A New Depression After All?

Some analysts have recently presented evidence showing that the current recession bears an uncanny resemblance to the Great Depression. Much of their evidence focuses on trends in international trade and industrial output. The comparisons will seem frightening to some, but they are incomplete. We have a way to go before the current downturn can approach the economic catastrophe of the 1930s.

Two key features of the Great Depression made it “great” — its severity and its duration. Between 1929 and 1933 real GDP in the United States fell almost 27%. U.S. GDP did not return to its 1929 level until 1936. By 1933 real personal consumption had declined more than 18%. In 1933, about one out of every four Americans in the labor force was jobless. The National Bureau of Economic Research, which is in the business of dating recessions, estimates that after reaching a cyclical peak in August 1929, the U.S. economy shrank for the next 43 months, by far the longest period of uninterrupted economic decline in the twentieth century. In the ten downturns since World War II, excluding this one, the average recession has lasted only 10 months. Even the longest post-war recessions, in 1973-75 and 1981-82, lasted just 16 months.

In severity and duration the current U.S. recession does not (yet) remotely approach the Great Depression. Arguably, the United States is on track to experience its worst post-World War II recession, but even the most severe post-war recession was mild in comparison to the downturn in the 1930s. After reaching a peak in the second quarter of 2008, U.S. personal consumption fell less than 2% over the next three quarters. In May the unemployment rate was more than 15 percentage points below the peak rate in the Depression. Although most economists, including me, expect unemployment to climb for several more months, it will be astonishing if the rate climbs far above the previous post-war peak, which was 10.8%. The nation does not now appear to face an economic or humanitarian crisis on the scale of the Great Depression. In the second quarter of 2009, some indicators of U.S. economic performance began to improve or at least to decline more slowly. Consumer confidence, for example, has improved since the beginning of the year. Job losses declined slightly in April and May compared with job loss rates earlier in the year. After reaching a low point in early March, U.S. stock prices began to climb, and the creditworthiness of many of the nation’s biggest financial institutions appeared to improve.

It is possible to cherry pick economic statistics and find some suggesting the onset of a downturn similar to the early months of the Great Depression. In many respects, however, the Depression began as an ordinary pre-war recession and then continued to grow worse for a frightening span of years. What is unquestionably true is that this recession, like the Great Depression, is world-wide. All of the industrial countries and many middle-income and poor countries have seen a drop in output and a sizeable fall in international demand for their traded goods. Among rich countries, the United States has so far suffered a relatively small drop in output. The latest estimates of GDP indicate that in the four quarters up to the first quarter of 2009, output fell 2.5% in the United States and 2.1% in Canada. The comparable rates of GDP decline were 3.2% in France, 6.9% in Germany, 5.9% in Italy, 9.7% in Japan, and 4.1% in the United Kingdom. On the whole, countries heavily dependent on exports experienced particularly rapid drops in output. U.S. exports have also fallen steeply, but imports have fallen even faster, so the net impact of collapsing world trade has been proportionately smaller on U.S. GDP. In fact, because the U.S. has a sizeable trade deficit, the change in the net U.S. trade position has actually slowed the pace of U.S. GDP decline.

Some statistics that appear to show an unprecedented surge in bad economic news actually provide evidence that policymakers are dealing with the crisis expeditiously and in a sensible way. For example, one of Derek Thompson’s recent charts in shows soaring federal deficits over the past 16 months, indicating a rapid deterioration in the government’s fiscal position. The surging deficit also reflects the effects of automatic stabilizers built into federal tax schedules and transfer programs and a planned response by Congress and the Administration to a severe economic emergency. If the automatic stabilizers and extraordinary policy responses work as intended, the present recession will be far less severe than the Great Depression. As has been notorious for more than seven decades, the policy responses of the Hoover Administration and Federal Reserve Board to the 1929-33 economic emergency were tepid and in many cases counter-productive. I expect the current Administration and Federal Reserve Board will do much better.