Hearing of the Economic Policy Subcommittee of the Senate Banking Committee - Lessons From the New Deal

CHAIRED BY: SENATOR SHERROD BROWN (D-OH)

WITNESSES: PANEL I CHRISTINA ROMER, CHAIR, COUNCIL OF ECONOMIC ADVISORS PANEL II JAMES GALBRAITH, LLOYD M. BENTSEN CHAIR, LYNDON B. JOHNSON SCHOOL OF PUBLIC AFFAIRS, UNIVERSITY OF TEXAS; J. BRADFORD DELONG, PROFESSOR OF ECONOMICS, UNIVERSITY OF CALIFORNIA BERKELEY; ALLAN WINKLER, PROFESSOR OF HISTORY, MIAMI (OHIO) UNIVERSITY; LEE OHANIAN, PROFESSOR, UNIVERSITY OF CALIFORNIA, LOS ANGELES

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SEN. BROWN: The subcommittee on Economic Policy will come to order. This is the first meeting of our subcommittee. Unfortunately, it is being delayed. I apologize for the -- starting about 10 or 12 minutes late.

Dr. Romer, thank you for joining us, and the other panel members -- whom I will introduce in a moment.

Senator Merkley will -- there are three votes. I just cast a vote. Senator Merkley will wait until the second votes start; will vote; then come back. And then I will go back; cast another two votes; and then come back. So, we will keep this committee going as Dr. Romer, and then the second panel, testifies -- so, testify.

We're facing an economic challenge few among us have witnessed. Unemployment in Ohio is 9.4 percent, the highest in 25 years. Several counties have rates, in my state, of more than 15 percent. My colleague, Senator DeMint's state -- Senator DeMint is the ranking Republican on this subcommittee, his state of, in his state of South Carolina the unemployment figure is 11 percent.

With all respect to the economists in the room, these numbers don't tell the entire story. Millions of men and women, as we know, are struggling to make ends meet, trying to shield their families as best they can, wrestling with the emotional problems all too common to job loss. We're unfortunately becoming accustomed to the refrain, "worst since the Great Depression." Unemployment reached one in every four workers 75 years ago, and economic output fell from a quarter between -- fell by a quarter from 1929 to 1933.

While not so severe, the policy challenges faced by President Obama and the Congress parallels some of those that Franklin Roosevelt confronted when he took office in March of 1933. Financial institutions are wounded and hesitant to lend. Demand has fallen as consumers lose their jobs -- or, as consumers lose jobs and see their savings diminish. Businesses are cutting workers while scrambling for credit.

We're learning to fear fear itself. Fear of the unknown -- whether it is job security or health security or asset-backed securities, is pervasive. We cannot draw lessons from every aspect of the Great Depression or from FDR's response, but one lesson we should draw is the United States did, indeed, recover from the Great Depression and will, indeed, recover from today's recession.

What lessons can Congress learn from the New Deal that can help drive our economy today? That is the purpose of today's hearing. The New Deal era remains historic for its ambition, for its aid to neediest, and for its lasting policies that helped strengthen the economy and improve the lives of three generations of Americans.

While not all perfect, the New Deal kept millions out of poverty. By 1940, unemployment was down to 12 percent. In real GDP, by one estimate, it had grown 65 percent from 1933.

Much of the New Deal's legacy remains with us today. Investments in infrastructure paved the way for the most dynamic economy the world has ever seen. The Fair Labor Standards Act has guaranteed decent wages and working conditions for millions of Americans, and Social Security has provided a secure retirement for generations of our senior citizens.

In fact, think where we would be today without the Securities and Exchange Commission, and the FDIC and the Banking Act? Americans know that, despite the troubles on Wall Street, their savings at the bank on Main Street are secure.

Until recently there was not much debate on whether the New Deal helped or hurt efforts to recover, but recently some of my colleagues have suggested that the New Deal failed. They argue that it was World War II spending that pulled us out of the Great Depression.

But, this is a false choice, in my opinion. Nothing I've seen or heard disputes the economic impact of our becoming the "arsenal of democracy," but this is not the same as saying that the New Deal was harmful or did no good.

Discussion of the New Deal over the past several months has served as a proxy debate for current economic planning and recovery planning. It's a topic worthy of our examination today.

Thomas Paine, many years ago, wrote, "By comparing what is past with what is present, we frequently hit on the true character of both and we become wise with very little trouble." Let's see if we should be so lucky today.

We're honored to have a distinguished group of witnesses with us today. I look forward to their testimony.

We will begin when Senator DeMint comes, and Senator Merkley comes, and Senator Tester, if he can make it, they certainly can feel free to make opening statements when that happens.

We'll start with Christina Romer. She's chair of the Council of Economic Advisers. She was a Class of 1957 Wilson professor of economics at the University of California-Berkley. Before teaching at Berkley, she taught economics and public affairs at Princeton from 1985 to 1988. She went to high school in northeast Ohio, so she is a Buckeye at heart.

Until her nomination, she was co-director of the Program in Monetary Economics at the National Bureau of Economic Research; and served as vice president of the American Economic Association, where she was a member of the executive committee. She's a fellow of the American Academy of Arts and Sciences.

Dr. Romer is known for her research in the causes and recovery of the Great Depression, and on the role that fiscal and monetary policy played in the country's economic recovery. Her most recent work, authored with her husband, David Romer -- also an economics professor, shows the impact of tax policy on government and on economic growth.

Dr. Romer, thank you for joining us.

MS. ROMER: Well, thank you. And, Chairman Brown, thank you for inviting me to join you today.

As you noted, in my previous life as an economic historian at Berkley, one of the things that I studied was the Great Depression. And in my current life, as chair of the Economic Advisers, I've been on the front lines of the administration's efforts to end what is arguably the worst recession our country has experienced since the Great Depression.

For this reason, I am delighted to be with you today to talk about the lessons learned from the Great Depression and President Roosevelt's New Deal, and how they've helped to inform us -- and I think will continue to help inform us, about the best way to approach dealing with today's crisis. So, to start out, I think the first thing to say is that it's very important to point out that the current recession, while unquestionably severe, pales in comparison with what our parents and grandparents experienced in the 1930s.

February's employment report showed that the unemployment rate in the United States had reached 8.1 percent, an obviously terrible number that signifies a devastating tragedy for millions of American families. But, as you noted, at its worst, unemployment in the 1930s reached nearly 25 percent. Likewise, following last month's revision of the GDP statistics, we know that real GDP has declined about 2 percent from its peak. But, between the peak in 1929, and the trough of the Great Depression in 1933, real GDP fell over 25 percent.

Now, I don't give these comparisons to minimize the pain that the United States economy is experiencing today, but rather to provide some crucial perspective. Perhaps it's the historian and the daughter in me that finds it important to pay tribute to just what truly horrific conditions the previous generation of Americans endured and, again -- as you pointed out, eventually triumphed over. And it's the new policymaker in me, I guess, that wants to be clear that we are doing all that we can to make sure that the word "great" never applies to the current downturn.

Well, while what we're experiencing is less severe than the Great Depression, there are parallels that make it a useful point of comparison and a source for learning about today's down -- about policy responses today. Most obviously, like the Great Depression, today's downturn had its fundamental cause in the decline in asset prices and the failure of -- or near failure of financial institutions.

Over the course of the early 1930s, nearly one half of American financial institutions went out of existence. This, in turn, had two devastating consequences -- a collapse of the money supply, as stressed by Milton Friedman and Anna Schwartz; and a collapse in lending, as stressed by the current Fed chair, Ben Bernanke.

In the current episode, modern innovations, such as derivatives, led to a direct relationship between asset prices and severe strain in financial institutions; and over the Fall we saw credit dry up and learned just how crucial lending is to the effective functioning of American businesses and households.

I think the similarity between the causes -- of the causes between the Depression and today's recession means that President Obama began his presidency and his drive for recovery with many of the same challenges that Franklin Roosevelt faced in 1933. Our consumers and businesses are in no mood to spend or invest; our financial institutions are severely strained and hesitant to lend; short-term interest rates are effectively zero, leaving little room for conventional monetary policy; and world demand provides little hope for lifting the economy.

Yet, the United States did recover from the Great Depression, so what lessons can modern policymakers learn from that episode that could help us make recovery faster and stronger today? In my written testimony I discussed six lessons. I want to, in my oral remarks, let me at least highlight three of them:

I think one crucial lesson from the 1930s is that a small fiscal expansion only has small effects. I wrote a paper back in 1992 that said fiscal policy was not the key engine of recovery in the Great Depression. From this, some have concluded that I do not believe fiscal policy can work today or could have worked in the 1930s. Nothing could be farther from the truth. My argument, in fact, paralleled E. Cary Brown's famous conclusion that in the Great Depression fiscal policy failed to generate recovery, quote, "not because it does not work, but because it was not tried."

The key fact is that while Roosevelt's fiscal actions, through the New Deal, were a bold break from the past, they were, nevertheless, small relative to the size of the problem. When Roosevelt took office in 1933, real GDP was more than 30 percent below its normal trend level. For comparison, the U.S. economy is currently estimated to be somewhere between 5 and 10 percent below its trend.

The emergency spending that Roosevelt did was precedent-breaking. Balanced budgets had certainly been the norm up to that point, but it was quite small. As a share of GDP, the deficit rose by about 1.5 percentage points in 1934. One reason that the rise wasn't larger was that there have been a very large tax increase passed just at the end of the Hoover administration.

Another key fact is that the fiscal expansion was not sustained. The deficit, as a share of GDP, declined in fiscal 1935 by roughly the same amount that it had risen in 1934. And Roosevelt also experienced the same inherently pro-cyclical behavior of state and local fiscal actions that President Obama is facing.

Because of balanced budget requirements, state and local governments are forced to cut spending and raise taxes when economic activity declines and state revenues fall. So at the same time that Roosevelt was running unprecedented federal deficits, state and local governments were switching into running surpluses. And the result was that the total fiscal expansion in the 1930s was actually relatively small. As a result, it could only have a modest direct impact on the state of the economy.

I think this is a lesson that the Obama administration has taken to heart. The American Recovery and Reinvestment Act, passed by Congress less than 30 days after the inauguration, is simply the biggest and boldest counter-cyclical fiscal action in American history. The nearly $800 billion of fiscal stimulus is roughly equally divided between tax cuts, direct government investment spending and aid to the states and people directly hurt by the recession. And the fiscal stimulus is close to 3 percent of GDP in each of the next two years.

We firmly expect this fiscal expansion to be extremely important in countering the terrible job loss that last month's numbers show now totals 4.4 million since the recession began 14 months ago.

A second lesson that we can draw from the recovery of the 1930s, I think, is that financial recovery and real recovery go together. When Roosevelt took office, his immediate actions were largely focused on stabilizing the collapsing financial system. He declared a national bank holiday, two days after his inauguration, effectively shutting every bank in the country for a week while the books were checked. This 1930s version of a stress test led to the permanent closure of more than 10 percent of the nation's banks, but improved confidence in the ones that remained.

Roosevelt also temporarily suspended the gold standard, paving the way for increases in the money supply. And in June 1933, Congress passed legislation helping homeowners through the Homeowners Loan Corporation.

Now, the actual rehabilitation of the financial institutions, actually, obviously took much longer. Indeed, much of the hard work of recapitalizing banks and dealing with distressed homeowners and farmers was actually spread out over 1934 and 1935. Nevertheless, the immediate actions to stabilize the financial system had dramatic short-run effects on financial markets. Real stock prices rose about 40 percent from March until May 1933. Commodity prices soared and interest rate spreads shrank and they actually surely contributed to the economy's rapid growth after 1933.

But it also pointed out that it was only after the real recovery was well established that financial recovery took firm hold. The strengthening of the real economy improved the health of the financial system. Bank profits moved from large and negative in 1933 to large and positive in 1935. Real stock prices rose, business failures fell and this virtuous cycle, I think, continued as the financial recovery led to further narrowing of interest rate spreads and increased willingness of banks to lend.

Well, I'd say that this lesson is another one that has been prominent in the minds of policymakers today. The administration has from the beginning thought to create a comprehensive financial sector recovery program. The Financial Stabilization Plan was announced on February 10th and it's been steadily put into operation since then. It includes a program to help stabilize housing prices and save responsible homeowners from foreclosure; a partnership with the Federal Reserve to help restart the secondary credit market; a program to directly increase lending to small businesses; the capital assistance program to renew the balance sheets of the largest banks and ensure that they're adequately capitalized; and the program we announced just last week to partner with the FDIC, the Federal Reserve and private investors to help move the legacy or toxic assets off banks' balance sheets.

This sweeping financial rescue program is central to putting the financial system back to work for American industry and households and should provide the lending and stability needed for economic growth. At the same time, the fiscal stimulus package enacted on February 17th was designed to create jobs quickly. And in doing so, it should lower defaults, improve balance sheets so that our financial system can continue to strengthen.

The third lesson that I'd highlight from the Great Depression is that it's important not only to deal with the immediate economic crisis, but to put in place reforms that help prevent future crises. Bank runs -- as you surely know -- are one of the key factors in the downturn of the 1930s. In June of 1933, President Roosevelt worked with Congress to establish the Federal Deposit Insurance Corporation. That act, together with subsequent legislation, established the insurance of bank deposits that we still depend on today.

And the FDIC, I think, has been one of the most enduring legacies of the Great Depression. Financial panics largely disappeared after the 1930s and have never truly reappeared. The academic literature certainly suggests that deposit insurance played a crucial role in this development.

One simple, but powerful piece of evidence of the importance of federal deposit insurance is that among the few bank runs that we've actually seen since the Depression were ones in non-federally insured savings and loans in Ohio and Maryland in 1985. And a striking feature of the current crisis has been the continued faith of the American people in the safety of their bank deposits.

And again, this way the reforms instituted in response to the Great Depression almost surely helped prevent the current crisis from reaching Great Depression proportions.

I think the importance of putting in place more fundamental reforms is another lesson of the New Deal that the administration is following. The current crisis has revealed weaknesses in the regulatory framework. Most obviously, we've discovered that financial institutions have evolved in ways that left systematically important institutions inadequately capitalized and monitored.

We've also found that the government lacks the tools necessary to resolve complex financial institutions that have become insolvent in a way that protects both the financial system and American taxpayers. We look forward to working with Congress to remedy these and other regulatory shortfalls. By doing so, we can make the U.S. economy more stable and secure for the next generation.

The very final lesson that I want to draw from the 1930s is perhaps the most crucial -- and it's one that Senator Brown already touched on -- and that's that a key feature of the Great Depression is that it did eventually end. Despite the devastating loss of wealth, the chaos in our financial markets and a loss of confidence so great that it nearly destroyed Americans' fundamental faith in capitalism, the economy came back.

Indeed, the growth between 1933 and 1937 was the highest we have ever experienced outside of wartime. This fact should give Americans hope. We are starting from a position far stronger than our parents and grandparents were in back in 1933 and the policy response has been fast, bold and well conceived.

If we continue to heed the lessons the Great Depression, there's every reason to believe that we will weather this trial and come through to the other side even stronger than before.

Thank you.

SEN. BROWN: Thank you for a very conclusive and comprehensive assessment of that -- and observation of that period.

Dr. Romer, you just mentioned that we had that high growth rate from '33 to '37. Critics of the New Deal will say that the recession within the Depression -- or the second big downturn in that decade that happened in 1937 -- illustrates that Roosevelt's New Deal didn't work, that unemployment went back up -- not as high as it was at the beginning of the decade.

What in your mind -- answer those critics, if you would. And specifically, what in your mind caused that downturn in 1937-1938 that led the critics to make those observations?

MS. ROMER: I think you actually bring up two very important points.

One is when people talk about the Depression being slow -- or certainly the recovery from the Depression being slow -- I think that is really a mischaracterization of the facts. And precisely as you pointed out, in the mid-1930s we just grew incredibly quickly, right? We were growing -- real GDP went up at about 10 percent a year for those three years in sort of the first three years of the recovery.

But part of what happens is then we do obviously have that second recession in 1938. In my mind, it is absolutely -- it's caused by two fundamental things. I think here I listen very strongly to Milton Friedman and Anna Schwartz who say it was a monetary contraction.

And actually, in my written testimony it's one of the other lessons that I draw from the New Deal is the importance of not cutting back on stimulus too soon, because I think one of the things that happened in 1937 is the Federal Reserve got nervous, all right? They said -- you know, they were worried that should they need to tighten the economy. There were so many excess reserves in the economy they thought, well, gee, maybe we can't do this.

So what they did was to just raise reserve requirements thinking it wouldn't have any effect. They just changed excess reserves to required reserves. What they didn't count on was that banks were nervous. They'd just been through the Great Depression and all these banking panics. And so they scrambled to get more excess reserves over the new higher level. And so we absolutely have a pretty severe monetary contraction in 1937 that pushes up interest rates, reduces lending and I think that's an important part of it.

The other is you do get some fiscal contraction as well. That sort of in 1936 we've had a big veterans' bonus -- so kind of a big sort of chunk of government spending that then disappeared in 1937. 1937 is when we first collect Social Security taxes and so we do have a certain fiscal contraction and I think that also played a role.

But I think neither of those would you are say are in any way an indictment of the New Deal policies. I think they are an indictment of using those tools of monetary fiscal policy not very well, right? And sort of inadvertently doing monetary and fiscal contraction.

SEN. BROWN: Some critics will argue then that the recession of '37, '38 was in part a response to wage hikes -- minimum wage had been implemented -- 40-hour work week I believe was beginning that there was collective bargaining, that wages were going up, that some critics will say that that was a sort of an artificial distortion of the marketplace. Weigh in on that if you would; in other words, do higher wages in effect cause less employment and therefore a contraction in the economy?

MS. ROMER: So, you know, I think that was a story that was out there, the way it's usually described was that firms in anticipation say of labor strikes that might be coming because of the new collective bargaining rules; sort of produced a lot in 1936 and 1937, kind of got a big run up in inventories and then cut back in 1938.

My own read and evidence is that there's not much sign that that was really the key thing going on. And here I guess I would invoke Milton Freedman, right, if there was ever a person that would tend to think that unionization or high wages or things might cause a recession, he'd be one of them. And yet he's probably, he and Anna Schwartz are the strongest proponents of the monetary explanation for what happened in 1937 and '38.

So I certainly think that the evidence is much more strongly on the side that it was an aggregate demand contraction that was the main reason for that downturn.

SEN. BROWN: And fiscal stimulus -- my understanding, you touched on this -- is Roosevelt in '37 '38 pulled back on, well one with the tax increase in Social Security. That was the only tax increase?

MS. ROMER: That was --

SEN. BROWN: That was relatively significant in that day's economy.

MS. ROMER: Yeah, it was not very large. So I think again if you're doing the weighing of these things, I would say the monetary contraction was more important. I would say the tax increase at the time -- I mean it was significant but it was not large. I don't think it was certainly large enough to cause the kind of downturn we saw by any means.

SEN. BROWN: And you also pulled back on the government expenditures and --

MS. ROMER: Absolutely. So we've had -- and it's again it's almost a little bit of an accidental thing in the sense that we had had a big surge in expenditures in 1936. It was a veterans' bonus, a bonus to World War I veterans --

SEN. BROWN: But not in '37, '38? That --

MS. ROMER: Right. So it was it in '36 and then it disappeared in '37, so if you look at the path of government spending it goes way up and then back down.

SEN. BROWN: As an economist, teach me something from sort of a bird's eye view here if -- many of my colleagues are concerned about the level of spending and borrowing. That same group wasn't all that concerned a year or two ago with spending and borrowing, but that's more of a political point that I don't want to get into. Can we do this -- why can't we do this through the Federal Reserve rather than fiscal stimulus? Talk me through what the difference is and why we need both in the economy rather than just the Fed, rather than pursuing monetary policy?

MS. ROMER: Gladly. So I would've said, you know, sort of again if you look at my sort of life's research, a big part of it has been pointing out that monetary policy is very effective. And I think if you had asked me five years ago in response to recession, sort of what's the main tool that one uses, it's monetary policy. And the usual reason for that is to say that is one it's very effective, and second, it's something that can be changed pretty quickly. And certainly the usual view if you do sort of the history of post war policy, you know, the record on using fiscal policy well had not been very strong; that we've, you know, the times we had tried to do fiscal expansion, we often did it too late, and so it tended to come after the recession was already over and things like that.

So that's all kind of a way of background of saying I think this time is different. The first is, you know, a typical post-war recession quite honestly was caused by monetary policy. A typical recession is the Fed would've tightened because they were concerned about inflation. The economy would go into a recession and then it was pretty obvious how you got out of it. They just loosened again, right?

What was very striking, this recession is very different in that it -- you know, the interest rates were already quite low when the trouble in our financial markets, the collapse of housing prices started. And so sort of the amount of room that we had to expand monetary policy, bring interest rates down, was not particularly large.

The other thing to say is we used the tools that we had, right. Very quickly the Federal Reserve did do a big monetary expansion and I would certainly say the Fed has been quite creative in trying to restart lending markets and trying to do expansionary, their usual expansionary policy. The problem that we faced is it wasn't enough, and I think that's the key reason why we need the second tool now, why we need fiscal policy.

The other thing and here I just -- you know, I mainly want to compliment Congress in the sense that I think this really is a triumph that we passed such a big, bold fiscal stimulus act at a time before we'd even hit bottom of the recession, right. That is very unusual to get our act together and get the aid that the economy needed through the fiscal side as quickly as we did.

But I think the main answer to your question is in a recession this big, you needed both of them.

SEN. BROWN: Thank you very much, Doctor, for coming to testify, and we appreciate the work you're doing. And I'm just going to continue with some of the questions that folks were interested in.

MS. ROMER: Mm hmm.

SEN. JEFF MERKLEY (D-OR): When you were studying and writing on the New Deal in the 1990's, did you ever imagine you might someday put that knowledge to use outside an academic setting?

MS. ROMER: I have to tell you I didn't. That, you know -- and when I think back of the number of times that I you know, would tell my introductory economics classes that -- you know, well the one thing I was sure of is you know we'd never face, you know, bank runs again. And so, you know, the first time that I saw people lining up outside a bank out in California last summer, it just -- or last fall I guess, I never dreamt that those kinds of things would ever happen again.

So, you know, I do want to come back to the point that even though I think the research is quite useful now, I mean, I do want to make it clear conditions are quite different, right, that as bad as things are, what our parents and grandparents went through, were certainly much worse.

And I like to think it's because we have learned a great deal and I do think that we've spent the last 60 years getting a much better handle on the economy. And I think part of the reason -- you know, I would say that the shock the economy has faced in this downturn are probably almost as big as what we saw in the Great Depression, the disruptions in our financial institutions, the collapse of asset prices, all of those have been just huge macroeconomic shocks. And I think the very fact that we are where we are today and not somewhere much worse is at some level because we've had a much better policy response.

SEN. MERKLEY: Thank you. Your predecessor as chair under President Bush now Fed Chairman Ben Bernanke, and there was fiscal action a little over a year ago. This suggests that pretty broad consensus among economists as he put it, quote, "fiscal monetary stimulus may provide broader support for the economy than monetary policy alone". Is there a fairly broad consensus among economists for the need for such stimulus?

MS. ROMER: I feel there is, I mean, one certainly there is always a certain amount of disagreement among economists, but I think one of the things that's been striking in this downturn is the degree to which there has been a professional consensus. I know back in December when we were thinking about you know, designing a fiscal stimulus and how big it should be, one of the jobs that I took on was just calling a wide range of economists from, you know, both ends of the ideological spectrum. And there was just, you know, you got a few people that would say no I don't think we need any and there was a number that would say I think it should all be in the form of tax cuts.

But what's really striking is the consensus that we needed something, that it needed to be big, that you know, we had tried monetary policy, we had done a lot there but we needed more. So I do think there is a strong professional consensus.

SEN. MERKLEY: You know, one of the things that I'm interested in getting your perspective on is that we not only have substantial national governmental debt, but we also have sizable consumer debt. When those are taken together, consumer and government debt, is there any parallel to the Great Depression in terms of percent of GDP or are we way beyond the level of debt that was carried, even at the height of the Great Depression?

MS. ROMER: I would say we -- I mean, I should check the numbers but I'd say we certainly are higher. I mean, one of the things that is important to realize is, right, before the Depression started, very much the norm had been a balanced budget. And so the debt to GDP ratio -- you know, we made a lot of progress coming out of World War I and had retired a lot of it. Likewise in the 1920s it had been sort of the beginning of the consumer, you know, durables revolution, people started to buy cars and appliances and things. But even so, consumers were certainly much less in debt than now.

So that certainly I think is a change between the 1930's and today.

SEN. MERKLEY: I saw a chart in a magazine article a year or so ago that seemed a little surreal to me. And I believe that what it showed -- and it was combining consumer debt and governmental debt -- was that during the height of the Great Depression, the debt to GDP, the combined debt, reached about two and three quarters times the GDP, not so much because the debt surged in the Depression, but because of the economy tanking. And the chart showed this combined debt now and now being about a year ago, had exceeded that height, the Great Depression was still headed straight up.

Those numbers are not -- I don't normally hear those numbers in the debate because we don't really talk about the combination of consumer and governmental debt. But -- but let's say this is -- are we out -- is it in the ballpark that we may be well over three times the GDP with the combination and -- and if so, how does that really constrain our ability to recover in this economic downturn?

MS. ROMER: I think on the numbers I'd just have to -- to go back and check them so it's not one that I have on -- on the top of my head. I think the place where economists are thinking certainly about the consumer debt is both consumer debt and I guess the other thing we talk a lot about is consumers have seen their wealth decline. At the same time, you know, they add a certain amount of debt. They've also seen their 401Ks and the value of their house go down.

And so how that kind of change in the household balance sheet is going to affect what they want to do going forward I think is an important question and certainly I think most economists predict that we're going to see consumers having a higher savings rate. We're already seeing that, and my prediction is that's what's going to be true as we go forward even once we're out of -- of this particular downturn. And so that's going to be an adjustment to the American economy to the degree that we have been, you know, sort of living on a consumer that was -- was going into debt and sort of spending beyond their means.

It is going to mean a readjustment, and I think it could be a very healthy readjustment in the sense that what would normally happen in an economy if consumers start to save more that tends to bring down interest rates in the economy. That tends to encourage investment and, you know, certainly from an economic perspective I think that would be good for the economy and would -- would put us on a path to a more sustainable future and a higher growth future.

SEN. MERKLEY: You know, so much of our effort now involves generating dollars through the Fed as well as appropriated response in terms of creating the stimulus. Do we have a very good way of judging the tipping point at -- at which the international community becomes concerned about the long-term health of the -- of the dollar?

MS. ROMER: I -- I think what -- what I would say is we probably don't have a good way of -- of judging it other than to say I'm -- I'm virtually certain we're -- we're not anywhere close to being at a tipping point. So I think what we have seen in this -- in this particular downturn, especially with the -- with the uproar in financial markets, what I found very striking is the degree to which in times of crisis everybody wants to invest in the United States, right. We've seen a lot of our interest rates in fact come down because foreigners want to hold American assets and the dollar.

So, you know, you raise, I think, a legitimate point. Mainly, you know, the way I think about it is sort of going forward. We do know that our budget deficit is very large, mainly because one, we inherited a large deficit, the economy is in a terrible way, and we're having to spend a lot to get out of this. But it is certainly something that I -- I don't feel can or should be sustained -- that it is something -- you know, the president has certainly said he wants to get this down, is committed to -- to bringing it down, and I think that is ultimately going to be important for everyone maintaining faith in the U.S. government -- that we need to show signs that we are going to get the deficit under control, make real progress, and I think that's something that the world will be looking at.

SEN. MERKLEY: You know, within the stimulus plan there's three major emphases in terms of restructuring our economy. And so I wanted to ask you about each of those starting first with the energy side -- and I apologize if I'm repeating any -- any questions that the chair had before he left. But specifically, the argument that we need to insulate ourselves from foreign energy price spikes such as we had last year driving $4 a gallon gas and just kind of the vulnerability, perhaps national -- the national security vulnerability as well as the economic security issue. And how important is it to use this opportunity to restructure our energy consumption and are the -- are the strategies that are in the stimulus the -- the right ways to do that?

MS. ROMER: I think you raise a great point. I mean, so there are a couple of things. One is your -- your mention of the stimulus package. One of the things that the president working with Congress felt was important is that if we -- if we need to be spending money to get the economy out of recession we ought to spend it wisely and so one of the things that -- that I think we all tried to do is to do things that we thought would benefit the American economy going forward.

And I think you're absolutely right -- anything that -- that helps to wean us off foreign oil we think is going to be good for the economy. We certainly think that the -- in the Recovery Act we had various incentives for alternative fuels, incentives for increased efficiency like weatherization, federal buildings, low-income housing. I think all of that are incredibly important and things that we probably should be doing more as we go forward and that's certainly been one of the key areas that the president has identified that even as -- as tough as times are now -- energy independence, weaning us off foreign oil, dealing with the long-run effects of -- of climate change -- I think that -- that he very much thinks warrant important investments.

SEN. MERKLEY: So one side of the energy puzzle is -- is certainly using less energy, using less oil. Another side is putting the United States in the position of manufacturing products, both intellectual property products -- patents, et cetera -- and actual physical products -- wind turbines, solar panels, et cetera -- to sell to the world. How important is the positioning ourselves in terms of the manufacturing side of the -- of the energy puzzle?

MS. ROMER: Certainly, the president has identified that as, you know, the -- sort of the alternative energies and the -- the manufacturing that goes with wind turbines and solar panels as -- as a win-win, right, so it's something that strengthens our economy, creates jobs here, and put -- you know, makes us be more efficient and able to -- to use the kinds of energy that we have here that are renewable and aren't coming from abroad.

SEN. MERKLEY: I heard a statistic today -- I'm not sure if this is -- is accurate or not -- that for every month of the last eight years, for every single month we have lost manufacturing jobs in this country. Is that -- is that accurate? Every single month?

MS. ROMER: That -- I'd have to check every single month. I certainly know it's -- it's actually been very striking. We actually -- the Council of Economic Advisors -- this has been an issue that we're very interested in. It's certainly a priority for the president, and so we've been doing some work looking at the decline in manufacturing. It's very striking.

You go back to, say, the 1982 recession and what's really been true after sort of each recession is you never quite come back to where you were before and -- and that we do see this -- this long-run decline in manufacturing and that's -- you know, so part of what, you know, we're experiencing now in Michigan, Ohio, Indiana where we see not only the effects of the very severe recession that we're in but this long-run decline in the manufacturing base, especially sort of the -- the Midwestern heavy industrial manufacturing base. It is absolutely a trend that is there.

SEN. MERKLEY: Is the preservation and expansion of a middle class in our country dependent upon the -- the expansion of manufacturing or are there alternative strategies to -- to have a large percentage of Americans in the -- in the middle class?

MS. ROMER: That's, again, a terrific question. You know, what I would say there -- there is a -- there is a sense that somehow there's something special about manufacturing or -- or -- and for an economist I think that is, you know, that we -- we have less trouble maybe than most in trying to -- you know, saying even if you can't see it -- you know, a service like a, you know, providing a mammogram for someone. Well, that's as much a -- a good thing as if, you know, you make a -- a motor or something.

So I wouldn't draw that kind of a distinction. But what has been true is that manufacturing jobs tended to be good, high-wage kind of jobs and so, you know, certainly one way to -- to sort of maintain the middle class or grow the middle class is to grow that sector of the economy. If that doesn't work, what you absolutely need to do is to create other kinds of jobs that -- that have those same characteristics.

So whether they are, you know, very, you know, services that require a certain amount of training, but whichever the case is you certainly need to be creating the -- the good jobs at good wages. That's what's fundamentally good for -- for making a big, strong middle class.

SEN. MERKLEY: Let me turn to the area of education --

MS. ROMER: Mm hmm.

SEN. MERKLEY: -- and I have often said that the success of our economy a generation from now depends on our investment in education today. But that's -- I'm a layman. I'm not an economist. Do we see a correlation in, as we look at economies around the world, in terms of their investment in education paying off in terms of the strength of their economy years down the road? And what -- what can we take -- what can we take from our observation of statistics around the world -- performance of economies around the world to help guide us in terms of our investment in education?

MS. ROMER: This -- this may be a very good question to ask Brad DeLong when he's on the next panel. Certainly, when you do the growth accounting, I think, across countries -- what we'd call human capital formation where that's mainly education -- I think the evidence is that it is quite important to the -- to the development of countries and to their ultimate economic success. Certainly, the -- the empirical literature on sort of the returns to education, how important it is, it's inherently hard precisely because which countries tend to invest more in education and so disentangling the causation. But certainly my own read of the literature is that there is a strong correlation and I think the causation (runs ?) from investments in education do indeed make you a stronger economy able to produce more, able to command higher wages.

SEN. MERKLEY: Are there further distinctions between the types of investment in education that we should be aware of as we -- we think about this issue of strengthening our economy, getting the most bang for the buck for investment in education?

MS. ROMER: Certainly, I think if you -- if you had my colleague on the Council of Economic Advisors, Cecilia Rouse, I think one of the things she would tell you is junior colleges are one of the places where you get some of the highest returns, sort of those -- that -- that those I think have certainly shown to be a very good investment in terms of both how much it costs to provide that education and the kind of jobs that you're able to get with an Associates degree. In -- in general, I think, you know, all types of education are good and, you know, certainly more is -- is -- is better. I think there is a certain amount of evidence that job training is -- is very good.

SEN. MERKLEY: Doctor, thank you.

I have just one more question for you, and that is turning to the health care side. We invest about a sixth of our economy -- about 18 percent; a little more than a sixth -- in health care, and yet Europe and Canada and many other modern, manufacturing economies are spending a great deal less. Is our health care structure a competitive disadvantage, and do we have to overhaul health care, not only for the quality of life of our citizens but in order to be competitive internationally?

MS. ROMER: I have to say it is. I think that is exactly why, again, even as tough as economic conditions are now, the president has identified reforming our health care system as a priority that can't wait. I think he would have exactly the point of view that you just mentioned, that this fact that the cost of health care is rising so rapidly in the United States -- faster than GDP and other costs -- has been certainly something that is bankrupting businesses; it's hard on households, and it's ultimately very hard on the federal government. So I think it is crucial.

SEN. MERKLEY: Thank you very much, Doctor. It's my turn to dash to the floor to vote. Thank you.

MS. ROMER: (Laughs.) Thank you.

SEN. BROWN: Thank you, Senator Merkley.

And Dr. Romer, thank you for your time. Thank you for your testimony, and especially thank you for your public service.

MS. ROMER: It's been lovely to be here. Thank you for having me.

SEN. BROWN: The chair will call up the next panel. Allan Winkler, James Galbraith, Lee Ohanian, and Brad DeLong; if the four of you would join us, please.

And we'll take a moment's break until they come forward.

We'll come to order again. Thank you all for joining us.

Dr. Allan Winkler is -- I will introduce all four panelists. We very much appreciate your coming and joining us today and sharing your wisdom and your thoughts and ideas with us. I'll introduce all four panelists and then we'll begin the testimony, Dr. Winkler, from you, left to right.

Dr. Winkler is distinguished professor of history at Miami University in the great state of Ohio. Thank you for joining us. He's taught at Yale University, the University of Oregon, and for one year each at the University of Helsinki in Finland, the University of Amsterdam in the Netherlands, and the University of Nairobi in Kenya. A prize-winning teacher, he's the author of 10 books, including Franklin Roosevelt and the Making of Modern America.

Dr. James Galbraith, whom I met in 1972 for the first time, teaches at the LBJ School. He holds degrees from Harvard and Yale -- Ph.D. of economics in 1981. He served in several positions on the staff of the U.S. Congress, including executive director of the Joint Economic Committee. Dr. Galbraith is the senior scholar of the Levy Economics Institute and chair of the board of Economists for Peace and Security, a global professional network. He writes a column for Mother Jones and occasional commentary in other publications, including The Texas Observer, The American Prospect, Washington Monthly, and The Nation.

Lee Ohanian has been a professor of economics and director of the Ettinger Family Program in Macroeconomic Research at the University of California-Los Angeles since 1999. Thank you for joining us, Dr. Ohanian. He also taught at the University of Minnesota and the University of Pennsylvania. He's a research associate at the National Bureau of Economic Research and has consulted in various capacities for the Federal Reserve. He's published numerous studies on the New Deal, and I've read one of his recent articles in The Wall Street Journal. So, welcome.

Brad DeLong is professor of economics at UC-Berkeley, chair of the Political Economy of Industrial Societies major, and a research associate of the National Bureau of Economic Research. He was educated at Harvard. He received his Ph.D. from that institution in 1987. He joined Berkeley as an associate professor six years later and became a full professor in 1997. He's been a fellow of the National Bureau of Economic Research, an assistant professor of economics at Boston University, and a lecturer at the Department of Economics at MIT. Professor DeLong also served on the U.S. government as deputy assistant secretary of the Treasury for economic policy from 1993 to 1995.

Dr. Winkler, let's begin with you. Thank you.

MR. WINKLER: Thank you very much, and it's a pleasure to be here for two reasons: First of all, as a historian I've spent a lot of time reading hearings and transcripts, and to be here is something I appreciate very much. Second, my father was a beneficiary of the National Youth Administration during the Depression. That allowed him to continue his education at the University of Cincinnati and made a huge difference in his life.

The New Deal basically was a response to the worst crisis in American history. It involved efforts to promote relief, to deal with the ravages of the Depression and create recovery, to reform elements of the American system, and it worked in all three different areas. And yet it wasn't a planned operation; it was haphazard, it was often contradictory, and elements in one area worked against the grain in terms of elements in another, and that is a large part of how we have to view it these days.

As Christina Romer indicated earlier, monetary policy played an important role. Fiscal policy likewise could have but was not really tried, in part because the conventional wisdom of the day didn't really understand where things were at that point.

The New Deal revolved around Franklin Roosevelt, who was an extraordinary leader. In his inaugural address when he talked about the need for "action and action now," he sounded just the right note. His comment that "the only thing we have to fear is fear itself" was something that really created a sense of confidence in the American people, and that was hugely important in what followed.

In the first hundred days launched almost immediately after the inauguration -- the important element here is that there was no complete coherent plan of what was going to happen. The banking crisis then, as now, was a major issue that had to be dealt with. The Emergency Banking Act was pushed through almost without having printed it and by a voice vote, and with that kind of momentum Roosevelt proceeded from one thing to another, and it went on from there.

Overall the New Deal did a range of different things. In the relief sphere there were a series of early initiatives that culminated in 1935 with the Works Progress Administration that put all kinds of people ranging from artists and authors and the like, as well as laborers, back to work, and that was hugely important. Recovery was something the New Deal recognized it had to deal with, and the National Industrial Recovery Act, creating the NRA, was again important in that area, even though it never worked particularly well, as I'll come back to. Reform elements were hugely important in the New Deal, ranging from creation of the Securities and Exchange Commission to Social Security in 1935, to the Wagner Act to deal with collective bargaining and the like.

The New Deal was important. It made some huge contributions. It put people back to work. It saved capitalism. It restored faith in the American system and revived a sense of hope in the American people. And yet economically, it never worked as well as it could have. As Christina Romer pointed out, monetary policy did lead to an expansion in the economy, and yet because we were starting at such a rock-bottom low level those elements were not as important as otherwise they might have been.

But fiscal policy was the real question. In 1936, John Maynard Keynes published his major work, The General Theory, in which he argued the Depression was not automatically going to disappear if you simply waited it out; that what was necessary to make that happen, in his phrase, was "deliberate, sustained, countercyclical spending." It was necessary for private spending to occur if that could happen; if not, the government needed to step in.

And yet Keynesian analysis never really caught hold during the Great Depression. Keynes and Roosevelt met one another on a couple of brief occasions. Neither man understood the other. Keynes understood the New Deal was not proceeding in the directions that he would have counseled, and that was important. And the contradictions in economic policy, according to Keynesian analysis, really give us some perspective on what was happening. Acts like the Agricultural Adjustment Administration -- the act creating that called for a processing tax that cut into the money that was being spent to pay farmers not to produce. Social Security, as was pointed out, was taking money out of people's pockets in 1937, with pensions not to begin until 1942. The cities and states trying to run surpluses or at least balance their budgets worked against the grain of what was happening with regard to larger government spending.

When the economy tanked in 1937, when Roosevelt cut WPA rolls significantly, when he cut back on the budget so that it was about a third of what it had been before, the economy went into recession. The lesson learned then was that if you began to spend you could bring it back, and that was what happened in the next couple of years.

What do we take from all of this? I would suggest the lessons are very clear.

Government can make a difference. A major stimulus, according to Keynesian analysis, is necessary and essential and can promote recovery.

It's, above all, important for us to ensure that measures do not work in contradictory ways, and to allow the stimulus to take the effect that it can have.

Thank you very much.

SEN. BROWN: (Off mike) -- Dr. Winkler.

Dr. Galbraith?

MR. GALBRAITH: Thank you very much, Chairman Brown. It's a privilege to be here to discuss the New Deal and its relevance to our present troubles.

In my view, we can distill three main principles for economic policy from the Great Depression, the New Deal and, ultimately, from the Second World War.

The first is that unregulated capitalism is not necessarily self- correcting. Mass unemployment, which a previous generation of economists thought was always going to be a temporary aberration, can in fact occur, and it can persist with no automatic tendency for it to disappear.

The second is that direct economic intervention by public policy works best when it is targeted directly to the broad population, rather than filtered through those at the top. And, of course, when it is implemented on a sufficiently large scale.

Now, we can come back to the discussion of whether the New Deal operated on a sufficiently large scale. Certainly in the Second World War, we did.

Third -- and Professor Winkler has already alluded to this -- the fiscal cutbacks which produced the recession of 1937-'38 showed that backtracking is disastrous. There is --

There will come a time when the private economy is sufficiently robust and resilient to launch and sustain economic growth on its own, but that time need not come particularly soon, and to anticipate it prematurely can lead to a severe interruption of the progress toward recovery.

In my brief remarks to follow, I shall summarize points that are made in greater detail in my written testimony, basically in four areas.

The first is that, like our present troubles, the Great Depression flowed from a collapse of the banking system and of asset values -- the great crash of October 1929 and subsequent events.

This was a fundamental and unprecedented development in the American economy in the depth and extent of the financial calamity, and it eliminated the possibility that recovery could be led by a revival of the financial system.

The result of this was that Roosevelt effectively bypassed the financial system via public spending and also direct lending to the private sector through the Reconstruction Finance Corporation and other vehicles.

I do not particularly subscribe to the view that monetary policy caused the Depression. I think that view was advanced by those who seek to minimize the inherent instability of the financial sector in those days, and nor do I subscribe to the view that monetary policy played the principle role in getting us out.

Second point, much of the New Deal is not, in fact, about fiscal expansion, but about the creation of a comprehensive network of social insurance and social protections -- the construction of institutions for collective action inside the population, including trade unions.

And this was true, for example, of the philosophy behind deposit insurance, behind the creation of the Social Security system to protect the elderly, behind the Agricultural Adjustment Administration, and also the much-maligned National Industrial Recovery Act, certainly true behind -- of the philosophy behind the National Labor Relations Act and the creation of the minimum wage.

Each of these institutions played an important role in reducing the amount of instability, insecurity, and privation in the broad population, and played an important role in the moral and psychological recovery from the Great Depression, even if its -- their contributions to aggregate effective demand and economic growth may appear, in retrospect, to be relatively modest. Strengthening social insurance is therefore extremely important.

Thirdly, there were, of course, massive employment programs in the early -- from the beginning of the New Deal -- 3.5 million or so people employed in jobs directly in the public sector. And this had a very important effect.

It's important to say that the principle behind these programs was not a short-run Keynesian stimulus. It was not designed to return the economy quickly back to the normal, the allegedly normal condition of the 1920s, but rather to provide immediate and necessary relief to legions of people who would otherwise not have been able to eat.

And it's important also to note that in terms of the effects on unemployment, the impact of these programs has been largely misstated in the literature, in a great deal of the literature, because economists in subsequent eras have adopted the habit of not counting people who worked for the New Deal as employed, although, in fact, they were fully employed, working every day and being paid for their labors.

And finally, in addition to its employment programs, the New Deal embarked on a massive program of public investment which was strongly oriented toward the long term, toward the benefits of education, transportation, art, culture, and conservation.

Those programs also had macro economic effects, but the important thing about them is that they in fact rebuilt the country. And I just want to close with a brief quotation from a recent paper by an economist named Marshall Auerbach, which I think captures the flavor of this particular aspect of the New Deal in a very effective way.

He writes, "The government hired about 60 percent of the unemployed in public works and conservation projects that planted a billion trees, saved the whooping crane, modernized rural America, and built such diverse projects as the Cathedral of Learning in Pittsburgh, the Montana State Capitol, much of the Chicago lakefront, New York's Lincoln Tunnel and Triborough Bridge complex, the Tennessee Valley Authority, and the aircraft carriers Enterprise and Yorktown."

It also built or renovated 2,500 hospitals, 45,000 schools, 13,000 parks and playgrounds, 7,800 bridges, 700,000 miles of roads, and 1,000 airfields. And it employed 50,000 teachers, rebuilt the country's entire rural school system, and hired 3,000 writers, musicians, sculptors and painters, including Willem de Kooning and Jackson Pollock.

The point, I think, being is that the New Deal was not an effort to return the country to the prosperity of the 1920s, but rather it recognized that the conditions of that period could not be recreated, set about to do something quite different, and did so with very considerable success.

Thank you.

SEN. BROWN: Thank you, Dr. Galbraith.

Dr. Ohanian, thank you. Welcome. Thank you for coming all the way from California. Welcome.

MR. OHANIAN: Thank you, Mr. Chairman.

Over the last decade, much of my research has focused in the area of economic crises, including work on the Great Depression and the New Deal.

My findings indicate that some New Deal policies -- those that impacted industrial product and labor markets -- delayed recovery by impeding the normal competitive forces of supply and demand from operating.

My research also indicates similar policies put in place by President Hoover also had a significant contributing effect during the early 1930s.

In terms of policies that I studied, one stands out, which is the National Industrial Recovery Act.

The NIRA was collusive. It permitted firms within industries to cooperate and coordinate on setting minimum prices, on restricting expansion in plant and capacity, provided that they paid wages that were well above trend.

Expanding monopoly depresses output and employment, and setting wages above trend or above levels consistent with market clearing makes labor expensive and leads employers to scale back on employment.

The NIRA was declared unconstitutional in 1935, but my research indicates that New Deal-type policies continued after that through lax prosecution of antitrust and, on the labor side, through the National Labor Relations Act, which substantially increased labor bargaining power during the short period of time unions and workers used the sit- down strike, in which workers occupied factories to prevent production, with great success against companies, including GM and U.S. Steel.

Immediately after the Supreme Court upheld the constitutionality of the Wagner Act, wages in a number of industries considered by the FTC to be collusive jumped significantly. This was in, I believe, May 1937, right at the start of the '37-'38 contraction.

There is significant evidence that these specific New Deal policies impeded recovery. Some evidence is that the recovery was delayed. Figures one and two in my testimony show per capita output, consumption, and investment and hours worked.

Per capita consumption relative to its normal 2 percent trend recovers hardly at all.

Per capita investment does recover, rising from about 80 percent below trend in this trough in 1933, but still remained more than 50 percent below trend by the end of the decade.

Other evidence -- and what I can point out is that the recovery failure seems particularly striking in that the economic fundamentals that were in place at the time seemed -- a number of them seemed to be very healthy. Productivity growth grew very rapidly after 1933. As mentioned earlier, the banking system had been stabilized. Liquidity was plentiful. Deflation had been eliminated.

And a number of economists ranging from Milton Friedman to Nobel Laureates Robert Lucas and Edward Prescott have pointed to the weak recovery and asked -- thought about whether government policies were important here.

Other evidence is that in the sectors that were covered by these New Deal policies -- in particular, much of major manufacturing -- wages and prices did indeed jump after NIRA codes of fair competition were adopted. Moreover, not only were prices and wages higher in these sectors, unemployment was low. In sectors that weren't impacted by the NIRA -- for example, the agricultural sector -- employment remained high and wages were below trend.

That's the most compelling evidence about the failure of the market economy at that time -- that it was distorted -- come from the fact that hours worked is low, consumption's low, but the real manufacturing wage is well above trend -- 10 to 15 percent above trend. The coincidence of such a high wage, in conjunction with the Depression, is puzzling, because you would usually think competitive forces would push down that wage and raise employment, consumption and output.

The main lesson, I believe, to be learned from the New Deal is that while a number of New Deal policies were really quite useful, some -- those that distorted product and labor markets impede the normal force of competition -- delayed recovery. And that when we consider policy in a future crisis, and we adopt what I might call crisis management policies to cushion the impact of a crisis on the economy, that those policies be consistent with good, long-run economic incentives.

Thank you very much.

SEN. BROWN: Thank you, Dr. Ohanian.

Dr. DeLong, thank you for coming all this distance to be with us.

MR. DELONG: (Off mike.)

SEN. BROWN: Your microphone's not on.

MR. DELONG: (Off mike) -- from the New Deal requires first understanding what the New Deal was.

Franklin Delano Roosevelt took everything that was on the kitchen shelf and threw it into the pot on March 4, 1933 and then began to stir it -- fishing things out that seemed not to be so tasty and having the Supreme Court fish a good deal of it out as well --adding spices, adding new ingredients, all the while watching the thing cook.

Now, the aspects of the New Deal we focus on today is the expansionary monetary aspects -- the conventional interest rate reductions, the quantitative easing by the Federal Reserve of the late 1930s, banking sector nationalization and recapitalization and fiscal policy expansion. How effective were these?

Well, I think there is a broad near consensus that the expansionary macroeconomic policies of the New Deal era were effective. Had Senator McCain won the presidential election now, last November, the first panel here would not have had Christina Romer. She would be back at Berkley and I would not be having to teach her course this semester.

Instead, if would have some someone like Douglas Holtz-Eakin or Kevin Hassett or Mark Zandi -- one of John McCain's senior economic advisers -- all of whom would be arguing that New Deal-like monetary and fiscal stimulus programs were effective, as part of arguing for the McCain fiscal stimulus program, that would in all likelihood -- or the McCain banking recapitalization program -- that would with all likelihood be proceeding through the Congress.

Now, back at the start of the Great Depression none of the major industrial powers of the world pursued these expansionary macroeconomic policies. They held, instead, that the government is best which governs least -- as far as interventionist policy is concerned -- and they bound themselves with the golden fetters to the gold standard. Only when these were broken could a new deal begin in any of the major industrial countries.

And we know when each of the five major industrial countries of the world back during the Depression cast off its golden fetters and began its new deal. We know also how quickly each of them recovered from the Great Depression -- that's the chart up there on your right.

There is a very strong correlation between how early a country abandoned gold and began its own individual new deal on the one hand, and how rapid and complete on its recovery was on the other -- as this chart I have reproduced from Barry Eichengreen's 1992 article and then scribbled on myself shows.

Those economies that abandoned the gold standard and started expansionary monetary and (do less as their extent ?) fiscal policies in 1931 did best. Those that abandoned the gold standard in '33 did second best. France, which waited until the very end of the 1930s to start its new deal, did worse.

Statisticians will tell you that if you thought before looking at this chart that it really didn't matter what a new deal did -- that the plusses and the minuses of new deal policies largely offset each other, that if you thought there was only a 50/50 chance that new deals mattered before looking at this chart, that after looking at this evidence you would be 95 percent sure that new deals mattered.

Which part of fiscal and monetary expansion of the new deals in all the different countries mattered? Probably all of them. It is difficult to write down a model of the economy in which some tools work and others do not. All four of the aspects operate through boosting spending -- either through boosting the money stock and hoping the velocity of money will remain unchanged, or through boosting the velocity of money and hoping that the money stock remain unchanged. And any model of the economy in which increases in spending cause not just inflation, but also boost employment and output, will see that all four of these policy tools are likely to be effective.

Which of the four components of macroeconomic policy help the most in the New Deal's aiding of recovery? That's a much more difficult question.

Christina Romer, who was here before, places enormous stress on the quantitative easing policies of the late 1930s; the mammoth expansions of the money supply -- even after interest rates on Treasury securities had already been reduced to effectively zero -- and says it played the most major role. Professor Galbraith earlier dissented from that.

Did the fiscal policy expansions help? Well, as Christina Romer said earlier, there were so little of them that it was hard to say. The gap between the size of the Great Depression in the United States and the magnitude of direct government spending was so large that it's truly hard to see whether fiscal policy might have mattered.

But as Professor Galbraith said, for evidence of the ability of fiscal policy to boost employment and production if used on a sufficiently large scale, we have to wait until World War II.

Monetary policy contraction, banking sector collapse and the transformation of irrational exuberance into unwarranted pessimism carried the U.S. unemployment rate up from 3 percent to 29 percent or to 23 percent from 1929 to 1932. Monetary expansion, banking reform and small deficits then drove the unemployment rate down to 9.5 percent by the start of large-scale mobilization in 1940. And wartime government expenditures and deficits drove the unemployment rate down to 1.2 percent by 1944.

Thank you.

SEN. BROWN: Thank you, Dr. DeLong.

I will ask -- I will sort of go left to right and ask each of you about five-minute's worth of questions, if no other senator shows up. And then -- and certainly feel free to weigh in on any question I ask any of the other three.

Dr. Winkler, starting with you: First, tell me about the National Youth Administration and what it did for your dad.

MR. WINKLER: He was employed. He ended up working in the Writer's Project for a chunk of time. As part of his responsibilities there, he worked with Harriet Arnow and a number of other people writing the Cincinnati and Ohio guides.

SEN. BROWN: You said -- you cautioned at the end of your -- near the end of your testimony you cautioned that measures not work in contradictory ways.

What's the potentially biggest damage that we can do in the way that we have pursued -- that President Obama and the House and Senate are pursuing our counterattack, if you will, on this terrible recession?

MR. WINKLER: The biggest difference between then and now, in my estimation, is that then they didn't really understand the impact a fiscal policy could have and now we do understand it. They were not aware of the processing tax in the AAA and the effect it was going to have on large fiscal policy. They didn't really understand what the Social Security tax was going to do, before you're beginning to pay out the pensions and the like.

We do understand those things now, but the debate of how much money you should spend and how extensive the spending should be is one that's comparable to this -- at this point in time as well.

It seems to me that with the awareness that we now have, to back off of the kind of spending that we have begun to do would be a serious mistake in light of what happened during the recession and in particular, during the 1937 recession period.

SEN. BROWN: So you're advocating -- you're advocating, depending on economic growth in the next 12 months, whether we do additional stimulus packages of some sort?

MR. WINKLER: I think it's clear that the growth will come -- whether it's in the next 12 months or thereafter.

And I think that one has to basically have faith and confidence that that will happen and that the deficits will be retired in time.

I think that was something that was not understood at the time of the Great Depression and during the New Deal, but that I think we do understand that now. We had the huge deficits of World War II and, in time, with the prosperity that followed the war, we were able to get the country back on a very sound economic footing before long.

SEN. BROWN: What did you mean when you said Keynes and FDR didn't understand one another? And what, more importantly than personal issues, is -- what did that mean to Roosevelt's pursuing Keynesian economics, in any way; or Keynes trying to advise Roosevelt from afar, with letter that was sent December 31st, 1933, that open letter to FDR?

MR. WINKLER: It meant that Keynesian economics -- at that time, when it perhaps could have had an impact, or even a couple of years later, simply wasn't tried. It took time until people began to understand what Keynes was doing and saying. Mariner Echols (sp), who was head of the Federal Reserve Board during the 1930s, did understand, by the end of the decade, what was going on. Other people began to promote Keynesian theories -- Alvin Hansen and others, and it began to catch on in ways that had not been the case in the 1930s.

But, the fact that the two men basically were cross -- talking at cross purposes in the meeting that they initially had is simply reflective of the fact that Keynes was not going to be listened to very coherently at that time.

SEN. BROWN: What do you make of Hoover's differences with Andrew Mellon in the last couple of years of his presidency when Mellon wanted no government intervention and Hoover presumably did?

MR. WINKLER: I wish that Hoover had responded, as he did in his memoirs, the same way much earlier. And I think it could have made a difference. I think the fact that the did listen to Mellon during the years after 1929, was catastrophic; and that I think Mellon's advice was all wrong, and that Hoover would have been far better off if he had taken advantage of the awareness that he later had.

SEN. BROWN: Thank you.

Dr. Galbraith, you spoke of the much maligned NIRA -- Dr. Ohanian pretty much maligned it. Talk to me about that.

MR. GALBRAITH: (Off mike.) Well, the NIRA was never popular with --

SEN. BROWN: Put your microphone on, please.

MR. GALBRAITH: The NIRA was never popular with the economics profession. It was essentially -- authorized the creation of cartels and deflated the antitrust acts, and it has been largely dismissed in the historical treatment of the New Deal.

So, I don't want to overemphasize the point, to simply say that I think we should be agnostic, in retrospect, about the effect of a program that was in effect during a four-year period when industrial production, in fact, doubled. So, it would be very hard to argue that the NIRA impeded industrial recovery, because it was proceeding -- between 1933 and '36, at a very rapid rate.

SEN. BROWN: There has been discussion from both the two of you, Dr. Ohanian and you -- but really all four of the panelists, and certainly by critics of the New Deal and supporters of the New Deal -- about the Wagner Act, about the, if you will, the artificial market intervention that increased wages, whether it was the sit-down strikes that Dr. Ohanian had mentioned, the minimum wage, the Wagner Act over all the collective bargaining. Talk to me, if you would, about -- sort of, answer his views that that, in fact, did cost jobs.

I believe, Dr. Ohanian, I would certainly want you involved in this discussion too, Dr. Ohanian. What it meant that the lowest growth sectors, in terms of jobs, seemed to be the highest wage sectors. I think that's pretty much what you said.

And then talk about -- in some immediacy, in some immediate terms, Dr. Galbraith, if you would, and then its impact on economic growth in the '50s and '60s -- the foundations of the New Deal, the Wagner Act, as wages were increasing, what that did to employment.

Dr. Galbraith, and then I'd like to hear your thoughts, Dr. Ohanian.

MR. GALBRAITH: Yeah, -- (inaudible) -- again, a commonly held view in the economics profession that high wages cause unemployment. But, I think the evidence for that proposition has always been extremely weak.

If one believes that the measures that supported trade unions in the middle 1930s produced unemployment, you have then to explain why unemployment reached 25 percent in the early 1930s before those measures took place. And you have to explain why, in the 1950s, a very extensive trade membership, which had reached 30 percent or more of the labor force, did not cause a reversion to high unemployment.

One can look at this question also in a comparative context in the modern world. And a very interesting way of doing that is to examine the European experience where we find that, quite systematically, across a wide range of countries, those which have more egalitarian wage structures -- the Scandinavian countries and the Northern European countries, tend to have, as a result of very long traditions of very high levels of trade union membership, tend to have systematically lower unemployment rates, better and more efficiently operating labor markets, than countries which tolerate very high degrees of inequality; and the very good and very conventional theological economic reasons why that would be expected to be the case.

SEN. BROWN: So, why would -- some critical New Deal policies emphasize that total hours worked, per adult, in the 1939, were 20 percent or more below their 1929 level. Isn't that an accurate indicator of what higher wages meant, in terms of people with --

MR. GALBRAITH: Well, no. 1929 was the peak of an enormous speculative boom.

And one cannot, I think, argue fairly that the experience of the late 1920s was sustainable. It wasn't. It led to a collapse of the financial sector, just as the speculative boom in housing in the middle part of this decade -- toward the end of this decade, led to a collapse of the financial sector that we're just experiencing. So, to draw a trend line through that period, and then say that in 1939 we were far below the trend, I think, is intrinsically questionable.

Beyond that, there is the problem of counting unemployment. And Brad DeLong, I think, gave the accurate figures. Now, the unemployment rate in the New Deal period fell from 25 percent to just under 10 percent by 1936. It then jumped back up again in the recession and was brought down again as Roosevelt relaunched the New Deal -- back down below 9 percent, again, before the start of the war.

That's a dramatic accomplishment in the face of an extremely serious situation that he started with.

SEN. BROWN: Dr. Ohanian, talk to me about distorted labor markets, and the Wagner Act, and minimum wage, and what that did to employment.

MR. OHANIAN: (Off mike.) My pleasure.

My pleasure. Can I respond to a couple of point --

SEN. BROWN: Well, of course -- yes.

MR. OHANIAN: -- that Professor Galbraith said.

SEN. BROWN: As any of you can, if you don't feel free in jumping in -- Dr. Winkler, or any of you.

MR. OHANIAN: Okay, so I believe Professor Galbraith made three or four points I'd like to respond to.

One, is the idea about benchmarking comparisons to the year 1929. And it actually does turn out that, statistically speaking, a 2 percent trend, -- (inaudible) -- goes through the year 1929 and captures the rest of the -- the rest of the economy, going forward, very closely. So, a statistical procedure known as (Lee's squares ?) draws that trend line going through 1929 in fitting the remainder of the economy really quite well.

Another point Dr. Galbraith made was, you know, how can it be that, you know, with a higher rate of unionization in the 1950s that the economy improved so much compared to the New Deal period? In terms of how much employment loss is going to be sustained, on the basis of unions or other types of institutions that raise wages, what's relevant is how high the wage is above its market clearing level. And the estimates I've produced indicate that the wage was much higher above this market clearing level in the late 1930s than it was immediately after the war.

And, in fact, to get your question about the Wagner Act, the Wagner Act and the National Labor Relations Act was significantly modified by the Taft-Hartley Act of 1947, which provided for the states to have -- "right to work" states, it gave states the right to outlaw the closed shop. So, what's really central for understanding how much work was lost is how high the wages, relative to trend or as a market clearing level, rather than the actual amount of individuals in unions.

Another point Dr. Galbraith made was about unemployment versus hours worked. I use hours-worked as a measure of labor, as do other macroeconomists, because that's the measure that's -- that we use for trying to understand how much production is occurring. Unemployment rates are tricky, because for long-term issues, such as we're talking about in the Great Depression -- you know, 9, 10 years, there's something called "the discouraged worker" effect, in which individuals leave the labor force, which reduces unemployment.

The final point that Dr. Galbraith made was about whether high wages do cause job loss. Most economists, in my view, do subscribe to the view that if wages are boosted above the market clearing level, that will reduce -- that will reduce jobs. The economic reasoning is well accepted among economists and there is significant evidence for that.

I'm not sure if I covered your initial question about the Wagner, but I'd be happy to.

SEN. BROWN: You did, You did, You did. Thank you.

You acknowledged, Dr. Ohanian, that there are New Deal policies that were useful, as you said, and Social Security and bank stabilization policies. What's the line between a useful social safety net and -- and politics -- I mean, policies that are meddlesome, too interventionist, too distorting of the market? Can you -- can you share how -- how you come to those conclusions or you just look at each one individually and make a -- make an educated sort of estimate?

MR. OHANIAN: Well, in my view, among the most useful policies in New Deal (get us down ?) to some basic social safety net. So unemployment benefits, for example, in my opinion were one of the most important parts of the New Deal. Establishing Social Security --

SEN. BROWN: I'm sorry. (Inaudible.) So you reject the view that unemployment extensions would -- would cause some people to not seek work therefore distorting the labor market and you don't -- you don't -- you don't buy those sort of conservative arguments that -- that the unemployment system really causes fewer people to want to work?

MR. OHANIAN: A number of economists have been working on the -- on the -- on the difficult issue of how to design unemployment insurance, disability insurance, other types of a social insurance to try to get incentives right, which is I believe what you're talking about, and at the same time trying to provide enough insurance, and that's a difficult, difficult question. What I can tell you is that, you know, current research indicates that the incentive issues become less problematic during periods when the chances of finding work are extremely low.

So, for example, during the Great Depression when, you know, labor markets are quite distorted, you know, expanding unemployment benefits -- well, they were adopted that time. But that might be -- would have been a good idea. In terms of trying to figure out which policies are useful and which aren't, good policy making really needs to be consistent with getting economic incentives right. I believe there's a large level of agreement among economists about what constitutes guides for good long-run policy -- increasing incentives to work, save, and invest, increasing the incentives, maintaining incentives for (financier ?) intermediaries to intermediate capital efficiently.

These are all good guides for policy. When we see policies that sharply deviate from those good long-run goals that's when I say these are policies that are going to have a negative impact on the economy.

SEN. BROWN: Thank you -- (inaudible). Dr. Long -- DeLong, would you weigh in on the -- the 1929, 1939 20 percent -- hours worked per adult 20 percent lower? Do you think that's an accurate indicator of -- of --

MR. DELONG: Well, it's a puzzling question that, right, that -- that it's indeed the case that unemployment declined -- the unemployment rate declined extremely sharply from 1932 to 1939, from 23 percent down to 11.3 percent according to the Weir measure, and practically all of this is indeed an increase in the fraction of the labor force that has jobs and very little of it being a discouraged worker effect because that discouraged worker effect is not present -- at least I at least can't see it in David Weir's labor force series.

Now, but nevertheless it's certainly true that hours of work per employed person were 13 percent lower in 1939 than in 1929, and Lee Ohanian wants to conclude that a substantial chunk of this decline is due to deficient demand -- that the economy was getting better at sharing the available work hours among workers but was not producing nearly as much demand for labor as we would want to see. And this is debatable, right -- that in 1949 hours worked per adult were 18 percent, in 1959 they were 17 percent below their 1929 level. But we want to conclude that the economy was even more depressed in the 1950s than it was in 1939? No.

The interwar decline in hours worked tells us a lot about the cycle and the trend -- that the decline in hours worked from 1914 to 1952 does not mean that the economy was performing much worse in 1952 than it was in 1914. The Great Depression comes in the middle of the last sharp decline in the American work week we have seen and shows us that Americans back then were deciding collectively to take a substantial part of their increased technological wealth and use it to buy increased leisure. And for that reason I'm more skeptical of the work hours comparison of 1939 to '32 and 1929 and I tend to see it makes -- I think it makes more sense to take the unemployment rate as an indicator of how complete recovery is.

SEN. BROWN: Interesting answer. Thank you. What -- what role did the Fed play in causing and reversing the Great Depression? What policies in particular should it have pursued?

MR. DELONG: Well, this is -- I mean, I think when you talk about the Federal Reserve in the Great Depression there really are three questions. The first is did the Federal Reserve cause the depression, all right. Was the economy along doing its normal thing and then the Federal Reserve all of a sudden decided to do something bad and as a result we fell into the Great Depression.

And I think the answer to that is clearly no -- that the Great Depression started for other reasons. The Federal Reserve was simply a bystander -- that as Professor Galbraith said earlier, there are signs of substantial natural instability, right, in the economy, at least as it stood in the interwar period. Then it starts down and it keeps going down.

The second question is could the Federal Reserve have interrupted, right, the Great Depression. Milton Friedman and Anna Jacobson Schwartz's "Monetary History of the United States" is a very large and very impressive book. I think Professor Galbraith calls it magisterial at some point in his written testimony. And it argues that the Federal Reserve could by itself have stopped the Great Depression in its tracks had it done enough to print up bank reserves, to encourage the Bureau of Engraving and Printing to print up currency, had it rescued threatened banks.

But the Federal Reserve did not do so. And this thesis of the monetary history of the United States has, I think, taken profound damage over the last two years, for Chairman Bernanke of the Federal Reserve and his team have, you know, via open market operations and now quantitative easing they've done exactly what Friedman-Schwartz recommended and claimed would have stopped the Great Depression in its tracks. You know, they have expanded bank reserves, the monetary base, and the money supply to an extent I would not have believed possible, right, three years ago.

Yet we all think that this was not enough -- that we need banking policy and probably fiscal policy as well in order to keep the Great Depression currently the last depression that America has suffered. And I think this is a substantial intellectual loss for Friedman- Schwartz and an intellectual victory for Bernanke-Keynes, who argued that all the conventional interest rate and quantitative easing monetary policy in the world might not be enough if the capitalization of the banking sector vanished and the credit (chunnel ?) got itself well and truly clogged, which is where we seem to be.

The third question is what role did the Federal Reserve play in spurring recovery, and here we have, you know, the debate and we've seen a piece of it in the debate between Professor Romer -- (inaudible) -- Chairman Romer and Professor Galbraith earlier, Christina Romer placing a very heavy weight on the quantitative easing policies of the Federal Reserve and of the gold inflow during the 1930s, arguing that even after the Federal Reserve has done everything it can to lower interest rates on Treasury securities to zero, if it continues to expand the money supply well, that money burns a hole in people's pockets and they spend it and that boosts spending, Professor Galbraith placing more stress on, right, what fiscal expansion there was and on the recovery of the banking system.

Here, well, my -- my office -- Professor Galbraith's office is a thousand miles away but in her previous life Christina Romer's office was only 50 some steps down the hall and she's very, very impressive and very, very convincing. So I tend to side with Christie on that one.

SEN. BROWN: Fair enough. I close with one question, particularly in light of his last comments about fiscal and monetary policy. I want to ask the same question of all four of you and let's close with that. The question is expand on whether -- whether it's fiscal policy or monetary policy that was primarily responsible for economic growth during the Depression in the 30s and your views of -- of what that means for today, if you would just take that question, Dr. Winkler, and each of you work through your thoughts on -- on that sort of central question.

MR. WINKLER: I've been thinking about fiscal policy and -- and particularly with regard to the NIRA that came up earlier in this conversation. There's no question that the NIRA did not work very well. It -- it was trying to stabilize prices and wages and hours and the like. In so doing, it probably reversed the deflationary cycle but it also discouraged investment. Business people who were not making profits were not likely to invest.

The point, though, is that they weren't going to invest anyway. Keynes was -- was absolutely right. This was not working. Something else needed to be done. My whole point, I think, has been that fiscal policy could have made a difference, as we look at this in retrospect, but did not because enough was not being spent, at least in the aggregate.

I tend to side with -- with Professor DeLong that -- that monetary policy did make a difference. Would that fiscal policy had been permitted to be used in the ways that might have made a greater difference and ended the Depression sooner.

SEN. BROWN: Okay. Thank you.

Dr. Galbraith?

MR. GALBRAITH: The judgment of contemporaries was that monetary policy played a very minor role in the recovery from the Great Depression, and I tend to share that judgment. The Federal Reserve at the time was regarded as something of a backwater, and I wonder to what extent the present emphasis on monetary means is in fact picking up the work of other agencies, and in particular the Reconstruction Finance Corporation and the institutions that were set up to help start the -- to recapitalize housing and to reconstruct the mortgage business.

But leaving that aside, public spending in the National Income and Product Accounts increased over 50 percent between 1932 and 1936, and as a share of GDP it rose from 10 percent to around 17 percent. Admittedly GDP was not rising very rapidly at that time. So it's a substantial increase both in absolute numbers and in proportions. And the argument that that is an insignificant factor, it seems to me, is at least somewhat questionable because we would then need to know whether the multipliers -- what the multiplier effects and the knock- on effects actually were at that time.

You said earlier -- you asked a question of Professor Winkler which I think is very pertinent to this issue, and that was what are the biggest differences between the approach taken in the New Deal and the approach that we are taking today, and I would like just to close by coming back to two of them that I think are very instructive and important for the design of policy going forward.

I think in our present environment, in our present situation, we are placing much more reliance on policies intended to resurrect the existing structure of banking and to get credit flowing again than was true in the early and middle 1930s. And that -- we are likely -- the present approach to the banking crisis is actually somewhat more reminiscent of the early 1930s than it is of the Roosevelt period and likely to meet the same disappointment, insofar as the problem is not one of a blockage in the pipes of credit but rather a collapse of asset values and therefore of the collateral against which -- on which credit rests -- the demand for credit not -- as much as of the supply. And that problem can only be solved by reconstructing the financial position of America's households and businesses. In the Great Depression that did not happen, and it didn't really happen until the Second World War -- completely recapitalized the private sector by giving them a vast stock of government bonds which became the basis of their financial wealth, middle class prosperity in the post-war period.

And the second point is that I think we are placing too much emphasis on the idea that by using a short-term Keynesian stimulus we can bring ourselves out of this problem in a short period of time. I think if we do that we are going to be prone to a policy reversal with the same danger that Roosevelt experienced in 1937. That is to say, when you reverse policy, the economy then rewards you by going back into the tank.

And it would be appropriate to take a lesson from the early New Deal that what is needed here is a comprehensive set of measures that will build an economy for the future, an economy which in particular deals with two vital challenges -- very closely related challenges. One of them is energy security, because if we don't deal with our energy security problems we are going to be at the mercy of rising oil prices just as soon as aggregate demand starts expanding aggressively. And secondly with climate change, a problem which we have an opportunity now to deal with and which if we do not take that opportunity we will both miss an opportunity to put the overall working of the American economy on an environmentally sustainable basis, but also an opportunity to take many millions of people and give them useful and -- useful employment for many years to come.

SEN. BROWN: Thank you, Doctor.

Dr. Ohanian?

MR. OHANIAN: If I might just briefly respond to one of the points Professor DeLong made about how much hours worked were depressed at the end of the 1930s -- so one point I just wanted make is that per capita hours in the 1950s are indeed higher than they are in the 1930s, just as they were in the 1920s.

The second point -- Professor DeLong indicated that as people become wealthier they increase their demand for leisure, and hours worked falls. There's not a conclusion about this force within the Depression. It's an area of active research, but if that force was operative, the Depression is a period of declining wealth and income, which would suggest people would be demanding less leisure rather than more leisure.

The (burning ?) question about recover and fiscal versus monetary policy -- expansion in output is necessarily due to expansion either in hours or output per hour. The numbers indicate there's not much expansion in hours in the 1930s, so the growth we do see in the 1930s is -- most of it is coming from output per hour -- productivity. Economists don't have a good understanding about cyclical changes in productivity. Our basic economic reasoning doesn't point to a substantial link between either fiscal policy or monetary policy and expansions in productivity. Economic (strain ?) -- Alexander Field has indicated that the 1930s were really a remarkable period for productivity growth -- true productivity growth in terms of efficiency gains. I don't see necessarily either monetary or fiscal policy playing a major role there.

In terms of today's economy, we face, as other panel members indicated, a different set of problems, in some sense related but in some sense really quite different. Reregulating the financial system is a tall order to fill. It's not an easy question. There's a number of complicated issues. Currently we have a system that's stocked a lot of risk onto the backs of taxpayers, and incentives were in place to make that happen at some level. So in my view, the major challenge we face is reregulating a financial system that became much more sophisticated and much faster than the current regulatory framework could deal with. That won't be an easy issue to make progress on, but in my view that's the main challenge we face.

SEN. BROWN: Thank you.

The last word -- Dr. DeLong.

MR. DELONG: All right. I think that the lesson from viewing fiscal and monetary policy and government attempts to use them to serve as balance wheels of the economy since the Great Depression, of the abandonment of Herbert Hoover's Treasury Secretary Andrew Mellon's dictum that liquidation is actually a healthy process; part of what economist Joseph Schumpeter called the "natural breathing of the economic organism" -- that we've abandoned that, and we think we have these policy tools and have been trying to use them, and the question is how effective they are. And I think the conclusion from 70 years of economists arguing and watching economies and watching the success of these tools is that almost all of the time monetary policy is more effective, and almost all of the time monetary policy is easier to implement and easier to change when conditions change, that it moves faster and it also is more flexible.

But then there come times like today, times when the interest rate on safe-, short-, and medium-term Treasury securities has been pushed all the way down to zero, and in which you have to ask if you undertake further expansionary monetary policy, well, whose incentives are you changing? We're economists; we believe that people respond to incentives, that government policies worked by changing the incentives that people face. But by the time you've pushed interest rates down to zero and can't push them any further, whose incentives are you changing by continuing to rely on monetary policy? And it's in that situation that we are now, and that's when you start dragging out the other tools of trying to keep spending in the economy at a normal pace -- the quantitative easing part of monetary policy, that maybe you can give people so much money it burns a hole in their pocket and they spend it; that the aggressive banking sector recapitalizations and government loan guarantee programs that we see the Treasury trying to roll out now that have their parallel in operations conducted by the Reconstruction Finance Corporation during the Great Depression -- which had, if I may say so, an easier time -- that the RFC had powers to bring banks into conservatorship without declaring that they were insolvent. And so to the extent that there's a fear that declaring that banks are, in the view of the government, insolvent will cause some kind of crisis of confidence and a shrinkage of the money stock as people pull their money out of banks -- well, the RFC had tools that would avoid this. And perhaps Tim Geithner's life would be a little bit easier at the Treasury if he had them now.

And last, there's the fiscal policy -- that government spending, government tax cuts, with the idea that if the private sector's spending is not staying stable, well, maybe the government can add to it and so keep things on an even keel.

And I think the prudent thing is, when asked which of these should we be doing, is to say, yes, that when there's great uncertainty and when you have a number of tools for all of which there's some reason to believe they're at least somewhat effective -- you know, well, do what Roosevelt did: experimentation. Try them all and reinforce the ones that seem to be working.

SEN. BROWN: Thank you, Doctor DeLong.

Thank you all for joining us. This is the first of several hearings that will help Congress shape the -- our response and our action to this economic crisis. I appreciate all of the service all of you have given by being here today and the good work you do, each in your institutions.

The record will be open for seven days for Senator DeMint and the two other members of the subcommittee. And if you want to revise your remarks or add anything or respond to any of the questions that you didn't feel that you got to respond to completely enough, certainly you're free to be in touch with the subcommittee to do that also.

Committee adjourned. Thank you very much.

END.

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