Lessons from how Australia came out of the Great Depression-updated

How Australia got out of the Great Depression in the 1930s could have lessons for today, for the global financial crisis and the Great Recession. In Australia, the massive fiscal contraction from late 1930 onwards was called the Premiers’ Plan. In 1931, unemployment rates was 25% or more.

The Premiers’ Plan required the federal and state governments to cut spending by 20%, including cuts to wages and pensions and was to be accompanied by tax increases, reductions in interest on bank deposits and a 22.5% reduction in the interest the government paid on internal loans.

The Premiers’ Plan was complementary to the Arbitration Court’s 10 per cent nominal wage cut in January 1931 and the devaluation of the Australian pound. Most countries had abandoned the gold standard by 1931 and 1932 and devalued by about 10% including the UK. These competitive devaluations were called currency wars. Most countries below started to recovery before they left the gold standard, a year or two before they left the cross of gold.

Real GDP and dates of exit from gold standard

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Sources: GGDC‑Maddison International Historical Database (http://www.ggdc.net/Maddison/), Bernanke et al. 1990; Gruen and Clark 2009.

The New Zealand Government also cut everything that could be cut by 20% in 1931.

Maclaren (1936) dated the Australian economic recovery from the last months of 1932. It was to take another three years before unemployment rates fell below 10 per cent — the rate it had been during most of the 1920s.

The June 1931 Premiers’ Plan of fiscal consolidation had time by late 1932 to become credible and take hold given the usual leads and lag on fiscal policy.

Unemployment data in the 2001 Australian yearbook of the Australian Bureau of Statistics graphed below shows a rapid fall in the high twenties unemployment rate in 1932 to be below 10 per cent by 1937. This fall started just after the 1931 Premiers’ Plan of fiscal consolidation.

Australian unemployment was 7.5 per cent in 1938, which is the long-term average for the period 1906 to 1929. The USA had an unemployment rate twice that in 1938 and was coming out of a double dip great depression.

Australia and New Zealand came out of the Depression earlier than most other countries because of the fiscal austerity under the Premiers’ Plan. The New Deal prolonged the great depression in the USA.

For those that doubt, how much lower would have been the Australian unemployment rate between 1932 and 1937 but for the fiscal contraction? What is your counter-factual? The role of fiscal policy in Australia in the 1930s is rather under-studied in Keynesian macroeconomics. Why?

The fiscal consolidation in the Premiers’ Plan removed fears of even harsher future taxes, stabilised expectations, increased consumers’ expected disposable incomes, and increased investor confidence and therefore stimulated private investment. See Keynes’ 1932 letter where he says

I am sure the Premiers’ Plan last year saved the economic structure of Australia.

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