The 1921 recession

Is the stimulus working? Is a second round of spending needed? These are some of the questions being asked in Washington today. Perhaps a better question is whether the stimulus package was even needed in the first place. After all, President Bill Clinton, after riding to the White House on the back of the famous campaign slogan "It's the economy, stupid!" ended up with a stimulus bill that was restricted to a mere $4 billion in extended unemployment benefits. As we all know, the economy went on to recover quite nicely.

Another interesting example is the 1920-21 recession and the public policy response -- which was essentially nothing. Although overshadowed by the Great Depression, this recession was a pretty nasty little episode in American economic history. As wikipedia describes it:

Various estimates show that one-year deflation figures were 18 percent, 13.0 percent, and 14.8 percent, respectively. The closest comparator is the 11.5 percent deflation recorded for 1931-32, the third year of the Great Depression. Wholesale prices declined by 36.8 percent for 1920-21, the largest one-year decline on record, going back at least to the American Revolutionary War period. The 1921 deflationcontains another striking feature. Not only was it sharp, it was large relative to the accompanying decline in real product. The ratio of the percentage decline in the GNP deflator for 1920-21 to the percentage decline in real GNP is 2.6 using the Department of Commerce figures. By contrast, during 1929-30, the first year of the Great Depression, the GNP deflator declined by 2.7 percent and real GNP by 9.4 percent, for a ratio of 0.3. The ratios of the percentage decline in GNP prices to the percentage decline in real GNP for 1930-31, 1931-32, 1932-33, and 1937-38, the other Great Depression years in which real GNP declined, were 1.0, 0.9, 1.2, and 0.3, respectively, all well below the 1920-21 figures.

Deflation was so sharp, both in itself and in relation to the decline in real product, because the deflation was produced by a sharp decline in aggregate demand combined with an increase in aggregate supply, a supply increase in which deflationary expectations played a prominent role.

Deflation can be considered more worrying than inflation because it encourages consumers to delay purchases -- after all, why buy now when in a few months time goods will be cheaper? Once you're in a deflationary spiral it can be tough to get out.

So how did President Calvin Coolidge respond? Well, he put together a Conference on Unemployment (at the behest of Herbert Hoover) that mostly conducted studies and served as a "clearinghouse of ideas." Other than that, not much. So how did the economy respond? Pretty well:

A buoyant expansion followed the severe contraction of 1920-1921. In the 22 months after the depression bottom, industrial production rose 63%, the money stock expanded by 14%, and wholesale prices rose by 9%. Net national product rose 23% in the corresponding two calendar years.

...The recession of 1921-1923 proved to be the sharpest economic downturn since the emergence of the business cycle in the early 19th century, but it also was one of the shortest reversals. The recession was over in one year.

Economist Thomas Woods argues that President Harding's laissez faire economic policies during the 1920/21 recession, combined with a coordinated aggressive policy of rapid government downsizing, had a direct influence (mostly through intentional non-influence) on the rapid and widespread private-sector recovery. Because there existed mass distortions in private markets due to government economic influence related to World War I, an equally mass "correction" to the distortions needed to occur as quickly as possible to realign investment and consumption with the new peace-time, government-free economic environment.

Indeed, the aftermath of the recession was the "roaring twenties."

Update: Received this email:

Warren G. Harding was president in 1921, not Mr. Coolidge. He ascended at Harding's death on Aug. 2, 1923....You might be interested in knowing that Harding had to fight to get Hoover in his cabinet. The old guard Republican leaders were opposed to Hoover, thinking him a Democrat or certainly not a dyed in the wool Republican. They didn't trust and, for that matter, never would. A deal was struck where Harding got Hoover but he had to take Andrew Mellon in return.