Why There Was No Depression
By Robert J. Samuelson
WashPost
Monday, October 5, 2009
How close did we come to the Great Depression 2.0? That question will spawn a cottage industry of books, studies and conferences. But Christina Romer, the head of President Obama's Council of Economic Advisers, already has an answer: pretty darn close. Her conclusion deserves attention because Romer, in her previous academic career, was a scholar of the Great Depression.
"Depression" is a term of art. It's more than a serious economic downturn. What distinguishes a depression from a harsh recession is paralyzing fear of the unknown -- so great that it causes consumers, businesses and investors to retreat and panic. They hoard cash and desperately curtail spending. They sell stocks and other assets. A devastating loss of confidence inspires behavior that overwhelms the normal self-correcting mechanisms (lower interest rates, inventory resupply, cheap prices) that usually prevent a recession from becoming deep and prolonged: a depression.
Comparing 1929 with 2007-09, Romer finds the initial blow to confidence far greater now than then. True, stock prices fell a third from September to December of 1929; but fewer Americans then owned stocks, and prices had risen early in the year. Moreover, home prices barely dropped. From December 1928 to December 1929, total household wealth declined only 3 percent. By contrast, the loss in household wealth between December 2007 and December 2008 was 17 percent -- more than five times as large. Both stocks and homes, more widely held, suffered larger losses.
Thus traumatized, the economy might have gone into a free fall ending in depression. Indeed, it did go into a free fall. The anniversary of Lehman Brothers' bankruptcy in mid-September inspired much commentary that saving the investment bank wouldn't have averted the crisis. Too many other lenders held bad loans. True. But allowing Lehman to fail almost certainly made the crisis worse. By creating more unknowns -- which companies would be rescued, how much were "toxic" securities worth? -- Lehman's bankruptcy converted normal anxieties into extreme fears that triggered panic.
(More here.)
WashPost
Monday, October 5, 2009
How close did we come to the Great Depression 2.0? That question will spawn a cottage industry of books, studies and conferences. But Christina Romer, the head of President Obama's Council of Economic Advisers, already has an answer: pretty darn close. Her conclusion deserves attention because Romer, in her previous academic career, was a scholar of the Great Depression.
"Depression" is a term of art. It's more than a serious economic downturn. What distinguishes a depression from a harsh recession is paralyzing fear of the unknown -- so great that it causes consumers, businesses and investors to retreat and panic. They hoard cash and desperately curtail spending. They sell stocks and other assets. A devastating loss of confidence inspires behavior that overwhelms the normal self-correcting mechanisms (lower interest rates, inventory resupply, cheap prices) that usually prevent a recession from becoming deep and prolonged: a depression.
Comparing 1929 with 2007-09, Romer finds the initial blow to confidence far greater now than then. True, stock prices fell a third from September to December of 1929; but fewer Americans then owned stocks, and prices had risen early in the year. Moreover, home prices barely dropped. From December 1928 to December 1929, total household wealth declined only 3 percent. By contrast, the loss in household wealth between December 2007 and December 2008 was 17 percent -- more than five times as large. Both stocks and homes, more widely held, suffered larger losses.
Thus traumatized, the economy might have gone into a free fall ending in depression. Indeed, it did go into a free fall. The anniversary of Lehman Brothers' bankruptcy in mid-September inspired much commentary that saving the investment bank wouldn't have averted the crisis. Too many other lenders held bad loans. True. But allowing Lehman to fail almost certainly made the crisis worse. By creating more unknowns -- which companies would be rescued, how much were "toxic" securities worth? -- Lehman's bankruptcy converted normal anxieties into extreme fears that triggered panic.
(More here.)
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