Yesterday I cautioned against comparing the current economic downturn to the Great Depression. The current recession is certainly severe, with overall economic activity on track to drop almost 4 percent. But the Great Depression was incomparably worse, with output dropping almost 30 percent.
In the comments, Merle Hazard offers an important addendum to my argument, which I heartily endorse. Merle says:
A plane crash averted does bear some resemblance to a plane crash that happened…not in the final outcome, but in the chain of events that took place up until the time the pilot pulled out of the nose dive.
The easiest way to see what Merle has in mind is to read John Kenneth Galbraith’s The Crash of 1929. The parallels between the lead-up to the Great Depression and the lead-up to today’s severe recession are eerie. Excess credit, reckless lending, high leverage, ponzi schemes … it’s all there. Some enterprising author should (with permission) go through the book, change a few hundred words and numbers and reprint it as The Crash of 2009.
Except for one thing: the economic costs of today’s downturn, although severe, appear to be much lower (knock on wood). The trillion dollar question is why. I see three possible explanations:
- Today’s policymakers have learned the lessons of history. They have avoided the obvious blunders of the Depression era and have taken bold and timely action to right the economy.
- Today’s economy is more resilient. The private sector does a better job of responding to shocks (e.g., through better matching of production to demand), while basic government policies have strengthened the fabric of the economy (e.g., deposit insurance prevents most bank runs).
- Today’s economic forecasters are way too optimistic. With the passage of time, we will discover that today’s crisis does indeed warrant comparison to the Great Depression.
Merle argues that the first explanation, better real-time policymaking, is a key part of the story. I agree. I also think greater resilience deserves some credit.
Only time will tell whether current forecasters are too optimistic. Let’s hope they aren’t.
(P.S. If you aren’t familiar with Merle Hazard, you should be. Click on over to www.merlehazard.com to hear some of his classics. My favorite? “Inflation or Deflation” which includes the immortal line: “Inflation or deflation. Tell me if you can. Will we be Zimbabwe or will we be Japan?”)