The parallels between the lead-up to the Great Depression and the lead-up to today’s severe recession are eerie. Why do the economic costs today appear to be so much lower (knock on wood)?
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:
The Great Depression was an unspeakably bad time for the U.S. economy. I know that sounds obvious, but it seems necessary to say given all the recent rhetoric about “the worst economy since the Great Depression.”
Our economy has indeed been in terrible shape lately, with millions of families struggling with falling incomes, job losses, home foreclosures, and plummeting wealth. The current recession is severe by any reasonable metric. But it still pales in comparison to the Great Depression.
One simple way to see these basic facts — that the current recession is severe by historical standards, but falls far short of the Great Depression — is to consider how much overall economic output declined during past downturns. The following chart shows the five largest declines in real gross domestic product (GDP) since the end of World War II. For the current downturn, I have used official estimates of GDP through the first quarter of this year plus the median forecast for Q2 (-1.4 percent) from the Wall Street Journal’s May survey of forecasters).