All recessions end some day

This is one of the common messages of the speeches of both Obama team’s top members – Larry Summers and Christy Romer. Summers summarises the Obama plans and Romer compares the  crisis with guess what- Great Depression.

Summers says:

Our problems were not made in a day or a month or a year, and they will not be solved quickly. But there is one ineluctable lesson of the history of financial crises: they all end.

Romer says:

Finally, the last lesson that I want to draw from the 1930s is perhaps the most crucial, right? A key feature of the Great Depression is that it did eventually end. Despite the devastating loss of wealth, chaos in our financial markets, and a loss of confidence so great that it nearly destroyed Americans’ fundamental faith in capitalism, the economy came back. Indeed, the growth between 1933 and 1937 was the highest we have ever experienced outside of wartime.

🙂 This is pretty obvious. All good and bad things come to an end someday.

Anyways, Summers summarises the Obama plan as two types – one for short term recovery and two for long term stability. Within short term he lists fiscal stimulus, financial stability and housing markets. Within long term – financial regulatory reform, fiscal discipline (which surprisingly is a few lines), and measures for sustainable growth (investments in energy, health-care etc).

Romer’s speech is more interesting (atleast for me). She is one of the best economics researchers around and depression has been one of her favorite topics.

She begins by showing this crisis isn’t anything like depression with latter being much more damaging (a useful comparison here). However, it is still important to compare the two:

Now, I don’t give these comparisons to minimize the pain that the United States economy is experiencing today, but to provide some perspective….. And I guess I should say it’s the new policymaker in me that wants to make it clear that we’re doing all that we can to make sure that the word “great” never applies to the current downturn.

Well, what we are experiencing is less severe than the Great Depression. There are parallels that make it a useful point of comparison and a source for learning about policy responses today. Most obviously, like the Great Depression, today’s downturn has its fundamental cause in the decline in asset prices and the failure or near failure of financial institutions.

Isn’t this same with almost all recessions? Yes, the magnitudes may differ but we do see a slide in fin markets, a loss of wealth etc. What I find perplexing is that despite the recession not anywhere near Great Depression (GD), the comparisons are always drawn from the same. Moreover, just like Obama, we keep hearing the same from Obama team now and then. Romer has done loads of research on the other recessions as well. Why not compare with the others? I understand GD is the biggest of them all, but we need some clarity from the experts on the matter.

Anyways, she points to 6 lessons from GD:

1) small fiscal expansions only have small effects.
2)monetary expansion can help to heal an economy even when interest rates are near zero.
3) Beware of cutting back on stimulus too soon
4) financial recovery and real recovery go together.
5) worldwide expansionary policy shares the burden and the benefits of recovery.
6) key feature of the Great Depression is that it did eventually end.

Regarding 1) she says:

I wrote a paper in 1992 that said that fiscal policy was not the key engine of recovery in the Depression. From this, some have concluded that I did not believe fiscal policy can work today or could have worked in the 1930s. Nothing could be further from the truth. My argument paralleled E. Cary Brown’s famous conclusion that in the Great Depression fiscal policy failed to generate recovery, not because it does not work but because it was not tried.

I did raise this point earlier (though am sure she is not answering me) but had also pointed this was similar in her other paper on recessions. In the latter paper she pointed that fiscal stimulus is usually late and small. So, this does fix the problem. Sorry Dr. Romer!

This brings me back to the old question- is criticism behind fiscal stimulus relevant? Just because it was not tried or was very small, could we say it does not work in recessions?  Adam Posen pointed in his research that in case of Japan it wasn’t tried.  Blinderalso writes the same on general fiscal policy. This has been raised numerous times by Krugman in his blog.

On 2) she says:

Okay, a second key lessons from the 1930s is that monetary expansion can help to heal an economy even when interest rates are near zero. In the same paper where I said that fiscal policy was not key in the recovery from the Great Depression, I argued that monetary expansion was very useful. But the monetary expansion took an unusual form: It was essentially a policy of quantitative easing conducted by the U.S. Treasury. So let me give a little — a quick background.

The United States was on a gold standard throughout the Great Depression….. In April 19933, Roosevelt temporarily suspended convertability into gold and let the dollar depreciate substantially. When we went back on gold at the new  higher price, large quantities of gold flowed into the U.S. Treasury from abroad.

Well, under a gold standard, the U.S. Treasury can increase the money supply without going through the Federal Reserve. It was allowed to issue gold certificates which were interchangeable with Federal Reserve notes on the basis of the gold it held. When the gold flowed in, the Treasury issued more notes. The result was that the money supply, defined very narrowly just as currency plus reserves, grew by nearly 17 percent per year between 1933 and 1936.

This monetary expansion couldn’t lower nominal interest rates because, as I mentioned, they were already near or at zero. What it could do was to break expectations of deflation.  Devaluation followed by rapid monetary expansion broke this deflationary spiral. Expectations of rapid deflation were replaced by expectations of price stability or even some inflation, and this change in expectations brought real interest rates down dramatically.

After nearly two decades of opining on monetary policy, one of the key roles of my current job is that I do not comment on Federal Reserve policy. So let me be very clear: I am not advocating that we go back on the gold standard just so we can go off it again, nor am I suggesting that Tim Geithner should start conducting rogue monetary policy. But the experience of the 1930s does suggest that monetary policy can continue to have an important role to play even when interest rates are low by affecting expectations and, in particular. by preventing expectations of deflation.

Excellent summary of monetary policy working in GD.

3) would depend on how deep the crisis continues to become. Even now Obama has planned to keep spending. Fed would also expand its balance sheets.

4) has been debated extensively as well and is accepted. 5) is beginning to be debated and concerns over non co-ordinations are rising.

So, pretty good readings both of them. They also have some interesting Qs and As at the end. However, it will be great if we move from usual comparisons with GD.


7 Responses to “All recessions end some day”

  1. Topics about Banking » All recessions end some day Says:

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    […] The Health Bee placed an observative post today on All recessions end some dayHere’s a quick excerptAnyways, Summers summarises the Obama plan as two types – one for short … measures for sustainable growth (investments in energy, health-care […]

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