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Roosevelt Recession

Roosevelt Recession

Franklin Roosevelt and the New Deal are best remembered for saving the United States from the Great Depression. However, that doesn't mean Roosevelt's time in office was always perfectly smooth sailing. In fact, there was a temporary additional economic decline in 1937 and 1938, known as the Roosevelt Recession. Learn about the Roosevelt Recession's causes, its impact, and significance here.

Roosevelt Recession Definition

The Roosevelt Recession was the economic downtown that occurred between May 1937 and June 1938. It was the third-worst economic decline the US faced in the entire 20th century, even though it paled in comparison to the decline of 1929 when the Great Depression began.

However, since the country was still in the midst of recovery from the Great Depression, it did take a heavy toll and temporarily frustrated the recovery. It is known as the Roosevelt Recession since it occurred under the presidency of Franklin D. Roosevelt and was caused in part by the monetary and fiscal policies of his administration.

Roosevelt Recession 1937-38 Unemployed Man StudySmarterFig. 1 - An unemployed worker in front of a storefront in February 1937.

Roosevelt Recession Causes

The Roosevelt Recession occurred during the recovery from the Great Depression. Before 1937, there had been a large recovery due in part to the policies of the New Deal. However, during the Roosevelt Recession of 1937-38, there was another steep decline before recovery continued.

There was a complex set of causes of the Roosevelt Recession. Let's first look at the initial recovery before considering the Roosevelt Recession's causes.

Exam Tip

Exam questions will ask you to construct historical arguments. As you read about the causes of the Roosevelt Recession below, consider how you might make a historical argument for how each caused the Roosevelt Recession.

Recovery from the Great Depression Before the Roosevelt Recession of 1937-38

At the start of 1937, things mostly appeared rosy. The country had climbed out of the bottom of the Great Depression in 1933. Gross National Product (GNP) had risen shapely in 1934 and 1935 and grew by an even sharper 14% in 1936. Between May 1935 and April 1937, unemployment had declined by one third.1 It appeared the country had rounded the corner.

In fact, in Roosevelt's State of the Union address in January 1937, he seemed to suggest the depression was over. Still, in it and his second inaugural address the same month, he acknowledged that there were still economic issues and disparities to be addressed. However, he and most policymakers failed to realize they were on the verge of another drastic decline.

Economists today still debate the causes of the Roosevelt Recession of 1937-38, and this decline and recovery are understudied compared to the 1929 crash and full recovery. However, those that have studied it agree there was a combination of causes.

Roosevelt Recession Stock Prices StudySmarterFig 2 - Stock prices with the declines starting in 1929, temperorary recovery and new drop in 1937.

Monetary Policy

Many of the economists who have studied the Roosevelt Recession's causes blame a shift in monetary policy. Believing the country was on track to recovery, a less expansionary monetary policy was adopted. The Federal Reserve and Roosevelt both worried that inflation was rising.

Monetary vs Fiscal Policy

Governments have two main ways to influence the economy, monetary policy and fiscal policy. These policies can be complex and complicated, but their general basis is not that hard to understand.

Monetary policy has to do with the supply of money available. This is usually managed by central banks. In the US, the Federal Reserve Bank is that central bank. They set interest rates for loans they make to other banks, which influence the interest rates those banks charge their customers on loans and offer them on their savings. When they raise interest rates, they encourage people to save, spend less money, and not take new loans, reducing the amount of money being spent in the overall economy. When they lower interest rates, they encourage people to borrow and spend more money, increasing the amount of money being spent in the overall economy. They also have the ability to buy and sell assets like stocks and bonds to influence the amount of money in circulation.

Fiscal policy has to do with the collection and spending of money by the government. They collect money primarily through taxes. They spend money by employing people, investing in projects like infrastructure, and aid programs. Therefore, they can increase the money in circulation (sometimes called stimulating the economy) by decreasing taxes and/or increasing their spending or decrease the money in circulation by increasing taxes and/or decreasing their spending.

Fearing banks would be quick to loan money back out and add to inflation, they opted to increase reserve requirements, forcing banks to keep more cash on hand. However, the effect was larger than expected as many banks, hoping to prevent the type of runs that had characterized the crash in 1929, chose to keep excess reserves on top of the limits.

Therefore, banks extended less credit and made fewer loans. This had a similar effect to the decline in available money that the crash of 1929 had provoked, stalling the recovery and contributing to a new decline. This view has been one of the most dominant among economists, as argued by Milton Friedman and Anna Schwartz.

Other economists have contended that the policy did not necessarily restrict the availability of credit. However, by signaling that the government was worried about inflation, they encouraged pessimism and less spending. In other words, the policy created a sort of self-fulfilling prophecy.

Did You Know

One of the causes of panic during the Great Depression was the failure of banks, during "bank runs" when people rushed to pull their money out of the bank. Since banks only had to keep a certain amount of cash on reserve, some failed when they couldn't give people their money, causing many to lose their entire savings. Increased required reserves were implemented in part to prevent these shocks from causing more bank failures.

Treasury Department's "Sterilization" of Gold

This period had also seen a large inflow of gold from Europe into the US banking and monetary system. Banks bought gold from European banks, and then they could resell certificates or bonds based on its value. This had helped boost the overall economy by increasing the money supply. However, it was also another potential cause of inflation, and the Treasury Department attempted to offset it by "sterilizing" the gold.

What this means is that the Treasury Department bought gold but did not then sell certificates or bonds based on its value, in essence reducing the amount of total dollars available and preventing the value of this gold from being injected into the economy.

Part of the problem is that the Federal Reserve and Treasury did not work together, but both adopted policies meant to resolve the same problem. In doing so, they basically over-fixed it, stopping the expansion of the money supply that had helped the recovery up to that point and overcorrecting for the feared inflation.

Had only one or the other been done, the retraction might not have been severe, but combined they basically cut off the expansionary spigot that had been fueling recovery, going so far as to have a contractionary effect.

Expansionary vs Contractionary Monetary and Fiscal Policy

Economic policymakers seek to promote a perfect balance between inflation, unemployment, and economic growth. Expansionary policies increase the money supply. They cause inflation or increases in prices and decreases in the value of a currency. A small amount of inflation is generally considered good for the expansion of an economy and keeping unemployment low, and expansionary policies are generally followed during times of economic decline to boost and stimulate the economy. However, too high inflation is seen as bad since it can discourage continued growth. Contractionary policies decrease the money supply and cause deflation or decreases in prices and increases in value of a currency. They are adopted to slow down economies when inflation is higher than desired.

Roosevelt Recession StudySmarterFig 3 - A young mother and migrant worker in March 1937.

Reduction of Deficit Spending

Another compounding factor for the Roosevelt Recession's causes was a return to more austerity.

Austerity

In economic policy, austerity is defined by policies that reduce budget deficits. This is done with decreases in government spending, tax increases, or a combination of both.

Large deficit spending, or the government spending more money than it collected, had been an important part of the New Deal and the Keynesian Economics that informed it. The deficit in 1936 was the largest in the country's history.

Worried about this, government spending was reduced over the second half of 1936 and first half of 1937. At the same time, the new Social Security tax went into effect in 1937.

This meant that not only was the money in circulation reduced by the monetary policies of the Fed and Treasury, but the federal government was also spending less while collecting more. In short, spending across the entire economy decreased, adding to the deflationary momentum.

Roosevelt Recession Impact StudySmarterFig 4 - People wait for relief checks in California in March 1937.

Increased Costs

Foreign and domestic factors also contributed to reduced profits for businesses. In Europe, the Spanish Civil War was underway, and most countries had begun rearming in prelude to World War II. This meant the cost of materials for many manufactured goods went up.

At home, workers and organized labor had achieved more power in the early New Deal. The number of strikes had risen, and increased bargaining power meant higher wages for workers, which meant higher labor costs for companies in addition to the increased cost of materials.

Roosevelt Recession's Impact

Economists still debate about which of these four different causes of the Roosevelt Recession of 1937-38 were most important.

However, it seems clear that they worked together to make the decline worse than it may have been. Essentially, there was less money available, less money being spent, prices were going down, and production costs were going up, leading to overall less investment and production.

What this meant in terms of the Roosevelt Recession's impact was that many of the gains of the recovery up to that point were quickly rolled back. As noted above, the Roosevelt Recession was the third largest in the 20th century history of the United States.

Real Gross Domestic Product (GDP) fell by 10%. Unemployment surged again to nearly 20%. Industrial production fell by nearly one-third.2

Roosevelt Recession Impact Unemployment StudySmarterFig 5 - US unemployment showing the peak in 1933 and the surge during the Roosevelt Recession of 1937-38.

Recovery from the Roosevelt Recession

Fortunately, the Roosevelt Recession's impact failed to reach the depths of the Great Depression. Policymakers reacted fairly quickly once it began, paving the way for a recovery.

The Fed reversed the increased reserve requirements, and the Treasury "de-sterilized" all the gold it had kept out of circulation. Meanwhile, the administration returned to a fiscal policy of deficit spending.

Between 1938 and 1942, economic output grew by 49%. Part of this was fueled by the defense buildup once the US entered World War II, but also by the return to expansionary monetary and fiscal policies.

Roosevelt Recession Impact Manufacturing StudySmarterFig 6 - US manufacturing output showing the declines after 1929 and during the Roosevelt Recession before full recovery after 1939.

Roosevelt Recession Significance

It's easy to look at the Roosevelt Recession as a hiccup on the road to recovery from the Great Depression. In fact, it's often overlooked as just part of the overall recovery from 1933-1942.

To some extent, that's true, although looking at it that way no doubt fails to recognize the Roosevelt Recession's significance for the people who lost jobs or suffered from lower wages.

The Roosevelt Recession's significance from a historical perspective today is more of a warning that ending policies that promote economic recovery too early can lead to the end of the recovery and even a new decline. The fine line between stimulus and overheating the economy is one they will surely continue to debate. Policymakers and economists, no doubt will continue to debate the correct approach to economic crises, based in part on the Roosevelt Recession's causes and impact.

Roosevelt Recession - Key Takeaways

  • The Roosevelt Recession of 1937-38 was a sharp economic decline that occurred in the middle of the recovery from the Great Depression.
  • The Roosevelt Recession's causes were complex and are debated by economists still today, but it was caused by a combination of deflationary monetary and fiscal policies along with rising business costs that created a vicious cycle of reduced money supply, prices, and production.
  • The impact of the Roosevelt Recession was severe, although not as extreme as the Great Depression, and recovery followed relatively quickly due to a return to expansionary policies.
  • From a historical perspective, it is today more of a warning that ending policies that promote economic recovery too early can lead to the end of the recovery and even a new decline.

References

  1. George Selgin, The New Deal and Recovery, Part 10: The Roosevelt Recession, CATO Institute, February 4, 2021
  2. Patricia Waiwood, Recession of 1937-38, Federal Reserve History, November 22, 2013
  3. Fig 5 - Unemployment chart (https://en.wikipedia.org/wiki/File:US_Unemployment_from_1910-1960.svg) by Pharexia (https://commons.wikimedia.org/wiki/User:Pharexia) licensed under Attribution-Share Alike 4.0 International (https://creativecommons.org/licenses/by-sa/4.0/deed.en)
  4. Fig 6 - Manufacturing employment chart (https://en.wikipedia.org/wiki/File:US_Manufacturing_Employment_Graph_-_1920_to_1940.svg) by Crotalus horridus (https://commons.wikimedia.org/wiki/User:Crotalus_horridus) licensed under Attribution-Share Alike 4.0 International, 3.0 Unported, 2.5 Generic, 2.0 Generic and 1.0 Generic (https://creativecommons.org/licenses/by-sa/4.0/)

Final Roosevelt Recession Quiz

Question

When was the Roosevelt Recession?

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Answer

From about the middle of 1937 to the middle of 1938.

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Question

Why did policy makers take action and help provoke the Roosevelt recession?

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Answer

They were worried about potential inflation.

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Question

How did the Federal Reserve influence the causes of the Roosevelt Recession?

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Answer

They increased the amount of money banks had to keep on reserve, reducing the money available for credit.

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Question

How did the Treasury Department influence the causes of the Roosevelt Recession?

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Answer

They sterilized gold coming from Europe, not putting the money into the economy.

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How did fiscal policy influence the causes of the Roosevelt Recession?

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Answer

The government decreased deficit spending and increased tax collection.

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Question

Which of the following was not a cause of increased costs for production during the Roosevelt Recession?

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Answer

Higher cost of labor

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Question

True or False: The Roosevelt Recession was worse than the Great Depression?

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Answer

True

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Question

Which of the following did not help the US recover from the Roosevelt Recession?

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Answer

Readoption of expansionary policies

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Which of the following was one of the effects of the Roosevelt Recession?

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Answer

Unemployment rose again

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Question

Why do some economists believe the Roosevelt Recession happened due to the Fed and Treasury not working together?

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Answer

Because they both adopted policies to fix the same problem, overcorrecting.

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