Lessons from the Great Depression

#Depression, Recession and Expansion

The term “depression” is not well understood and is not in wide use today.

Economists prefer terms like

• “recession,” which means two or more consecutive quarters of declining GDP with rising unemployment, and
• “expansion” which covers periods of rising GDP between recessions. 

Economists like the fact that recession is mathematically defined and measurable, whereas depression is subjectively defined and somewhat in the eye of the beholder.

Policymakers avoid using words like depression for fear that the public may become depressed and stop spending — the opposite of what is desired.


#Characteristics of Depression

Depression does not imply long periods of declining GDP. 

It is possible to have rising GDP, falling unemployment and rising stock prices in a depression.  Indeed, this is exactly what happened from 1933 to 1936 in the middle of the Great Depression.

What characterizes a depression is that

• growth does not return to long-term potential, and 
• total output, labor force participation and asset prices languish below prior peaks in some combination. 

This definition was first laid out by John Maynard Keynes in 1936 in his magnum opus, The General Theory of Employment, Interest and Money. It is not mathematically precise, but it is highly serviceable.

The importance of Keynes’s definition is that depressions are not merely longer or more persistent versions of a recession.  They are qualitatively different. 

# Tackling recession and depression

A recession is a cyclical phenomena amenable to liquidity and interest rate solutions applied by central banks.

Depressions are structural and do not respond to central bank remedies.

Depressions are only cured by structural changes in areas such as fiscal policy, regulation, and labor markets that are not controlled by central banks, but rather by legislatures and the executive.

#Lessons from the Great Depression of 1929 to 1940

The mystery of the Great Depression is not why it began but why it lasted so long.

The answer appears to be something economists call regime uncertainty.

• The Hoover-Roosevelt programs seemed to come out of nowhere and disappear just as quickly confusing business leaders. 
• Programs were launched with great fanfare then abandoned based either on Supreme Court decisions declaring  them unconstitutional or because of their failure to produce results.
• In response, private capital went to the sidelines and refused to invest. Instead of a labor strike, there was a capital strike. 
• No amount of government intervention could make up for the lack of private capital investment caused by the policy uncertainty of those years.

The Great Depression in the United States is conventionally dated from 1929 to 1940. These dates are somewhat arbitrary.

• It began with the stock market crash in October 1929, and only ended when the U.S. massively restructured its economy to produce war material, first for our allies, particularly the U.K., in 1940, and later for our own forces after the U.S. entered the Second World War in December 1941.
• The U.S. depression was part of a larger global depression that was visible in the U.K. in 1926, and in Germany in 1927, and that was not fully resolved until the new international monetary arrangements agreed at Bretton Woods in 1944 and implemented in the post-war years. 
• But the core period, 1929–1940, covering President Hoover’s single term, and the first two terms of President Franklin Roosevelt, are the object of intensive interest by historians and scholars to this day.

The conventional narrative of the Great Depression is known by rote.

• Herbert Hoover and the Federal Reserve are the typical villains who committed a series of policy blunders that first caused the depression, and then failed to alleviate it.  
• Franklin Roosevelt is portrayed as the hero who saved the day and led the country back to growth through activism, government programs and massive spending. 
• This narrative has been the blueprint and justification for liberal government intervention and spending programs ever since.

This narrative is almost completely wrong.

• One much closer to the truth of what happened in the 1930s shows that there was a great deal of continuity between the Hoover and Roosevelt administrations. 
• Both were activists and interventionists.
• Both believed in public works and government spending.  
• Major depression-era projects such as the Hoover Dam were begun in the Hoover administration; Roosevelt merely continued such hydroelectric and flood control projects on a larger scale with his Tennessee Valley Authority and other projects.
• Importantly, Roosevelt did not end the depression in the 1930s; he merely managed it with mixed results until the exigencies of war production finally helped the U.S. escape it. 
• Indeed, the U.S. had a severe relapse in 1937–38, the famous “recession within a depression,” that reversed some of the gains from the period of Roosevelt’s first term.

#Implication for the U.S. today

Indeed, the U.S. is in a depression today, and its persistence is due to the fact that positive structural changes have not been implemented. 

Federal Reserve policy is futile in a depression.

The implication is that the current period of low growth in the U.S. will continue indefinitely until positive structural changes and greater clarity in public policy are achieved. 

This new depression may be a long one.