In the current climate of economic turmoil, with Europe and the U.S. both trying to push back the fateful pay day when decades of governmental overreach and overspending come home to roost at the same time that economic growth appears to be stalling, so-called liberals and progressives like to argue against budget cuts with the Keynesian argument that austerity would be poison for any hopes of economic recovery, let alone renewed growth. As the economy lurches, and stock market indices tumble, you will no doubt see this argument made forcefully by proponents of unrestrained government spending.
Lucky for us, we can turn to at least one significant historical example when the U.S. government did NOT resort to hectic macroeconomic retooling, pump-priming, and deficit spending. As Professor George Selgin explains, the sharp economic reversal of 1920 did not deter the government (and this means essentially the just-elected Harding government, as the Wilson administration was hardly functioning at the end of Wilson’s 2nd term) from prioritizing cutting the bloated wartime budget and retiring the enormous wartime debt. Far from plunging the nation into ruin, these policies worked so well that within two years an unemployment rate of close to 12 percent had given way to labor shortages, and industrial production, which had fallen precipitously in 1920, rose to new record levels.Notably, government spending was tightly controlled during the Harding/Coolidge years, while the economy boomed.
As Selgin points out, Treasury Secretary Mellon was unfairly tarred as “liquidationist” by none other than Herbert Hoover, who did not in fact follow austerity measures while battling the Great Depression. Moreover, the Harding/Mellon austerity of 1920/1921, which was continued under the Coolidge administration, is rarely given credit for turning the economy around. It seems austerity just can’t win!