Saturday, May 2, 2020
Will the worst downturn since the Great Depression last as long?
That shocking reality naturally invites analogies and raises what is perhaps the most important economic question of our time: How long will the bad times last? After all, what made the Great Depression so great was not just the severity of the slump but its extraordinary length — beginning in the United States in the second half of 1929 and not really ending until almost 10 years later.
Policymakers are hoping that the modern economy will come roaring back when things “open up,” but disagree about when that can or should happen and exactly what it means. Although very severe recessions are sometimes short, America’s most recent recessions — even the milder ones — have tended to be long, and the most recent one was both long and deep.
A prolonged collapse akin to the Great Depression is by no means inevitable, but it’s not impossible either. The fate of the American economy will rest not just on the course of the virus but on economic policy choices. Will Congress and the Federal Reserve provide the kind of dramatic stimulus we need to return to full employment, or will they opt to just muddle through?
The most striking thing about the American economy in the 1930s is that the Depression went on and on and on. There are a few different ways you could look at this, but probably the simplest is to consider the unemployment rate.
Here’s a chart showing joblessness calculated in two ways. One is the official unemployment rate from Stanley Lebergott of the Bureau of Labor Statistics, the other line is a more optimistic model constructed years later by economist Michael Darby, who argues that the official statistics of the day improperly classified people with unemployment relief jobs as not working. The Lebergott-Darby gap of roughly 5 percentage points makes a difference, but either way, it’s a long depression.
Even using Darby’s numbers, the unemployment rate never got low during President Franklin D. Roosevelt’s New Deal programs. After getting steadily worse under President Herbert Hoover in the early 1930s, the economy got better under Roosevelt, which is why he won reelection overwhelmingly in 1936. But things were still really bad during the New Deal’s best moments.
Then it got worse, because in 1937, the US stopped making progress and fell into a new recession within the depression. Policymakers corrected some of the errors that led to the 1937 recession (more on that later), and the unemployment rate started falling again.
But even by 1940, the labor market was still in shambles. It’s only the extraordinary events surrounding World War II that really brought the Depression to an end. And that resolution shows us two things.
One is that if politicians had been willing to try more drastic things earlier, they may have been able to generate the rapid recovery that took place in 1940 earlier, too. The other is that if war hadn’t broken out, the very modest and unsteady pace of recovery that was happening under Roosevelt might have just continued for years more. Nothing about the nature of an economy guarantees that it will “bounce back” from bad news.
And America has had a lot of recessions like that. In July 1981 the unemployment rate was 7.2 percent, surging to 10.8 percent by December 1982, but then tumbling back to 7.2 percent by June 1984.
That was the worst of the V-shaped recessions, but they used to be fairly common — especially in the 20 years following the end of World War when we had four of them in a row. These recessions all have an underlying dynamic, where the Federal Reserve starts to worry that the economy is overheating and inflation is rising so they raise interest rates. Then interest-sensitive sectors of the economy rapidly start to shrink, and unemployment soars. When the time is right, the Fed flips the switch and things pick up again.
America’s more lingering recessions — like the one that sparked by the financial crisis but also the much more mild but annoyingly long-lasting one touched off by the collapse of the 1990s stock market bubble — tend to have more complicated dynamics. The Fed tries to fight them by cutting interest rates, but the Fed didn’t cause these recessions by raising rates, so taking them all the way down to zero doesn’t necessarily get the job done. Today, the Fed has already taken rates down to zero and the economy is still heading south, so there’s reason to worry that once again we won’t get a “V.”
With this view, you might see the economy as sort of like a spring. It’s been compressed, for now, for the sake of flattening the curve. But when pressure abates — whether because of policy shifts or medical breakthroughs — it’ll bounce right back. Former Treasury Secretary and National Economic Council director Lawrence Summers tentatively endorsed something like this view in early April, analogizing the current depression to a seasonal downturn or a long weekend. He acknowledged, though, that this was “only an optimistic guess” and he was “not sure” if it’s right.
The overall record of macroeconomic forecasting as a discipline is not very good, and in this case, economists are looking at a situation they have no real experience with.
And it’s certainly possible that this could prove correct. Simply proclaiming that America is back open for business is unlikely to produce a huge surge in growth, but real medical advances that put the public health crisis behind us could. You could imagine a tremendous amount of pent-up demand as a long-frustrated public goes out and does things they’ve been afraid or banned from doing for months.
There could also be a surge of optimism as people feel the American can-do spirit has triumphed against an “invisible enemy” and now is a great time to make risky bets on the future. Millions of Americans have been familiarizing themselves with new digital productivity tools during the extended work-from-home era and organizations may return to the post-Covid world stronger and more efficient for it.
The economy initially headed into what looked like a mild recession, driven by a decline in housebuilding activity associated with the fall in housing prices. But then came a severe financial crisis that sparked concerns about widespread bank failures or a total breakdown of the financial system. That plunged the country into what became an extremely severe recession over the winter of 2008-’09. But a range of emergency measures undertaken by the Federal Reserve and the US Congress successfully saved the financial system which, by mid-2009, was clearly not going to collapse. And, indeed, by the second half of 2009 the economy was growing again — just not fast enough.
Jobs came back, but at a much slower pace than they’d disappeared, giving the recession a prolonged and asymmetrical character. A financial breakdown caused the job losses, but fixing the financial breakdown didn’t cause a rapid bounce-back.
Making things worse, it took six years for total employment to return to its precrisis levels, and by the time it did, the US population had grown considerably. In 2015 and 2016, more Americans were working than at any previous time in history. But because the working-age population kept growing the labor market remained weak. It was really only in the 24 months before coronavirus arrived that the job market was finally functioning “normally” with workers quitting jobs at high rates, and employers experimenting with pay raises to retain staff or recruiting marginal candidates like ex-convicts and recovering addicts.
The shallow recession of the early 2000s was much less severe but had a similar quality — the recovery was much slower and weaker than the initial collapse, provoking much frustration. The common element that these two recessions share with the Great Depression is that none of them were deliberately provoked by a Federal Reserve trying to control inflation. Consequently in all three cases even though the Fed cut interest rates to try to help the economy, the switch couldn’t be flung hard enough to make the economy bounce back. What it took was either time or, in the case of the Depression, extraordinary measures.
Conversely, in 1937, when public officials decided the recovery was underway and it was time to return to more conventional policy, everything slid back down quickly.
In retrospect, the United States almost certainly could have restored full employment in the wake of the 2008 financial crisis more rapidly had policymakers acted more forcefully in the spirit of 1933. What we got instead was a frustrated back-and-forth effort. Big fiscal stimulus in 2009, followed by significant austerity starting in 2011. Bold Federal Reserve initiatives like quantitative easing, alternating with statements about how eager the Fed was to return to normal.
The results were much better than in the Great Depression, but much worse than the recovery could have looked like.
The economy probably won’t revive on its own
The basic case for pessimism about the economy in the medium term is this: Most Americans are going to exit this crisis poorer than they were at the beginning, thanks to some combination of job loss, reduced hours, pay cuts, investment losses, lost tips, or reduced sales. People who have less money than they had before the crisis can’t simply “go back to normal” when the crisis is over, they need to deal with the fact that they are poorer now by restraining their spending. But because my spending is your income and vice-versa, that collective restraint will keep holding the economy back.
If the coronavirus crisis were a uniquely American phenomenon, Americans could get out of the jam by selling things to foreigners — but the whole world is basically in the same boat.
If interest rates were high, the Fed could make them low making debt more affordable and generating a surge of debt-financed activity — but rates were low when the crisis began and they’ve already been cut to zero.
That essentially leaves us where we were in the Great Depression, with an economy that’s going to be depressed simply because it’s been depressed. People with no money can’t buy things, and in a global downturn there’s nowhere to turn for customers. A solution would need to involve either unorthodox Federal Reserve actions — a search for a modern-day equivalent to abandoning the gold standard — or else the government serving as a customer of last resort, as it did during the lead-up to World War II.
To normalize the economy, it won’t be good enough to lift restrictions and address the underlying public health emergency, people are going to need sources of income. The federal government, which is uniquely positioned to spend much more than it takes in, can serve as that source of income. But for it to happen, politicians will need to avoid the kind of premature pivot to deficit reduction that happened in 2010 and 2011.