In a recent interview with 60 Minutes’ Steve Kroft, President Obama was asked if he felt he overpromised during the last presidential campaign when it came to fixing the economy. The president responded:
I didn't overpromise. And I didn't underestimate how tough this was gonna be…Reversing structural problems in our economy that have been building up for two decades, that was gonna take time. It was gonna take more than a year. It was gonna take more than two years. It was gonna take more than one term. Probably takes more than one president.
It is uncommon, but I must admit that I totally agree with Obama. However, my agreement with him is for a reason that he did not intend with his remark. He was espousing the view that it would take many more years of Keynesian economic policies to dig ourselves out of the economic ditch. I am saying his position is precisely why it will take many years to recover from the great recession. Essentially history proves that Keynesian economic theory does not work. In fact, it has been proven to make things worse.
An often forgotten (either intentionally or not) economic depression took place in 1920. It was in 1920 that the spending of Congress and the inflation of the dollar by the Federal Reserve in order to fight World War I finally caught up with the U.S. economy. After the artificial boom brought on by government policy busted, unemployment increased from 4 percent to 12 percent. At the same time, GNP contracted by 17 percent. Relatively speaking, the depression of 1920 was as severe as any in U.S. history.
In those days, America still believed in free market capitalism. President Harding’s response was to slash the federal budget almost in half between 1920 and 1922. He also reduced tax rates for all income groups and decreased the national debt by one-third. Additionally, the Federal Reserve did not use its powers to increase the money supply to fight the contraction.
No, the federal government and the central bank’s response were to let the economy liquidate the bad investments that had built up during the spending and inflating of the war years. It wasn’t to try to stimulate the economy back to growth and the Federal Reserve did not attempt to reinflate the economic bubble.
By 1922, unemployment was back down to 6.7 percent and it was only 2.4 percent by 1923. Recovery occurred within two years of the onset of depression and opened the gate for a decade of enormous economic growth.