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Recession of 1938

The brief but sharp recession of 1938 has never been explained satisfactorily. It has sometimes been considered as a deflationary contraction caused by the decline in Federal expenditures in 1937. Yet that cut was very small. Federal expenditures in the fiscal years 1937 and 1938 were still in excess of ordinary receipts; the budgetary deficit was $3,253 million in 1936-37 and $1,450 million in 1937-38. Furthermore, the gross national product rose from $70.8 billion in 1935 to $81.7 billion in 1936 and to $87.7 billion in 1937.

This rise seemed to indicate that Federal expenditures, increased to meet the emergency of the great depression, might have been cut down without setting a deflationary spiral in motion. It therefore appears unlikely that the moderate reduction of Federal expenditures could have caused a contraction of employment and production even more violent than that in the winter of 1929-30.

In terms of national income, recovery had been nearly completed by 1936, when national income reached $65.2 billion at average 1935-39 prices. This amount, in fact, was near the 1929 peak ($68 billion), somewhat higher than in 1928 ($64.8 billion), and more than half again as much as in 1932, the lowest year of the depression ($41.6 billion).

Yet 14.4 percent of the workers were unemployed in 1940 (including persons engaged in relief work projects), which indicates that work opportunities were about 10 percent less than would be wanted to employ the available labor force after allowance of 4-5 percent is made for frictional temporary unemployment.

In retrospect, the recession of 1937-38 appeared to some to have been essentially a prewar depression, similar to that in 1914-15. The world was living in expectation of a general conflagration. War was already flaring in Spain, Africa, and the Far East. In his Chicago speech on October 5, 1937, President Roosevelt warned the Nation that "the presentreign of terror and international lawlessness" has "reached a stage where the very foundations of civilization are threatened."

The role of the USA in the coming war was uncertain, and the disturbing effect of this uncertainty was aggravated by increasing social tensions, evidencedby the sit-down strikes in the summer of 1937 and their repercussion on the business community.

In these circumstances, the rise in production and employment which had proceeded since the spring of 1933 came to a standstill. The decline in 1938 reflected the progressive deterioration of the international situation: seizure of Austria by the Germans, the threat to Czechoslovakia and Poland, the desperate attempts of France and Great Britain to exorcise the danger and stop the avalanche without resorting to force.

After Munich, which seemed to have cleared the situation, employment in production of durable goods went up while employment in nondurable-goods industries continued to decline. The recession in 1938 in the United States paralleled deterioration in business conditions in Great Britain, Canada, Poland, Denmark, the Netherlands, Sweden, Norway, and Switzerland, while a boom of rearmament was gaining momentum in Germany, Italy, and Japan.

As in 1914-15, the prewar depression was characterized by considerable ups and downs in the volume of economic activity. After a sudden drop in 1938, employment and production in the United States rose steadily in 1939; the economic system adjusted itself to the conditions of the post-Munich world with the prospect of a war far from American shores. It is not clear whether, and to what extent, this recovery was ac-celerated in the last quarter of 1939 by the actual outbreak of war in Europe, which foreshadowed munitions orders from Great Britain andPrance and rearmament of the United States.

Early in 1940, however, when the lull of the "phony war" developed in Europe, the business barometer again fell rapidly, industrial production and factory employment went down, and unemployment began again to rise.

After the invasion of the Low Countries by Germany, FDR's defense program was initiated and the US economy shifted from the prewar depression to a war boom. The decline in the earlypart of 1940 was offset by expansion of production later in the year, and, for 1940 as a whole, industrial employment, production, and national income were probably not far from what they would have been if there had been no war.