Recently Allan Meltzer, a former Vice Chairman of the Federal Reserve, wrote a widely noted and provocative article in the Wall Street Journal called “What Happened to the ‘Depression?’” He called for an end to deficit-inducing stimulus because the cries of Depression from noted mainstream economists has been proven false. His thesis is that these economists, most notably Paul Krugman and IMF Chief Economist Olivier Blanchard, are hyping the downturn to support a specific policy agenda with which he vehemently disagrees.
Conflating issues for ideological purposes
While his opinion piece deserves discussion, I find his argument disingenuous as he too is promoting a specific policy agenda. The crux of the matter is three-fold:
- How severe is this downturn and financial crisis?
- How severe would it have been had specific policy measures not been taken?
- Irrespective of the severity of the downturn, were these the right steps to have followed?
I delineate the argument as such because Meltzer, I believe purposely and misleadingly, conflates these issues for political purposes. His goal is to present a narrative in which stimulus, especially deficit-inducing stimulus is seen as wasteful and misguided. This may be the case (although I do believe certain types of stimulus are purposeful). I don’t intend to examine that issue because it is as much political and ideological as it is economic. It distracts from the real question: how severe could this downturn have been?
Nowhere near the Depression
When it comes to this core question, I agree wholeheartedly with Meltzer. This is not the Great Depression II, nor will it be, nor was it likely to have been. I wrote a fairly personal post on this very point at the height of the panic last year called “Worse than the Great Depression.” My point was that America, the world really, is much richer than it was in 1929. The social safety net is much more robust. And policy makers are more knowledgeable than they were eight years ago. Comparisons to the Great Depression are misplaced.
But, Allan Meltzer is incorrect when he compares this downturn to 1973-75. The present downturn is clearly more severe. The financial system has been hit very hard with a number of prominent institutions either dying (Lehman, Bear Stearns, Washington Mutual, Merrill Lynch and Wachovia) or being critically wounded (Citigroup and Bank of America).
When one looks globally, the same is also true. Large or venerated institutions like RBS, Lloyds/HBOS, Hypo Real Estate, Dresdner/Commerzbank, Fortis, Dexia and UBS have all collapsed or been forced into the arms of government. In 1974, we had a financial crisis that centered on the death of Herstatt in Germany and precipitated the first real modern crisis of financial contagion since Creditanstalt in 1931 (hence the term Herstatt risk and the reason for Bear Stearns’ bailout in 2008). But, this financial crisis was mild in comparison to what we have seen recently.
Employment is the difference
The real difference is the weakness of consumers, particularly in Anglo-Saxon countries and Spain. Here, we see a mountain of debt, huge losses in wealth and a bevy of macroeconomic disequilibria without parallel – even in the Great Depression.
What’s more is this is indeed the worst period of employment growth in the U.S. since record keeping began during the Great Depression. Below is a chart showing the 100-month change in seasonally-adjusted non-farm payrolls. This could generally be considered a length of time which spans an entire business cycle. In April of 2009, we saw the first period during which non-farm payrolls decreased over a 100-month span.
What this data should make plain is that the downturn we are experiencing is really an outgrowth of the recession and jobless recovery of 2001-2003. Only through the extraordinary efforts of Alan Greenspan in inflating a housing bubble to replace the telecom and technology bubble were we able to escape this downturn relatively unscathed.
Bubble economics has created a calamity
So, my conclusion is three-fold.
- This is not the Great Depression II, but it is indeed a serious crisis – much more serious than 1973-75. That makes this downturn more akin to the Great Depression than it does to other economic recessions in the post World War II period.
- The downturn would have been greater had it not been for the policy response. Policy makers have thrown everything they could at the problem – some would say too much! It is simply misleading to suggest that economic stimulus including fiscal stimulus has not pumped up the economy. I would argue that we are about to see that not enough stimulus was provided to avoid a potential relapse – something I have been saying since before Obama came to office. It is this fact that has left the door open to claims like Meltzer’s.
- I will leave it to the ideologues to debate the correct response. But if a 1937 outcome arrives, you will know why. I have said my piece about easy money; it was ineffective in bringing on sustainable recovery in 2001 and precipitated a more calamitous downturn. I don’t think things will be different in 2009. But, that leaves the question of budget-busting fiscal stimulus – the crux of Meltzer’s article. There are some who think it better to swallow a bitter pill and let the downturn happen a-la Warren Harding in 1920-21 (see Wikipedia here and here). I have sympathy (as I suspect Meltzer does) for that view because of malinvestment that stimulus is likely to induce; Just look at China today. But I do think it is that sort of severe downturn which gave us Hitler and Mussolini and I worry about a 1937-style outcome.
There are no easy answers here. Difficult policy choices must be made and the outcome based on these choices is far from clear. However, Allan Meltzer is demagoguing this issue and not being straight about his ideological agenda. It would be infinitely preferable if we could discuss this issue on the merits and not based on a fiction of ideology.