Why Didn't the U.S. Unemployment Rate Rise at the End of WWII? (with Shigergu Fujita)

This paper investigates why the U.S. unemployment rate rose only a few percentage points despite the dramatic decline in government spending and other upheaval at the end of World War II. Using a new longitudinal data set based on archival sources and government surveys, we study the many facets of this question. Our findings suggest the following answers. First, the dramatic decline in government spending led to a significantly smaller decrease in GDP than predicted by standard Keynesian models. Instead, private job creation surged as private activity was “crowded in” by the fall in government spending. Second, even accounting for the smaller fall in GDP, the unemployment rate rose much less than predicted by Okun’s Law. We develop a new decomposition method that reveals how unusual movements in labor force participation rates, hours worked, and productivity led to a breakdown in Okun’s law during the 1940s. Third, the U.S. labor market worked with astounding efficiency: despite large sectoral shifts at the end of the war, most of the workers who separated from their jobs moved directly into new jobs without experiencing unemployment. All of these factors lined up to create a post-war boom despite the largest fall in government spending in U.S. history.