The smooth transition to peace was accomplished despite the existence of a fiscal policy that was the very antithesis of Keynesian economic prescriptions to deal with falling aggregate demand. The most dramatically contractionary fiscal policy in modern American history failed to materially alter the pace of economic activity.
Thanks to Alex Tabarrok for forwarding me the link.
The authors look at real GDP, which I did not show you in my last post. Here it is (as of today, that is; Vedder and Gallaway were looking at different numbers):
Nominal Government Spending
Real Government Spending
Some points stand out:
1. Real GDP reportedly fell by more than 10 percent, even though nominal GDP increased.
2. In 1945, government spending was 40 percent of GDP in nominal terms, and almost 70 percent (!) of GDP in real terms.
My reading is that the attempt to inflation-adjust numbers from the 1940's to try for comparability with today introduces tremendous noise in the yearly movements in estimated real magnitudes. I believe that this phenomenon is known as base-year drift. As you change the base year for calculating real GDP, you get anomalies in years that are not close to the base year. Vedder and Galloway put it,
Between 1960 and 1990, government economists approximately doubled their estimate of the inflation occurring from 1944 to 1947
I see that not as a conscious change in estimated inflation but instead as a mechanical result of base-year drift. If what you want to do is compare the standard of living in 1945 to the standard of living today, then you have no choice but to use real GDP. However, if what you want to do is estimate the trajectory of the economy from 1945 to 1947, I think you are better off using nominal GDP. What you miss in terms of inflation adjustment is way less than the error that you introduce due to base-year drift.
Another point, which Vedder and Galloway also make, is that with government spending accounting for so much of GDP (even forgetting the suspect estimates for real GDP), one really has to worry about whether the estimated value of government purchases is correct. Private-sector spending is subject to market discipline, which leads people to pay no more for something than the opportunity cost of the resources used to provide it. With government, we have no such assurance.
In the end, I do not know how to value what the government bought with its credit card in the 1940's ("Defeating Hitler: priceless"). Did government pay draftees the opportunity cost of their time? I'm guessing not, which would mean that government GDP was under-estimated. On the other hand, government probably overpaid for other resources.
In a comment on my previous post, Dan Klein points to Robert Higgs, who takes the view that wartime GDP was overstated and postwar growth was understated. Higgs has thought about this much more than I have, but I would like to poke around in the history myself before taking a strong stand.