I want to return to the Vedder-Galloway paper, that I mentioned here. I want to make it clear that I have a lot of problems with that paper, and I will not be basing my own views on it. More below the fold.

[UPDATE: Revisiting the 1945-47 austerity is something that has occurred to folks at Cato recently as well. See Jason E. Taylor and Richard K. Vedder. Same Vedder who had written the paper with Galloway 20 years ago.]1. As I said in my earlier post, I think that one should just ignore the estimates for real GDP that use recent years as the base year. Although V-G understand that the real GDP figures are messed up, their attempt to fix them is neither necessary nor sufficient. Either you have to go back and fix the real GDP numbers using raw data from the period, or you should just stick to nominal GDP.

2. They try to argue against the view that “pent-up demand” created the recovery. Again, I do not know why you would want to make that argument, nor do I think they succeeded.

From an accounting perspective, something had to create the recovery in demand. GDP rose and government spending fell. That leaves consumer spending, investment, and next exports. Regardless of which of those rose (all three did, in fact), it tells you nothing about Keynesian theory. It tells you something about accounting. If consumer spending rose because of “pent-up demand,” I do not count that as a win for Keynesian theory. As David Henderson points out, real Keynesians at the time did not think that “pent-up demand” was going to produce full employment.

To me, “pent-up demand” is just an ex post rationalization. It says, “even though government was cutting spending, the economy recovered on its own.” Why argue with that?

V-G want to argue that it was not pent-up demand because assets did not fall. Instead, the saving rate fell. To me, that does not prove their case.

3. V-G want to say that there is an alternative explanation for the recovery, which is that real wages fell. But relative to textbook macro, that is not an alternative. Textbook macro has an aggregate supply curve that depends on prices rising and real wages falling. Moreover, the evidence that V-G cite for lower real wages is not all that dramatic. To me, the drop that they demonstrate appears to be within the range of measurement error.

I want to emphasize that we are not in the same situation today that we were in 1945. I just use the 1945-1947 episode to caution against a simple mechanical view that government spending always drives the economy,