

That is from his contribution to a roundtable discussion at The Economist of a column by Romer in which she revisits the recession that interrupted the recovery from the Great Depression in 1937. She writes:

The recovery from the Depression is often described as slow because America did not return to full employment until after the outbreak of the second world war. But the truth is the recovery in the four years after Franklin Roosevelt took office in 1933 was incredibly rapid. Annual real GDP growth averaged over 9%. Unemployment fell from 25% to 14%. The second world war aside, the United States has never experienced such sustained, rapid growth.

However, that growth was halted by a second severe downturn in 1937-38, when unemployment surged again to 19% (see chart). The fundamental cause of this second recession was an unfortunate, and largely inadvertent, switch to contractionary fiscal and monetary policy.

Therefore,

The 1937 episode provides a cautionary tale. The urge to declare victory and get back to normal policy after an economic crisis is strong. That urge needs to be resisted until the economy is again approaching full employment. Financial crises, in particular, tend to leave scars that make financial institutions, households and firms behave differently. If the government withdraws support too early, a return to economic decline or even panic could follow. In this regard, not only should we not prematurely stop Recovery Act spending, we need to plan carefully for its expiration. According to the Congressional Budget Office, the Recovery Act will provide nearly $400 billion of stimulus in the 2010 fiscal year, but just over $130 billion in 2011. This implies a fiscal contraction of about 2% of GDP. If all goes well, private demand will have increased enough by then to fill the gap. If that is not the case, broad policy support may need to be sustained somewhat longer.

It sounds like she is laying the groundwork to follow DeLong's advice. That may be hard to pull off, politically, as Andrew Leonard notes polls show concern about the federal deficit (as they did in 1935 and 36, Krugman points out).

In his column, Paul Krugman also argued it is not the time to let up:

The debate over economic policy has taken a predictable yet ominous turn: the crisis seems to be easing, and a chorus of critics is already demanding that the Federal Reserve and the Obama administration abandon their rescue efforts. For those who know their history, it’s déjà vu all over again — literally.

For this is the third time in history that a major economy has found itself in a liquidity trap, a situation in which interest-rate cuts, the conventional way to perk up the economy, have reached their limit. When this happens, unconventional measures are the only way to fight recession.

Yet such unconventional measures make the conventionally minded uncomfortable, and they keep pushing for a return to normalcy. In previous liquidity-trap episodes, policy makers gave in to these pressures far too soon, plunging the economy back into crisis. And if the critics have their way, we’ll do the same thing this time.

Update (6/21): Catherine Rampell of Economix puts those poll results in perspective:

2009’s federal deficit is projected to be a larger percentage of G.D.P. (12 or 13 percent) than it has been any year since 1945, and yet a measly 5 percent of Americans are complaining that deficit/debt/budget issues are the country’s biggest problem.