Home > economics profession, financial crisis > Revisiting the Second Great Depression and other Fairy Tales

Revisiting the Second Great Depression and other Fairy Tales

from Dean Baker

As President Obama’s re-election campaign heats up, there are several new accounts of his track record finding their way into print. One item for which he is undeservedly given credit is saving the country from a second Great Depression.

The political elites believe in the salvation from the second Great Depression myth with the same fervency as little kids believe in Santa Claus. And, it has just as much grounding in reality.

While the Obama Administration, working alongside Ben Bernanke at the Fed, deserves credit for preventing a financial meltdown, a second Great Depression was never in the cards. The first Great Depression was brought about not only from misguided policies at the onset of the financial crisis, but also from an inadequate policy response.

The spending associated with World War II ultimately got us out of the depression. There is nothing magical about spending on war; spending of the same magnitude on road, schools, hospitals or anything else also would have lifted out the economy out of the depression at any point after the initial collapse in 1929-1930.

The problem was the lack of the political will to spend in these areas, whereas there was plenty of political support for fighting the war after the attack at Pearl Harbor. The lesson from this period is that the United States could have gotten out of the Great Depression any time it was prepared to spend the money to do so. This means that a financial meltdown could not have possibly condemned us to a decade of double-digit unemployment, since that would require a decade of ongoing policy failures after the original collapse.

All this should be obvious to anyone familiar with the history of the depression, however, we don’t have to go back 70 years for lessons on recovering from financial crises; we just have to look to the south. In December of 2001 Argentina broke the link between its currency and the dollar and defaulted on its debt. The result was a financial meltdown that was certainly at least as severe as the worst-case scenarios that the United States might have faced in the dire days after the collapse of Lehman.

Following this default, Argentina’s economy went into a freefall for roughly three months. Banks were insolvent, families and businesses could not get access to their savings, and normal business-dealing became almost impossible.

However, by the second quarter of 2002, the government had largely pasted things together to the point that the economy had stabilized. It began growing rapidly in the third quarter of 2002 and continued to grow rapidly until the world recession slowed the economy in 2008. By the middle of 2003, it had recovered all the ground it had lost in the initial crisis after the default.

Based on the experience of Argentina, we can say that in the case of a full meltdown, we might have seen three months of freefall (even worse that we actually experienced from September of 2008 to April of 2009), followed by three months of stability and then a return to growth six months out. Of course it’s possible that our policy crew of Ben Bernanke, Larry Summers, and Timothy Geithner may not be as competent as the team in Argentina, but even if we double the time periods, we get six months of freefall and three years to get back to pre-crisis levels of output. That’s bad news for sure, but quite a bit short of anything that could merit the title of a “Great Depression.”

The attack on the second Great Depression myth is not simply an exercise in semantics. The Obama Administration and the political establishment more generally want the public to be grateful that we managed to avoid a second Great Depression. People should realize that this claim is sort of like keeping our kids safe from tiger attacks. It’s true that almost no kids in the United States are ever attacked by tigers, but we don’t typically give out political praise for this fact, since there is no reason to expect our kids to be attacked by tigers.

In the same vein, we all should be very happy we aren’t in the middle of a second Great Depression; however, there was never any good reason for us to fear a second Great Depression. What we most had to fear was a prolonged period of weak growth and high unemployment. Unfortunately, this is exactly what we are seeing. The only question is how long it will drag on.

This article originally appeared in The Guardian.

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  1. Mike Meeropol
    February 18, 2012 at 12:52 pm

    Dean — how about a thought experiment? Suppose US policy after September, 2008 not only “permited” a financial meltdown but followed up with a firm belief that a policy of austerity would bring the “confidence fairy” along to revive the economy.

    Wouldn’t that be a prescription for the kind of policy idiocies that prolonged the Great Depression?

    As it is, the failure to follow up the initial stimulus with anything but promises to cut deficits (which the current Obama budget continues) almost stalled the recovery…

    I agree with your larger point that our current policy idiocies (not as bad as during the Great Depression) have caused unneeded pain and suffering by making the “recovery” so long and tortured ….

  2. February 18, 2012 at 2:54 pm

    I am NOT an economist but WHY would Dean Baker deny that we ARE in a GREAT DEPRESSION – how rich is he? Rita Addessa 18 Feb 2012

  3. February 18, 2012 at 3:39 pm

    What do you economists think we should have done? Should we have let all the banks fail, then pumped a ton of money into the system such as rebuilding the infrastructure (no doubt there has been a debate about this many times over, but I didn’t read it and would like a review of the consensus, thanks).

  4. robert r locke
    February 18, 2012 at 4:16 pm

    Why would you be denigrating Obama for his policies not having prevented the second great depression? Because you are a truth seeker. Pleaazze…. Have you looked recently at the people who oppose Obama in this election? Would you rather have them? Also, stop acting as if the President of the United States were a dictator. Have you read the connstitution lately? He cannot do much without Congress and Congress with a super majority needed to get anything done neverr would have carried through the sort of spending that is necessary to recovery from depression. Sometimes I think economists need a primer on how and why government (mal)functions.

  5. paul davidson
    February 18, 2012 at 11:06 pm

    robert Locke:

    roosevelt was not an economic dictator and he also faced a congress that was not very happy with his New Deal policies. But it is my unerstanding that one of the important job creation institutions — the Works WPof roosevelyts administratin was created originally by Exectutive Drective — no9t Congressional legislation.

  6. February 19, 2012 at 5:08 pm

    A Great Recession was in the cards. The post WWII cycle of economic growth in the United States wasn’t able to generate enough opportunities for households to pay their debts and to expect higher salaries. The rest of the world was catching up and affluent nations, consisting of only 15% of the world population were not going to be able to keep the majority of world resources to themselves anymore. The United States got out of the last recession when it became clear to the markets that there was no currency that could yet compete with the US dollar for international currency status. Europe was equaly affected by the financial meltdown but didn’t have yet the room to manoeuvre the Federal Reserve has to print money to buy money that was printed to buy money that was printed to buy money that…
    http://nexusofchange.wordpress.com/2011/06/20/the-difficult-transition-to-sustainable-growth/

  7. Dave Raithel
    February 19, 2012 at 6:38 pm

    About all I can understand from Baker’s arguments about this (he’s posted this meme before) is this: The status quo is crap; people who tell you that this crap is better than the worse crap avoided are wrong, because the worse crap was never possible….

    But I don’t believe that people really do know how bad it is, not even Mr. Baker. It’s not good logic to site my own experiences – out of work 15 months, I do not know of A SINGLE person I KNEW to be unemployed who has found work over that period. Not one. I do know of at least TWO people who have since become unemployed, like me.

    Suppose then we go with the “official” stats – things suck, as Baker observes, but they are getting better at a miserably slow rate….

    Except that the dude who runs Gallup was on Squawk Box one day last week, and he said this: Government numbers are wrong, they have bad data collection methods. Per him, unemployment is still going up….

    The matter of what praxis, if I may be so quaint, should be adopted which incorporates Baker’s analysis is beyond me. Surely we don’t let the Teabaggers just have Congress and the White House. But surely we don’t re-elect Obama and his minions – as they are incompetent.

  8. Peter T
    February 20, 2012 at 11:09 am

    I think looking hard at the Great Depression is valuable, but you have to take care to actually look, not just bring use it to illustrate your own views (as Friedman and Bernanke did). The Depression was a turning point between the technologies and economics of the 1890s and those of the 1950s. Lots of new technologies and means of organisation, unable to gain the scale and the necessary supporting structures to take off, while the old ones could not cope. The War did not just throw money at the problems, it created most of the infrastructure that made wide application of the new technologies and forms practically possible – it produced millions of trained electricians, radio operators, pilots, factory workers, welders, mechanics, machinists, brought whole classes out of rural backwardness, shattered assumptions about what was possible politically and economically, forced new relations between worker and employer. This could not have been done just by spending money (and countries that just spent money did not get the same social transformation).

    Is the US in a similar position now? Possibly. If this is an element, what does it need to spend money on, and what political and economic assumptions does it need to over-ride? As an example, Keynes came to think free trade was a mistake. Was he right?

  1. February 20, 2012 at 6:39 pm

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