Policymakers like to say that they kept the financial crisis from causing the type of economic damage that the Great Depression did, and they're right — but maybe only for another year.
That, at least, is the sobering conclusion of a recent paper by former International Monetary Fund Chief Economist Olivier Blanchard and former Treasury Secretary Lawrence Summers. They point out, as you can see above, that while the economy never experienced the type of complete collapse in 2008 that it did in 1929, the recovery has been so much slower this time around that it won't be long until our total growth since the start of the crisis will be worse than it was at this point of the Great Depression. In other words, the economy has grown less in the 2010s than it did in the 1930s. That's even accounting for the fact that you'd expect growth to be a little more sluggish today now that so many baby boomers are hitting retirement. They're not comparing gross domestic product, you see, but gross domestic product per working-age adult. That strips out how much of the economy's growth is solely due to the population's growth, and gives you an idea of the underlying strength — or weakness — of things.
Which one was supposed to be the Great Depression again?
Of course, a couple of caveats are in order. The safety net, the stimulus, the bailouts, and the Federal Reserve's unconventional efforts to prop up the economy have all kept the human cost of the 2008 crisis from ever approximating anything like what happened after 1929. Unemployment didn't get up to 25 percent, shantytowns didn't become a regular part of the urban landscape, and bread lines weren't people's primary source of nutrition. This, though, is the lowest of low bars. Double-digit unemployment, millions of foreclosures, and many more on food stamps were all more than bad enough. For all the progress we've made the last seven or eight years, there are still too many people being left behind — and, in the process, succumbing to drugs and despair.
The problem is that our policymakers have been aggressive, but not radical. The lesson of the 1930s is that you need to be both.
Now, there were really two recoveries from the Great Depression. The first one began in 1933 when FDR took us off the gold standard, and the second one did in 1939 when he had us ramp up war production to help Britain. In between, a series of mistakes derailed it all, and nearly crippled his presidency. A premature return to normalcy is only a return to stagnation — or worse.
Why is that? Well, the thing you have to understand about a crash like the one we had in 2008, or 1929 for that matter, is that it doesn't just happen on people's balance sheets, but also in their minds. What I mean by that is that the aftermath of a debt-fueled bubble — that's what both of them were — leaves a lot of people unable to spend, and everyone else afraid to. So you need policies that do something about both. Going off the gold standard did that during the Great Depression by increasing inflation enough to help people who owed a lot of money and spurring the well-to-do to put their cash to use before it lost its value. This was what's called a “regime shift,” and, as economist Scott Sumner points out, it helped kick-start an almost immediate recovery. Industrial production actually rebounded 57 percent between March and July of 1933 alone.
But the Fed wasn't willing to go quite so far in 2008. Neither was it in 2009, or 2010, or 2011, or, well, you get the idea. Instead, it was as bold as it could be without challenging any of the tenets of its prevailing orthodoxy — 2 percent inflation targeting. That was enough to stave off a complete collapse, but not start a real recovery. At least not one that made up for all of the ground we had lost. That would have required a shock to the system like going off gold had been in 1933. Something like saying that the Fed would let prices catch up to where they would have been if there hadn't been a crash instead of raising rates at the first sign of inflationary pressure. That might sound like a subtle difference, but it would be a big one for the Fed's policy. Indeed, former Fed Chair Ben Bernanke has recently proposed his own version of this idea, which, if it were in place today, would mean that interest rates would not only be zero right now — they're at 1 percent to 1.25 percent — but also at least for a few years into the future.
It's the same story when it comes to fiscal stimulus. It takes a lot to make up for an economy that's suffering from a debt hangover. Not to mention that it takes a long time, too. Now, the government can always keep the economy from contracting by using the money that the private sector won't while it pays down its debts, but that tends to be more than politicians are comfortable spending for very long. Even FDR and Obama both turned away from stimulus and toward deficit reduction despite still-fragile recoveries out of a combination of political expediency and genuine fealty to what was thought of as fiscal rectitude. In the best case, the result was an even more glacially paced recovery; in the worst, it was an outright relapse into recession.
The difference between then and now was that in 1939 the absolute worst kind of public works program kicked in, one that even conservatives couldn't say no to. It was called World War II. The life-or-death struggle with fascism made mega-deficits politically possible, and, in the process, got the economy back to full strength. Now, the good news is that there hasn't been anything that bad to make the government spend so much money today. But the bad news is that there hasn't been anything at all to make the government spend any money today.
Think of it as a reverse Goldilocks economy. Things aren't desperate enough to force the government to do more, but they aren't good enough to put everyone to work. It's juuuust wrong.
It might not be a great depression, but it is a long one.