Recession of 1937-1938
The Recession of 1937-1938 was a significant economic downturn in the United States that emerged after a period of apparent recovery from the Great Depression. By 1936, while the economy showed positive signs, including a return to GDP levels similar to those of 1929, many Americans still faced high unemployment and economic struggles. The recession was marked by a sharp decline in economic activity, driven by factors such as changes in federal fiscal policy, rising labor costs, and restrictive measures from the Federal Reserve.
As the government reduced its spending to curb the Depression's effects, the economy lost essential support that had stimulated consumer spending. Increased labor costs, driven by rising wages and social security taxes, further strained businesses, which faced shrinking profits and diminished investment. The Federal Reserve's decision to raise reserve requirements led to higher interest rates, compounding the challenges for businesses seeking to invest.
The impact of this recession was severe, with unemployment soaring above 20 percent, production of durable goods plummeting by 67 percent, and industrial stock prices dropping significantly. Although the economy rebounded relatively quickly, the experience prompted the Roosevelt administration to adopt more Keynesian economic strategies, favoring budget deficits and increased government expenditures to stabilize and stimulate the economy in the future.
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Recession of 1937-1938
The Event Sharp economic downturn that occurred before the economy recovered fully from the Great Depression
Dates May, 1937, to June, 1938
Coming early in Franklin D. Roosevelt’s second term as president of the United States, the recession of 1937-1938 undermined hopes that the nation was on the path to economic recovery.
In 1936, total output, or real gross domestic product (GDP), in the U.S. economy was at about the same level as that of 1929, the peak level prior to the Great Depression. Although unemployment remained at historically high levels and real GDP per capita was still below the level of 1929, the economy appeared to be moving in the right direction. The New Deal seemed to restore prosperity and hope for the economy.
Lurking below the aggregate numbers for the economy, though, lay a number of problems, which are thought to have played a role in the sharp downturn in 1937. While economists differ in their views of the importance and magnitude each played in causing or exacerbating the recession, there is some agreement that the federal government’s fiscal policy, rising wage rates, and Federal Reserve policies each played a role.
As the economy improved during the year leading up to the recession, the federal government began reducing the amount of expenditure meant to stimulate the economy in order to bring the country out of the Depression. One program in particular, which is credited with stimulating the economy during the second half of 1936, was a bonus paid in bonds to soldiers of World War I in June of 1936. By the end of the year, nearly all of the bonds had been cashed, which added significantly to personal income and expenditures. Without the consumer spending induced by this program and the changes in fiscal policy leading to a lower government contribution to consumer incomes, the economy lost some of the supports that had been holding it up.
Also, during the latter part of 1936, business costs began rising at a faster rate than the prices businesses could get for their products. Representing a significant portion of that cost, labor costs were rising as a result of increased unionization and a general feeling that higher wages would allow for more consumer spending and therefore more economic growth. The newly created Social Security tax further increased labor costs. Other expenses of production also increased during this time as many companies added to their inventories, fearing that costs were going to rise further in the future. With costs rising faster than prices, business profits were reduced, making new investment less profitable.
As 1937 dawned, banks held a larger percentage of funds in reserves. With strong economic growth and rising prices for commodities and finished goods, there was concern at the Federal Reserve that large amount of excess reserves at banks could be used to fuel unsustainable economic growth and destabilize the economy. To reduce this risk, the Federal Reserve increased reserve requirements to eliminate the possibility that the excess reserves would be loaned out in the future and lead to inflation. Banks responded by increasing reserves further. As a result, interest rates increased, which may have further reduced investment spending.
Whatever the precise causes of the recession, the sudden and rapid decline in economic activity wiped out many of the gains made during the previous years. The unemployment rate once again swelled to more than 20 percent, production of durable goods fell 67 percent, and industrial stock prices dropped more than 40 percent.
Impact
While the economy recovered relatively quickly from this recession, the severity of the drop in output and its possible linkage to reduced federal government spending caused many in the Roosevelt administration to more fully embrace the ideas put forth by John Maynard Keynes in The General Theory of Employment, Interest and Money (1936). Budget deficits and government expenditures to stabilize the economy became more acceptable policy options.
Bibliography
Kindelberger, Charles P. The World in Depression, 1929-1939. Berkeley: University of California Press, 1986.
Roose, Kenneth D. The Economics of Recession and Revival: An Interpretation of 1937-38. New Haven, Conn.: Yale University Press, 1954.
Smiley, Gene. Rethinking the Great Depression. Chicago: Ivan R. Dee, 2002.