A fairly common way of distinguishing recessions/depressions, at least in non-interventionist circles, is to create a dichotomy between short and long trade cycles. The idea is that intervention, such as fiscal stimulus, can soften the contraction, but that the efficiency losses that result lead to a lengthening of the recovery. Is this distinction fair? The problem is that there are various factors which can lead to longer recovery periods, inherent in the “unique” nature of the trade cycle, and it’s not all that clear how much time is added by something like fiscal stimulus. Also, most economists will agree that there are many interventions that could lengthen the recovery period — I hope no economist, for example, advocates sowing our soil with salt (Romans are not exempt) —, and an argument against some policies is not an argument against all policies. If we compared real world cases of trade cycles of similar type, matching those characterized by intervention and non-intervention, my prediction is that the lengths would look similar (not perfect and not always, given outliers like the Great Depression).

Carmen Reinhart and Kenneth Rogoff, in This Time is Different (2009), classify trade cycles by their general characteristics and find that recovery lengths are generally well associated with the type of cycle. They reaffirmed this interpretation in a October 2012 response to various op-eds that had used their research to justify the accusation that the current recovery is, by historical standards, longer than it should be. The length of a recession is partially determined by “unique” features of the cycle; by “unique,” I mean traits that are present in some, but not all trade cycles. These include sovereign debt defaults (governments declaring bankruptcy), financial crises, and currency crises. Within these broad features, other characteristics can be isolated: for example, did the sovereign default on internal (issued under the rules of that country) or external debt (issued under the rules of some foreign country)? Recessions with systemic financial crises, for example, tend to do more damage and take longer to recover from. None of this directly disproves the theory that “free market liquidation” recessions are sharper and shorter than “counter-cyclical intervention” recessions, but it does suggest that we should adjust for variations in depth and recovery length for other determining factors before making any comparison.

I assume that the claim (concerning intervened and non-intervened recessions) considers discretionary fiscal policy strictly — and some other policies, such as minimum wage legislation and automatic fiscal stabilizers. The alternative would be to assume that the claim concerns any policy, losing any helpful meaning. Most economists will agree that most of possible counter-cyclical policies are harmful. Few will support, to give a few examples, socializing everything (except socialists, using a strict definition), inducing hyperinflation, or employing the unemployed as fanners to the members of the ruling party. These examples are admittedly extreme, but, similarly, few economists support something like Franklin Roosevelt’s NRA. My point is that “Keynesians” advocate for a specific set of policies, and so it’s these policies we should consider when testing the claim that these policies stunt the depth, but lengthen the recovery of the business cycle. There’s also monetary policy. But, to some extent, counter-cyclical monetary policy replaces the automatic stabilizer of an elastic currency that the free banking model predicts.

Is there any theoretical justification for the argument? Take it for granted that there is reasonable disagreement over the effects of fiscal stimulus, and that this argument is made moot by the “fact” that fiscal policy is expansionary, meaning it will cushion the crash and hasten the recovery. Just, for the sake of argument, assume that fiscal policy can temporarily increase output/employment, but at some efficiency loss. The theory is heavily based on static models. Time is difficult to conceptualize in static equilibrium (or “timeless”), and the situation it depicts is some final equilibrium: there is no more need for change. The real world isn’t “timeless,” though, and is subject to change. There are many inefficiencies caused by factors like imperfect information, error, and property right conflicts (e.g. externalities). What makes markets preferable, under most circumstances, is their dynamic efficiency; the advantage of markets are the institutional features which act to discipline bad decision making.

Assume that we can divide fiscal injections into discrete events. Any resource rationed by government is one not allocated by the market, in that instant. This produces some inefficiency. But, in market economies, fiscal injections generally occur within the institutions of the market. Resources are frequently re-distributed in the market, which should mitigate some of the negative impact of fiscal stimulus. My intuition is that the dynamic inefficiency of fiscal stimulus is more limited than a static model would suggest — point being, despite the initial redistribution, errors will be corrected. If the dynamic market helps attenuate some of the impact of fiscal stimulus, then its effects on the depth and duration of the business cycle should be similarly limited. The model predicts some efficiency loss, but its dynamic inefficiency is difficult to predict, ambiguous. (It’s also probably difficult to get an empirical measurement, because there are many simultaneous factors that determine capital growth. For example, monetary policy can offset fiscal policy, so we would have to adjust for that.)

Other deciding factors of depth and duration, like banking, debt, and currency crises. The extent of the damage to the capital stock also matters. How much weight should we really place on fiscal policy? Ultimately, its an empirical question, but I think there’s a strong probability that the impact of fiscal stimulus is less than what a static model would predict.

One piece of evidence is the Depression of 1920–21. This event is often cited as evidence of the benefits of a non-intervenionist approach to the business cycle. See, for instance, Murphy (2009) and Woods (2009). But, the evidence is not so clear. Blogger “Lord Keynes” argues that: (1) the recovery, compared to post-war fluctuations, was lengthy (18 months v. 11); (2) the fluctuation in output was comparatively mild; (3) there was a positive supply shock in some industries, inducing deflation (although, I’m not sure how we can reconcile this argument with the second one); (4) there was no systemic financial crisis; and (5) the depression was sparked, and then ended, by a change in Fed monetary policy. Kuehn (2011) also argues for the monetary interpretation. Kuehn (2012) argues that the non-interventionist interpretation has not read the evidence on fiscal policy well enough. Kuehn suggests, given that fiscal policy is needed only when there are demand shortages, it’s not very relevant for the supply constraint world of 1920–21. This may compromise the depression’s usefulness as evidence in this case.

There’s also reason to doubt the Great Depression’s usefulness as evidence. The set of counter-cyclical policies enacted during the 1930s was broad. Not only was there fiscal stimulus, but there were extreme legal constraints on business, agriculture was heavily regulated, and world trade plummeted. Accounting for how deep the decline in output was, the ~1933–36 recovery was comparatively strong. There is evidence (see also Glasner [2011]) that a significant contributor to the recovery was monetary policy, by reducing the money shortage.

My guess is that there are too many more important factors that determine the depth and duration of the business cycle. The impact of fiscal policy is probably comparatively small. If we could conduct an empirical comparative analysis, my prediction is that depth and duration should be generally similar. More specifically, the impact would have a marginal effect on depth and duration (remember, the non-interventionist prediction is that fiscal policy can attenuate the depth, but will lengthen the duration). The empirical evidence that comes to mind agrees. For an event like the Great Depression, there were some strong constraints on American economic activity, with policies that suppressed business and agricultural activity. These constraints are unique to the Great Depression. Along with the Depression of 1920–21, the evidence is ambiguous at best.