Perhaps the most forgotten period in American economic history is the eight years that followed the creation of the Fed and the income tax in 1913. From 1913 to 1921 the growth rate came in at just 1.4 percent per year. The period included two long recessions: one beginning in 1913, in which that year’s level of production was equaled only two years later (and with the assistance of military production that did nothing for living standards), and another from 1919 to 1921 that was simply the worst depression the nation would ever suffer outside of the 1930s. “Unemployment” quickly joined the parlance; people scrambled to measure the phenomenon, and the consensus was that it stayed in the high double digits in the latter recession. And then this novelty: the price level went up by 110 percent from 1913 to 1920, and then swerved down in the year following by 25 percent. Strikes swept the land, since wages had no hope of keeping up with the unprecedented inﬂation, and the new income tax system hit persons making as little as $1,000 a year ($11,000 in today’s terms).
Before 1913, there had been at most only shadows of government ﬁscal and monetary policy, and the United States had cruised at its 5 percent per-annum rate of expansion, with the price level making small oscillations around the antebellum number. But after 1913, the government used its new macroeconomic policy tools to the hilt. Immediately after its creation, the Fed arranged for a doubling of the money supply—this in the face of a manifest recession. The inevitable result was the doubling of the price level. As for income taxes, the ﬁrst top rate, upon passage of the Sixteenth Amendment in 1913, was 7 percent. In four years’ time, it was up elevenfold, to 77 percent. Meanwhile, someone whose income merely kept up with the inﬂation engineered by the Fed—that is, someone who saw no actual gain in income—could be pushed into the stratospheric top tax bracket, since the progressive tax brackets were not adjusted for inﬂation. (This is the phenomenon known as bracket creep.) The investor class soon adjusted away from entrepreneurship and into tax shelters.
Then there was the recovery—perhaps the most famous recovery in American history. The Roaring ’20s that followed 1921 aped the bygone era very well: 4.7 percent yearly growth through 1929, unemployment gone, and a price level that barely moved. The government’s macroeconomic policy posture during this period is unmistakable: the Fed expressly got out of the business of trying to undo the 1913–20 inﬂation via a commensurate massive deﬂation, and the marginal rate of the income tax was cut by 52 points. In other words, ﬁscal and monetary policy retreated.
How we have ever associated the onset of the Great Depression with a “crisis of capitalism” is anyone’s guess. In fact, the years 1929–33 brought historic governmental intrusions in the economy. In late 1929, the Fed resumed its 1920–21 efforts to reclaim the 1913 price level by appreciating the value of the dollar. Deﬂation held at 9 percent per year from late 1929 to early 1932, blowing away the gentle deflation standard of the post-1873 years that had seen constant, rapid growth. Over the same interval, the marginal income tax rate jumped by a magnitude of one and a half, to 63 percent. Severe deflation and conﬁscatory taxes led to a capital strike, with savage unemployment being the inevitable result. And this is not to mention the Smoot-Hawley Act of 1930, which raised tariffs to record levels, cut foreign trade in half, and convinced the world that convertible currencies—and indeed international economic cooperation—were no longer useful.
In other words, ﬁscal and monetary policy extended their scope and sway as never before. In turn, real conditions in the United States became as horrendous as any developed country had experienced since the dawn of the industrial age.
This article appears in its entirety in the Spring 2011 edition of the Intercollegiate Review. Read the full article, and see the issue’s Table of Contents here.
This essay is adapted from the book Back on the Road to Serfdom: The Resurgence of Statism, edited by Thomas E. Woods Jr. (ISI Books, 2011).