So what else should I be reading on the Great Depression?
There’s Ben Bernanke’s research in the 1980s – that’s probably his most important contribution in terms of macroeconomics and financial economics.
Yes, I saw the Dow Jones Newswires quote on Bernanke’s book, Essays on the Great Depression, which made me laugh: “With some observers saying that the ongoing financial crisis could be the worst since the Great Depression, the greatest living expert on that period is getting the chance to apply its economic lessons.”
Well Bernanke was thinking that way in April 2008. I remember talking to him at the time, just after the Bear Stearns initial intervention. I got a chance to ask him a question about why they were so aggressive at that time when things didn’t look so bad. And his response was that basically he was worrying about a Depression-type scenario – and trying to act early to nip that in the bud.
So what is the thrust of his book and why is it important?
It’s focusing on the Great Depression as a credit implosion, not so much the money supply, which Friedman and Schwartz had emphasized, but a somewhat related phenomenon, which is credit availability. That had been imploding from 1929 through to the trough, early in 1933. So it’s really focusing on the credit aspects and trying to measure that, particularly by looking at patterns in interest rates.
Today, for example, if you look at the spread between lower quality bonds – like B-rated corporate bonds, say – and compare those to treasury yields, that’s a good indicator of the extent of stress in the credit markets. And actually the recent period is going back to the kinds of spreads that you saw in the early 1930s. Well, perhaps not quite as much, but certainly reminiscent of that. So he’s focused on that as a measure of the extent of the credit stress, and on the other side he focused on how what turned things around was when the credit problems were being eased.
People often think that the US economy stagnated in the Depression all the way through the 1930s, and didn’t at all get out of that until World War Two – and that really is not accurate, it’s not what the data look like. In fact the growth rate of the US economy from 1933 until 1937 is extremely rapid. It’s actually the fastest growth period of any peacetime period of that length in the whole history. Maybe it’s not as fast as you would have hoped for or wanted, given how big the contraction was, but it’s very rapid – and then it’s unfortunately interrupted by a pretty big recession, 1937-8, which was probably caused by the Federal Reserve doubling the reserve requirement in 1937. It’s pretty unbelievable that they did that actually.
The Fed was probably the reason, though people have advanced other possibilities. But then it starts again, from 1938-41, there’s also very rapid growth, before the US is into the war and has a lot of expenditures. 1941 is the first year where there is a lot of big federal US expenditure related to the war, there’s not really much of a build-up in 1939-40, which is also kind of surprising.
So going back to your other bibliographical picks, you recommend some recent papers by Cole and Ohanian (Harold Cole and Lee Ohanian, The Great Depression in the United States from a Neoclassical Perspective and Harold Cole and Lee Ohanian, New Deal Policies and the Persistence of the Great Depression: A General Equilibrium Analysis) What are they about?
They focused more on some of these anti-market FDR policies. I think they’re right that these are mistakes, as are some of the tax increases. There was a tax increase under Hoover and then some under Roosevelt, trying to balance the budget, which was clearly a mistake in the context of the very high unemployment rate and the poor economy. But as to how much that mattered is much less clear. Similarly the Smoot-Hawley Tariff in 1930, which every economist agrees is ridiculous – it’s not clear how much that actually mattered in terms of the macro results.
I thought that the Great Depression was the ultimate cautionary tale on the dangers of protectionism. That’s not the case?
No I think what is much clearer is the role of the financial system and the credit implosion, both in the 1930s and today. The rest of the stuff may just be a sideshow, it may not be that important. There’s a strong tendency for the economy to recover on its own, as long as it’s not subject to further new shocks, so a likely scenario is that that is what will happen today as well. And then the Obama administration will say that it’s because of our policy that things recovered, and there won’t be any way to prove whether that’s right or wrong.
So are you not a fan of what Obama is doing?
I think the stimulus package was very stupid; it was awful. It’s just a tremendous waste of money and it’s going to cause some trouble in terms of a bigger public debt; it’s just wasting resources. But the more important thing is the financial system, and the housing related aspects. So on that, despite a lot of floundering around, mostly I think what they were doing is in the right direction. I think they made a big mistake by not bailing out Lehman Brothers – I think they recognized that two days later. That was Paulson’s individual fault and responsibility from what I can gather.
But I noticed you did not sign that full page advertisement in The New York Times opposing Obama’s stimulus package. A lot of other economists did, including Edward Prescott, who won the Nobel Prize for economics, so presumably should be taken seriously. Has he done any work on this?
I don’t know what he’s contributed that is particularly relevant on this issue. He has done some brilliant work and deserved the Nobel Prize, but his empirical stuff is not that good frankly. I didn’t sign that advertisement because I don’t really like to sign things in general – I prefer to write my individual thing.
But you’re broadly sympathetic to that viewpoint?
For a while there was this ridiculous view that there was this massive consensus in favour of Keynesian stimulus. And Biden even said at some point that, “Every economist agrees that we need this stimulus.” Of course that was always nonsense. So in that sense I agreed with the sentiment of what was in that signed advertisement.