The Greatest Depression that could so easily have happened in 2009 but did not is the tribute that the world owes to economics.
In 2008, as the global financial crisis unfolded, the reputation of economics as a discipline and economists as useful policy practitioners seemed to be irredeemably sunk. Queen Elizabeth captured the mood when she asked pointedly why no one (in particular economists) had spotted the crisis coming. And there is no doubt that, notwithstanding the few Cassandras who had correctly prophesied gloom and doom, the profession had failed colossally.
The totemic symbols of this failure were, of course, the two most individually important policymakers, Alan Greenspan and his successor as chairman of the US Federal Reserve, Ben Bernanke. They, among many others, helped create a belief system that elevated markets beyond criticism. They failed to see, and hence failed to act against, the destructive power of the untrammelled workings, especially of financial markets.
But crises will always happen, and even if there is a depressing periodicity to them as Professors Reinhart and Rogoff have catalogued, their timing, form and provenance will elude prognostication. Most crises, notably the big ones, almost always creep upon us from unsuspected quarters; that is perhaps the very definition of a crisis. As Keynes wisely observed, “The inevitable never happens. It is the unpredictable always.” So, if the value of economics in preventing crises will always be limited (hopefully not non-existent), perhaps a fairer and more realistic yardstick should be its value as a guide in responding to crises. And here, one year on, we can say that economics stands vindicated.
How so? Recall that the recession of the late 1920s in the US became the Great Depression, owing to a combination of three factors: Overly tight monetary policy; overly cautious fiscal policy (especially under Franklin D Roosevelt in 1936 when tighter fiscal policy led to another sharp downturn in the US economy), and dramatic recourse to beggar-thy-neighbour policies, including competitive devaluations (as countries went off the gold standard in the 1930s) and increases in trade barriers worldwide. The impact of this global financial crisis has been significantly limited because on each of these scores, the policy mistakes of the past were strenuously and knowingly avoided.
On monetary policy, Bernanke was true to the word he gave to Milton Friedman on the occasion of his 90th birthday: “Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.” Bernanke, the pre-eminent student of the Great Depression, found conventional and some very unconventional ways of not doing “it” again. At the peak of his interventions, the US Fed came to resemble the Soviet Gosbank, more a micro-allocator of credit than a steward of macroeconomic policy.
On the fiscal side, policymakers enacted huge stimulus packages. They took their cue from the writings of the academic scribbler of yore — Lord Keynes — and provided massive public demand for goods and services where private demand had collapsed under the weight of indebtedness and non-functioning credit markets.
And, most surprisingly, despite the unprecedented collapse in trade, few countries resorted to beggar-thy-neighbour policies. For sure, there were large-scale currency changes, but these were mostly market-driven, except in the case of China where the hand of policy in manipulating competitiveness has been more evident. It is also true that several countries raised trade barriers. But these were small in magnitude, limited in geographic scope and product coverage and mostly WTO-consistent. The exception to this rule was the large-scale assistance to the financial and automobiles sectors especially in the US which had the extenuating argument that the assistance was aimed at averting extinction rather than providing a competitive boost. Overall, it was clear that this forswearing of beggar-thy-neighbour policies stemmed in large part from the awareness of its devastating consequences.
What is striking about the influence of economics is that in all these areas, similar policy responses in the fiscal and monetary areas, and non-responses in relation to competitive devaluations and protectionism, were crafted across the globe. They were crafted in emerging market economies and developing countries as much as in the industrial world; in red-blooded capitalist countries as well as in communist China and still-dirigiste India. And they were crafted with little questioning of their necessity and desirability. If ever there was a Great Consensus, this was it.
If the Great Depression had not happened 80 years before, there may not have been a “natural experiment” to draw upon, and perhaps 2009 might have turned out differently. But the fact of the Great Depression was only a necessary condition. We were not condemned to repeat the mistakes of history because the economics profession had learned and distilled the right lessons from that event.
For sure, we may not have learnt all the lessons. It is also probable that we may be setting the stage for future crises, not least because we are still groping for ways to tame finance. So, economics is bound to fail again. But the Greatest Depression that could so easily have happened in 2009 but did not is the tribute that the world owes to economics, or rather, it is the atonement of economics for allowing the crisis of 2008 to happen.
The author is Senior Fellow, Peterson Institute for International Economics and Center for Global Development, and Senior Research Professor, Johns Hopkins University.
This piece originally appeared in Financial Times
