The Great Depression in the United States is generally dated as beginning in 1929 and ending in 1941, give or take a year. This has led many commentators to disregard or to pass quickly over the serious depression that began in 1937 and ended—if returning to the 1937 level can be considered a depression’s end—in 1939 or 1940. (See "What Caused the Great Depression?"

The contraction’s dimensions certainly qualify it as a major bust. Real annual GDP fell by more than 5 percent between 1937 and 1938. Real gross business product declined by almost 7 percent; real gross private domestic investment by 21 percent; real private investment in producers’ durable equipment by more than 31 percent; and real private investment in new industrial structures by more than 50 percent. The Federal Reserve’s index of industrial production dropped from 8.3 in the spring of 1937 to 5.6 in May 1938—a plunge of 33 percent—and it did not regain its 1937 peak until the fourth quarter of 1939.

The rate of unemployment, which had been declining since 1933, now ascended rapidly. In May 1937 the Bureau of Labor Statistics unemployment rate (which counts persons employed in emergency programs, such as the Works Progress Administration and the Civilian Conservation Corps, as unemployed) had fallen to almost 12 percent. It then rose slowly until winter, when it began to climb rapidly, reaching a peak at 20.7 percent in April 1939 before falling. The decline accelerated in the latter part of the year. (Estimates of unemployment that count workers in emergency employment programs as employed place the rate of unemployment at 9.2 percent in 1937, 12.5 percent in 1938, 11.3 percent in 1939, and 9.5 percent in 1940.) Private nonfarm hours worked fell by about 9 percent between 1937 and 1938 and did not exceed their 1937 amount until 1940.

Investors took a beating. Standard and Poor’s index of common stock prices fell between 1937 and 1938 by 25 percent. The market value of stocks traded on the New York Stock Exchange went down by more than 40 percent. All stocks and bonds traded on registered security exchanges lost 41 percent of their market value.

These dire events came as a shock to most people, including President Franklin D. Roosevelt, most of his leading subordinates, and most supporters of the New Deal. In 1935 and 1936, when the economic recovery was proceeding faster than it had in the previous two years, Roosevelt administration leaders had begun to believe their policies were working successfully and that before long those measures would lift the economy out of the depression completely. “The President,” according to historian Alan Brinkley, “clung fervently to that conviction despite the persistence of high unemployment, the absence of significant new private investment, and the continuing sluggishness of several major industries.” The President therefore resolved to propose a balanced budget for the fiscal year beginning July 1, 1937.

When the bust had become undeniable, Roosevelt described it as a recession rather than a depression, to distinguish it from the terrifying slide between 1929 and 1933, but his heart did not coincide with his language. “The collapse,” writes Brinkley, “created an anxiety within the government that at times verged on panic,” and the President’s subsequent speeches and actions revealed that he had no real understanding of why the contraction had occurred or how he might contribute to its reversal. Representative Maury Maverick of Texas told his colleagues in the House, “Now we Democrats have to admit that we are floundering. We have pulled all the rabbits out of the hat, and there are no more rabbits. . . . We are a confused, bewildered group of people, and we are not delivering the goods.”

Ever the politician, the President blamed the depression on “economic royalists” intent on destroying him—“I welcome their hatred,” he declared—and he set in motion a large-scale investigation by the newly created Temporary National Economic Committee, as well as dramatically beefed-up antitrust prosecutions to bring these “princes of property” to heel and to punish them for mounting a “strike of capital” intended to “sabotage” recovery. As New Deal insider Raymond Moley wrote in 1939, the President’s “calling of names in political speeches and the vague, veiled threats of punitive action all tore the fragile texture of credit and confidence upon which the very existence of business depends.”

For the past half-century, however, dispassionate analysts have generally dismissed the President’s capitalist-devil theory and have explained the bust in two main ways: A Keynesian interpretation blames primarily a fiscal shock caused by the federal government’s reduction of its budget deficit from $3.6 billion in calendar year 1936 to $0.4 billion in calendar year 1937; alternatively, a monetarist interpretation blames primarily a monetary shock caused by the Fed’s doubling of its member commercial banks’ required-reserve ratios between August 1936 and May 1937. This monetary policy triggered a decline in the money stock, which had been growing rapidly since 1933: The money stock (M2 definition) fell by 2.4 percent between the second quarter of 1937 and the second quarter of 1938.

Notwithstanding these macroeconomic interpretations’ status as leading competitors in mainstream macroeconomics, they have been vigorously challenged over the years. The Keynesian view has serious empirical and logical defects too numerous to recount here; until recently, leading mainstream economists had largely abandoned the rudimentary Keynesian framework of analysis. The monetarist interpretation also presents serious problems. In a study published by the European Commission’s Directorate General for Economic and Financial Affairs in February 2010, Paul van den Noord concludes that “while the 1937/38 recession is generally attributed to a tight stance of macroeconomic policy” that produced negative fiscal and monetary shocks, the likely effects of these shocks cannot account for the actual magnitude and contour of this contraction, and “this view is thus questionable.”

To strengthen his explanation of the depression within the Depression, van den Noord appeals, as have other economists (notably Richard Vedder, Lowell Gallaway, Harold Cole, and Lee Ohanian), to factors that also impressed many analysts at the time: rapidly rising real wage rates caused in large part by the Wagner Act’s stimulus of labor unionization, governments’ tolerance of sit-down strikes, and the Roosevelt administration’s vocal hostility—expressed in word and deed—to businesspeople and investors, which caused entrepreneurs and capitalists to fear an impending dictatorship that would greatly weaken or destroy the free-enterprise system. The President’s shrill denunciations of businessmen in 1936 and 1937, his attempt to pack the Supreme Court and reorganize the government, his administration’s stream of tax proposals aimed at fleecing investors, and the New Deal’s many economic regulatory ventures—particularly the Securities and Exchange Commission and the National Labor Relations Board, among many other menacing developments—generated what I call “regime uncertainty,” which helps to explain the extraordinary collapse of investment, especially long-term investment, in 1937 and 1938.