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?”)
Thanks Donald. By the way, another book that seems to have anticipated the present by carefully analyzing the past is “Manias, Panics and Crashes” by Charles Kindleberger, the late MIT economist. Particularly the role of “money supply” growth during the manic phase, with money supply being not necessarily just central-bank created money. In the present debacle, this included funky stuff such as commercial paper issued by junky off-balance-sheet SIVs buying CDOs, which the market created without any direct help from the Federal Reserve.
“issued by junky off-balance-sheet SIVs buying CDOs, which the market created without any direct help from the Federal Reserve.”
Created without any direct help, but with an implicit understanding that they would be bailed out by the fed, having used these junky financial instruments to leverage themselves up to the point where they’re “too big to fail”.
For the record, you’re not out of the woods yet, policymakers haven’t learned anything from history (except how to disguise their robbery better), deposit insurance has made nothing more resilient, and Rothbard’s America’s Great Depression and Mises’ Human Action are the best sources for understanding what happened in 1929 and what is happening today.
Merle Hazard agrees with you that Moral Hazard is alive and well!
Not to take away from the deft wisdom of crisis-managing policy makers, but we also today have built-in stabilizers that didn’t exist at all in the 1930’s that offer substantial income support. These require no judgement or action to kick in and consume very large portions of the Federal budget.
Unemployment insurance, social security, Medicare, Medicaid, TANF, deposit insurance, securities oversight, refundable tax credits… none of these had even been invented during when the stock market crashed in 1929. You lost your job then and all you had was your savings to live off, savings that you soon lost when your non-FDIC insured bank failed.
I’m unaware of the data on this, but surely these income support and structural stabilizers make a huge difference both to consumer confidence and actual consumer purchasing power for millions of unemployed workers that help keep slowdowns from turning into depressions.
So Merle Hazard is not the Okie from Muskogee.
Hey, found your site by accident doing a search on Google but I will definitely be coming back. As for your post… I agree with a lot of what you’re saying here but wouldn’t it be just as easy to try something else? I mean why mess with your quality of life if you don’t have to?
the economy is more globalized so the circumstances are completely different