1937: When U.S. Austerity Turned To Disaster In the depths of the Great Depression, FDR's New Deal cut unemployment dramatically. But by the start of his second term, when things were starting to look up, he switched gears to promote austerity. Unemployment soared. Former Treasury Secretary Larry Summers says rushing to cut spending was a mistake then — and could be again today.

When A Turn Toward Austerity Turned To Disaster

1937: When U.S. Austerity Turned To Disaster

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President Franklin D. Roosevelt drummed up populist support in one of his last campaign speeches at Madison Square Garden in New York, on Oct. 31, 1936. But after he was re-elected, Roosevelt slashed government spending. Associated Press hide caption

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Associated Press

President Franklin D. Roosevelt drummed up populist support in one of his last campaign speeches at Madison Square Garden in New York, on Oct. 31, 1936. But after he was re-elected, Roosevelt slashed government spending.

Associated Press

Four years into Franklin Roosevelt's first presidential term, the worst of the Great Depression seemed behind him. Massive jolts of New Deal spending had stopped the economic slide, and the unemployment rate was cut from 22 percent to less than 10 percent.

"People felt that there was momentum," U.S. Senate historian Donald Ritchie tells Guy Raz, host of weekends on All Things Considered. "Finally, there was the light at the end of the tunnel."

So Roosevelt, on the advice of his conservative Treasury Secretary Henry Morgenthau, decided to tackle the country's exploding deficits. Over two years, FDR slashed government spending 17 percent.

"All of a sudden," Ritchie says, "after unemployment had been going steadily down, unemployment shot up, the economy stagnated, the stock market crashed again. And now it seemed we'd come out of the Hoover Depression to go into the Roosevelt recession."

Similar decisions Roosevelt made about spending and austerity are being discussed at the White House right now. In the long term, both political parties say they agree that austerity is a good thing. But what about in the short term, while unemployment remains high?

Could austerity slow economic recovery?

'More Stimulus Now'

Economists disagree about what caused the 1937 recession.

Unemployment jumped 3 percent the year after FDR cut spending. At the same time, the Federal Reserve built its reserves, which meant banks had less to lend. And the payroll tax had just been introduced.

But some, including Bruce Bartlett, who held senior policy positions under Presidents Reagan and George H.W. Bush, fear major budget cuts of the size proposed by President Obama — $4 trillion over 10 years — could be dangerous to short-term recovery.

Larry Summers, formerly one of President Obama's top economic advisers, says turning too quickly to austerity could be disastrous for the economy. Chip Somodevilla/Getty Images hide caption

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Chip Somodevilla/Getty Images

Former Treasury Secretary Larry Summers is also worried.

"Rushing to deficit reduction was Roosevelt's mistake in 1937, and that would be a serious mistake today," he tells Raz.

He points out that current budget negotiations are different from those in 1937. Proposals under consideration today would spread cuts over 10 years, instead of FDR's two.

But Summers says it may still be too soon for austerity.

"The right strategy is stimulus now and more deficit reduction programmed for after the economy has recovered," he says.

Last year's compromise on a payroll tax suspension, he says, is as an example of what might be politically possible, given the spending impasse between Democrats and Republicans. Summers calls for lengthening that payroll tax cut, spending more on infrastructure and extending unemployment benefits.

"We say that in a technical sense the recession is over," he says. "That means the economy is growing. But when you walk through the Grand Canyon, you're going uphill long before you get back to sea level. And I think we've got several years before this economy is back to normal levels of employment."

What Economists Miss

In the years leading up the recession, journalist Gillian Tett was one of the first people to warn that something new and dangerous was happening in the global credit market.

She was named British Journalist of the Year in 2009. Today she's the U.S. managing editor for the Financial Times. And she has a doctorate not in finance, but in anthropology. And that's one reason she says economists like Summers don't have all the answers.

"Because right now, issues like social cohesion are crucial for understanding what's going on," she says. "America is not a country which has a very strong sense of resource constraint. It was created by pioneers who came here believing that there would always be more resources. And there's been such a focus on growing the economic pie that people haven't really stopped to ask, 'How do you divide up that economic pie?' "

European investors and policymakers, by contrast, can't wrap their heads around the U.S. debt deadlock, she says.

"They find it quite unbelievable that a country would, in a sense, choose to walk into a debt crisis, given that people in Europe are having a debt crisis imposed on them without choice. There is a sense of incomprehension that the politicians can't sit around the table and come up with some sort of proactive plan."

Summers' forecast of several more years without normal levels of employment is sobering, she adds.

"It makes a question of social cohesion and whether America has a way of allocating pain even more pertinent," Tett says.

Social divisions are widening in America, she says. Income inequality is growing. Tett warns that may create even more tension going forward.

"And I love America," she says. "I think it's got so much to be proud of. I just really hope that it finds a way to tackle these problems."