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Joshua Hausman has a very good paper on the 1936 veterans’ bonus, in the AER. This was a payment of $1.8 billion to about 3.2 million WWI veterans. The benefits were originally supposed to be in the form of a pension, but Congress bowed to public pressure and voted to make immediate lump sum payments to the veterans (in the form of bonds). FDR viewed the bill as irresponsible, but it passed over his veto.

Hausman provides lots of pretty convincing evidence that the bonus payments boosted consumption, at least by those who received the payments. He estimates a MPC in the .60 to .75 range. One telling fact is that 80% of the bonds were cashed in during 1936, despite the fact that they paid an above market rate of interest (3%). I imagine that after 7 years of depression, lots of the veterans were liquidity constrained and we were not in a Ricardian equivalence world. Nonetheless, I’m skeptical that the bonus program was effective, not surprisingly for monetary offset reasons.

The bonus bill was passed in January 1936, and the payments went out to veterans in late June 1936. As a bit of background, the recovery had temporarily stalled under the NIRA, indeed from July 1933 to May 1935 there was no increase in industrial production. After the NIRA was ruled unconstitutional in May 1935, industrial production started rising rapidly, and continued doing so into early 1937, when growth slowed. In late 1937 and early 1938, industrial production plummeted, as the US entered one of the most severe depressions of the 20th century. So the bonus payments came part way through a period of strong growth.

I do believe that 1936 GDP was higher than it would have been without the bonus program, but I don’t think the overall effect was expansionary. Less than a month after the payments were distributed, the Fed embarked on a major anti-inflation program. On July 15, the Fed voted to raise reserve requirements sharply. By itself, this action probably had only modest effects, not enough to offset the fiscal stimulus. But then in December 1936, the Treasury began sterilizing gold inflows. In March 1937, reserve requirements were raised again, and then again in May 1937. By this time the reserve requirements had doubled from the levels of early 1936.

In my book on the Great Depression, I suggested that other factors largely explain the severity of the 1937-38 slump, especially higher labor costs in early 1937 combined with a bout of gold hoarding in late 1937. This gold hoarding was a dramatic turnaround from the gold panic of late 1936 and early 1937 (which involved gold dishoarding). Nonetheless, the various contractionary monetary policies were probably enough to offset the bonus payments, which were about 2.1% of 1936 GDP.

There are three possibilities, anyone of which seems plausible. The monetary policy tightening might have offset, more than offset, or less than offset the bonus payments. We don’t know, and given the “game theory” aspects of this problem, we will never be able to know for sure. But it’s worth noting that 1936 was an almost ideal time to do fiscal stimulus:

1. Generally speaking, monetary policy was quite passive during the period after 1934, with the monetary base tending to rise along with the monetary gold stock. Under a gold standard regime, monetary offset is less likely to occur, and indeed the constraint of the gold standard is one reason why I was skeptical of the effectiveness of the various contractionary monetary policies in 1936-37.

2. FDR had allies at the Board of Governors.

3. Interest rates were near zero, which is generally assumed to be a condition where monetary offset is less likely to occur.

Thus I find it interesting that 1936-37 looks like an almost classic example of monetary offset. There was a very specific, highly visible fiscal stimulus. It occurred during a period of rising (wholesale) prices, and inflation seemed to accelerate further after the bonus was paid. Then policymakers take not one but four steps to restrain AD and slow inflation, with the first occurring less than a month after the bonus payment. And then the economy slows and eventually falls sharply. Admittedly that’s all circumstantial, but it’s almost a textbook example of what you’d expect monetary offset to look like.

Interestingly, Hausman doesn’t focus on monetary offset (his study uses cross sectional data, as well as survey data). But he does allude to possible fiscal offset:

As is customary, I consider the multiplier for the bonus ignoring any political economy affects of the bonus’ passage on other spending and taxing decisions. The veterans’ bonus was itself deficit financed, but its passage led to political pressure for higher taxes. Thus the veterans bonus contributed to the enactment of the undistributed profits tax (the Revenue Act of 1936) in June 1936 (Romer and Romer 2012). This bill imposed taxes on undistributed corporate profits and also raised taxes on dividends. It did not affect other personal taxes. The political dynamic through which the veterans bonus contributed to the passage of this tax increase can be compared to the way the American Recovery and Reinvestment Act (the Obama stimulus) may have contributed to later spending cuts.

PS. Just to be clear, I think the bonus program was expansionary during 1936. My skepticism has to do with the effects of monetary offset on the economy in 1937 and 1938. And my skepticism about the bonus as fiscal stimulus doesn’t mean I necessarily think it was a bad program. I certainly have sympathy for WWI veterans, although I also understand the reasons why FDR vetoed the program.

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This entry was posted on April 05th, 2016 and is filed under Fiscal policy, Monetary History. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response or Trackback from your own site.



