Roosevelt Recession Begins After Conservative Treasury Secretary Persuades FDR to Cut Spending 17 Percent

The American economy enters a severe recession in May 1937, lasting 13 months through June 1938, after President Franklin D. Roosevelt accepts the advice of his conservative Treasury Secretary Henry Morgenthau Jr. to slash government spending by 17% over two years in an effort to balance the federal budget. The Roosevelt Recession—America’s third-worst downturn of the 20th century—sees industrial production decline almost 30%, durable goods production fall even faster, and unemployment jump from 14.3% in 1937 to 19.0% in 1938, demonstrating how premature fiscal austerity can abort economic recovery and vindicate Keynesian theory over balanced-budget orthodoxy.

By 1937, the fledgling recovery from the Great Depression creates an opening for conservatives within Roosevelt’s administration to press their case for budget balancing with a generally sympathetic president. Treasury Secretary Morgenthau and his aides favor balancing the federal budget, while other advisers in Roosevelt’s inner circle—including Harry Hopkins, Federal Reserve Chairman Marriner Eccles, and Henry Wallace—have accepted the recent theories of British economist John Maynard Keynes advocating continued government spending during economic downturns. FDR agrees to begin scaling back emergency spending that had been bolstering growth since 1933, resulting in drastic cuts to the Public Works Administration and Works Progress Administration in the 1937-1938 fiscal year budget.

The recession’s multiple causes include both fiscal and monetary contraction. On the fiscal side, government spending cuts combine with sharply rising tax receipts from economic growth and newly-implemented Social Security payroll taxes, which drain approximately $2 billion from the economy in their first year of operation. Simultaneously, Federal Reserve governors orchestrate a severe monetary tightening that most economists consider more harmful than the fiscal contraction. The combined effect devastates the economy: by the end of 1937, real GDP drops 10%, unemployment soars back to 19%, and GNP declines 6.3%.

Business-oriented conservatives attempt to blame the recession on New Deal hostility to business expansion during 1935-1937, while Keynesian economists identify it as proof that premature efforts to curb government spending and balance the budget abort recovery during depression conditions. The debate is resolved empirically on April 2, 1938, when Roosevelt reverses course and sends a new large-scale spending program to Congress, receiving $3.75 billion split among PWA, WPA, and various relief agencies, with total appropriations reaching $5 billion by spring 1938. The economy recovers following this spending surge. The Roosevelt Administration’s acceptance of what becomes known as Keynesianism establishes the precedent of using deficit spending as a vehicle for promoting recovery in times of fiscal crisis, while the recession itself demonstrates how conservative pressure for premature austerity can sabotage economic recovery—a lesson repeatedly forgotten in subsequent decades.