A Tale of Three Crises

Conservatives like to pooh-pooh the US economy’s recovery from the worst downturn since the 1930s. But because the Great Recession is so singular, it’s difficult to judge recent economic performance, and the effectiveness of the government and Fed response. No downturn since World War II compares. Both for the conditions that triggered each, and their severity, the closest and nearest-in-time comparisons we have are the Great Depression and the Panic of 1893. And the US economy did much better this time around.

The Great Depression remains the worst of them all. GDP fell 30% and unemployment got to 25%. The Panic of 1893 saw GDP drop 5 to 10%, and unemployment peak at 12 to 18%. (Measures for that period remain crude.) The Great Recession was less severe: US GDP dropped 4.7% and unemployment topped out at 10%.

The key to our escape from what might have been a replay of the Great Depression was massive, directed spending on the part of the federal government, and perhaps more importantly, a commitment on the part of the Federal Reserve to pump cash into the economy, to prevent deflation. By one measure, US GDP in 2010 was 13% higher than it would have been in the absence of Fed and fiscal action.

It is not generally appreciated that the initial drop in economic activity during the 1st 3 quarters of the Great Recession during 2007-08 was in fact STEEPER than 1929-30. In other words, at the outset, the US was on track for a 1930s-style depression. The difference, according to the best research on the subject (cited below), was aggressive fiscal and monetary intervention.

Financial bubbles happen when banks continue to pour money into an economy, even as asset prices inflate. When banks collectively get cold feet and stop lending, asset sellers quickly outnumber buyers, and prices collapse – as they do, a lot of money vanishes. It doesnt merely change hands – it ceases to exist – no longer available for borrowing, investing or buying. In 1893, the asset bubble was concentrated in railroads. In the Great Recession, it was housing. In the Great Depression, the bubble wasnt specific to a particular industry. In all three, the crash was preceded by a massive run-up in private-debt, followed by a prolonged economic malaise, in which banks were insolvent, and personal savings was wiped out – there was no money left in private hands to buy anything.

Getting out of such a funk takes time. With the Panic of 1893, real per capita GDP needed 6 yrs to get back to 1892 levels. And even after it did, unemployment (which lags behind other indicators) was 12% – the economy wouldnt get back to full employment until 1900, 7 yrs after the bubble burst. The Great Depression was worse: real per capita GDP didnt get back to its 1929 level until 1937, and full employment wasnt achieved until World War II.

By comparison, real per capita GDP after the GR needed 5 years to get back to its 2007 level. Full employment (which is not well defined) may be achieved next year, which would make for a 7 to 8 year recovery. Not quite 5 1/2 years since the GR began in Dec 2007, unemployment today is a manageable 6.7% (though labor force participation remains quite low). 5 1/2 years after the Panic of 1893 and Great Depression, unemployment was still in double-digits.

The relative shallowness of the Great Recession – both in unemployment and GDP contraction – can be directly attributed to a policy of deficit spending by the federal government, and aggressive action by the Fed to shore up banks and maintain money supply. The aim of these policies at the time was to take the edge off – and they succeeded. In 1893 and 1929, prices collapsed soon after asset values. During and after the GR, the US teetered on the edge of deflation but never succumbed – this alone may have halved the depth of the contraction.

The short of it is that financial crises dont make for ordinary recessions – the recovery that follows has always been slow, and is beset by persistent unemployment. But the US economy has come a long, long way since the dark days of 2008, thanks in large part to aggressive government and central bank action.







great source for historical macro data: http://www.measuringworth.com/

help wanted: i’d be very grateful for a historical graph on private debt for the US that looks like this one for Australia: http://www.creditwritedowns.com/wp-content/uploads/2011/11/Australia-private-debt-to-GDP.png







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