But Have We Learned Enough?
So who can we trust to anticipate the future in the markets? It looks like no one.
The New York Times, October 26, 2008
ECONOMIC VIEW
But Have We Learned Enough?
By N. GREGORY MANKIW
LIKE most economists, those at the International Monetary Fund are lowering
their growth forecasts. The financial turmoil gripping Wall Street will probably
spill over onto every other street in America. Most likely, current job losses are
only the tip of an ugly iceberg.
But when Olivier Blanchard, the I.M.F.’s chief economist, was asked about the
possibility of the world sinking into another Great Depression, he reassuringly
replied that the chance was “nearly nil.” He added, “We’ve learned a few
things in 80 years.”
Yes, we have. But have we learned what caused the Depression of the 1930s?
Most important, have we learned enough to avoid doing the same thing again?
The Depression began, to a large extent, as a garden-variety downturn. The
1920s were a boom decade, and as it came to a close the Federal Reserve tried
to rein in what might have been called the irrational exuberance of the era.
In 1928, the Fed maneuvered to drive up interest rates. So interest-sensitive
sectors like construction slowed.
But things took a bad turn after the crash of October 1929. Lower stock prices
made households poorer and discouraged consumer spending, which then
made up three-quarters of the economy. (Today it’s about two-thirds.)
According to the economic historian Christina D. Romer, a professor at the
University of California, Berkeley, the great volatility of stock prices at the
time also increased consumers’ feelings of uncertainty, inducing them to put
off purchases until the uncertainty was resolved. Spending on consumer
durable goods like autos dropped precipitously in 1930.
Next came a series of bank panics. From 1930 to 1933, more than 9,000 banks
were shuttered, imposing losses on depositors and shareholders of about $2.5
billion. As a share of the economy, that would be the equivalent of $340 billion
today.
The banking panics put downward pressure on economic activity in two ways.
First, they put fear into the hearts of depositors. Many people concluded that
cash in their mattresses was wiser than accounts at local banks.
As they withdrew their funds, the banking system’s normal lending and money
creation went into reverse. The money supply collapsed, resulting in a 24
percent drop in the consumer price index from 1929 to 1933. This deflation
pushed up the real burden of households’ debts.
Second, the disappearance of so many banks made credit hard to come by.
Small businesses often rely on established relationships with local bankers
when they need loans, either to tide them over in tough times or for business
expansion. With so many of those relationships interrupted at the same time,
the economy’s ability to channel financial resources toward their best use was
seriously impaired.
Together, these forces proved cataclysmic. Unemployment, which had been 3
percent in 1929, rose to 25 percent in 1933. Even during the worst recession
since then, in 1982, the United States economy did not experience half that
level of unemployment. (more…)
There are a number of important tax law changes that take effect this year, including three changes that will affect some homeowners. There are also changes that impact business owners.
