Learning lessons from the Great Depression

Mickey HepnerThe Edmond Sun
With a steady drumbeat of bad economic news and a recession that looks to be the most severe since World War II, it is inevitable that there would be many concerns about a repeat of the Great Depression. Such concerns, however, are unwarranted.There is clearly reason to be concerned about the economy, and a need for a stimulus package of some sort. The Congressional Budget Office released its latest economic outlook last week in which they predicted the current recession will turn out to be the longest downturn since World War II. On Friday, the U.S. Bureau of Labor Statistics reported that the U.S. economy shed another 524,000 jobs in December bringing the total job loss for 2008 to 2.6 million. Most disturbingly though, is that the job losses accelerated at the end of 2008 with the economy shedding 1.9 million jobs in just the last four months alone. With the automakers, financial institutions and retailers still struggling, more job losses are likely to come in the next few months.The magnitude of the job losses and the depth of this recession have led some economists to invoke the dreaded “depression” word. Princeton economist and recent Nobel Laureate Paul Krugman’s latest book is even titled “The Return of Depression Economics and the Crisis of 2008.” Also, a new report by the Center for American Progress shows on its front cover a picture of a Depression-era food line. Before we get too carried away with the Depression references though, let’s look at some facts.Below are the annual changes in U.S. Gross Domestic Product from 1930-33:• 1930: GDP fell by 8.6 percent.• 1931: GDP fell by 6.4 percent.• 1932: GDP fell by 13.0 percent.• 1933: GDP fell by 1.3 percent.How does this compare to today? While the final numbers for 2008 GDP will not be known until March (the advance estimates are due at the end of January), it appears that in 2008 GDP will fall by at most 1 percent. As for next year, the Congressional Budget Office estimates that GDP will fall by 2.2 percent before rebounding in 2010. In other words, the economy of today is nowhere near as bad as the economy of the Great Depression. Although it almost was.Perhaps the definitive book on the causes of the Great Depression was “A Monetary History of the United States,” written by Milton Friedman and Anna Schwartz in 1963. Friedman — who was arguably the greatest economist of the 20th century — and Schwartz found that a series of banking crises and bank runs in the early 1930s, coupled with an inattentive Federal Reserve, generated a significant contraction in the supply of money in the economy. It’s what Friedman and Schwartz called “The Great Contraction.” Since money is the fuel that powers commerce, with less fuel there is less commerce. In the 1930s this “Great Contraction” of money turned an ordinary recession into the Great Depression. According to Friedman and Schwartz, if the Federal Reserve had more aggressively sought to offset this contraction and pump more money into the financial system the Great Depression would have been avoided.Interestingly, earlier this year we saw this same scenario begin to play out, but with a much different ending. Just as we saw at the beginning of the Depression a banking crisis began to contract the money supply. In this case, banks holding assets that were plummeting in value began hoarding cash instead of lending it out into the economy. As a result, interbank lending interest rates nearly doubled in just the few weeks from late September to early October as banks demanded that borrowers pay higher interest rates in order to receive a loan.It was at this time that the Federal Reserve and the U.S. Treasury began pumping about $2 trillion of money into the economy. These efforts have ensured that we do not see another “Great Contraction” today. In fact, with more money available in the economy, interest rates have fallen, thereby facilitating more commerce. In other words, by not repeating the mistakes of the Great Depression, the efforts of the Federal Reserve and the U.S. Treasury are keeping us from repeating the experience of the Great Depression.The economy is not yet out of the woods. We are not yet on the verge of a recovery. The financial crisis of the past few months generated ripple effects throughout the economy that will take months to sort out. But the good news is that the Federal Reserve, and the U.S. Treasury, appear willing to do whatever needs to be done in order keep the money flowing. In short, it looks as if they have learned the lessons from the Great Depression.MICKEY HEPNER is an associate professor of economics at the University of Central Oklahoma.