During the worst years of the Great Depression, unemployment hit 25 per cent. Our current calamity is so often compared to that era that it worth asking: will things get that bad?
Economist Robert Murphy says they won’t. Our government won’t make the same high wage policy mistake that cripled the jobs economy in the 1930s, and even if stickiness in wages (due to minimum wage hikes or government support of unions) inflation will actually push wages higher.
The single biggest blunder Herbert Hoover made was insisting that businesses maintain wage rates after the stock-market crash in October 1929. Hoover adhered to an “underconsumptionist” theory of the business cycle, in which a small shock to business could end up cascading into a full-blown depression if market forces were left to their own devices. In Hoover’s view, the worst thing businesses could do in 1930 would be to slash wage rates, because then workers would have even less money to buy products; there would be a downward spiral into oblivion.
The problem was that the United States was still on a gold standard, and so the Fed couldn’t inflate the economy with new paper money with reckless abandon (the way it has done in subsequent recessions). When Americans began panicking and pulling their money out of the banks, the overall quantity of money (measured by aggregates such as M1 or M2) fell sharply, declining by about a third from 1929 to 1933.
Because of the shrinking money stock as well as people’s desire to hold larger cash balances, prices in general fell substantially as well, falling at an annualized rate of more than 10 per cent for portions of the Hoover years.
This is why Hoover’s high-wage policy proved so disastrous. With everything except labour getting cheaper by the month, unemployed workers found it difficult to re-enter the work force. With sales and revenues plummeting, no employer wanted to hire workers at the same wage rate prevailing at the height of the boom in 1929. Because Hoover insisted that wage rates stay the same, even though the market-clearing wage rate was falling with productivity and general prices, the result was larger and larger unemployment. This is Econ 101.
In our present crisis, we don’t need to worry about unemployment rates hitting 25 per cent. Even though federal policies will reduce labour productivity, and even though Obama’s pro-union policies will exacerbate “wage stickiness,” over the next few years I predict large price inflation that will tend to mitigate these factors. In short, most workers will still be able to find jobs, because Bernanke’s running of the printing press will ensure that their paychecks don’t buy very much at the stores. Consequently, it won’t be as difficult for employers to justify taking on people laid off from other firms, compared to the situation in the Hoover years.
Unfortunately, this isn’t quite the good news that it seems. Murphy predicts that the economy will stall out while we experience the worst price inflation in US history. He calls this “hyperdepression.”
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