The Great Depression, the worst crisis in American history, brought the country to its knees by 1933 when Franklin Roosevelt took office. FDR and his team launched the New Deal to help get the country back on its feet. They succeeded, yet the myth persists that the New Deal had little effect on economic recovery and only World War II ended the Depression.
The proximate cause of the Great Depression was the financial meltdown that began in October 1929. Stock prices nosedived, millions defaulted on mortgage payments, and thousands of businesses and banks were shuttered.
The real economy was going into recession well before Black Friday, when all hell broke loose. Investment shrank, wages were slashed, layoffs multiplied, and consumer demand shriveled, propelling the economy into a downward spiral. By early 1933, GDP had fallen by half, industrial output by a third, and employment by one-quarter.
A key accomplishment of the New Deal was to get the U.S. financial house in order. Failing banks were culled, deposit insurance instituted, homeowners bailed out, and mortgages guaranteed. The Federal Reserve loosened up the money supply and credit began to flow again.
Meanwhile, billions were pumped into the economy through emergency relief funds and public works programs, from the CCC to the WPA. Not only were millions of desperate American put to work, their families had spending money to stimulate aggregate consumption.
Furthermore, federal spending shot ahead of tax revenue, creating a large budget deficit. FDR didn’t believe in deficits, but was willing to try anything, thus inventing ‘fiscal policy’ even before economist John Maynard Keynes gave it a name.
The economy took off, reaching double-digit growth rates. By 1937, the Great Recovery had pushed output, income, and manufacturing back to 1929 levels. Then recession hit in 1937-38, dropping output by a third and driving unemployment back up. Three things contributed to the setback: FDR tried to re-balance the budget; Social Security taxes kicked in; and the Federal Reserve tightened money supply.
Nevertheless, growth resumed in 1939 and regained its long-term trajectory before war broke out. The big exception was unemployment, which stayed above 10 percent, forever marring the New Deal’s reputation. Worse, a key study exaggerated joblessness by not counting the millions working in federal work programs.
World War II brought full employment through military recruitment and full-tilt production, with the federal government running more massive deficits than the New Deal ever dared.
To be sure, recovery cannot be ascribed only to the New Deal. By the 1920s, the American economy was the largest in the world and the assembly line, electricity, chemicals, and petroleum had unleashed a new Industrial Revolution. Advances in productivity continued through the 1930s. Dramatic improvement in transportation was helped by the New Deal’s extensive road building. The downside was closure of obsolete factories and railways, terminating millions of jobs, which explains much of the unemployment that remained despite the Great Recovery.