OCTOBER
2008

 

By
Larry DeBoer
 
Professor of
Agricultural Economics
Purdue University

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10-23-08

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Why It's Not 1929


You can't open the paper these days without reading something like, "This is the (fill in the blank: worst, biggest, first time) since the Great Depression." So people might wonder, will this be another Great Depression?

We'll have a recession, maybe a bad one. The financial crisis has stopped banks from lending, and that will reduce business spending. The rest of the world is having troubles, too, and that will reduce spending on our exports. The drop in home prices and in the stock market has reduced household wealth. Our third-quarter pension statements have made that uncomfortably clear. Consumers will spend less.

But all that bad news won't cause a depression, and certainly not a capital-G capital-D Great Depression. Here's why.

There are three strands of thinking about what caused the Great Depression of the 1930s. One blames the Federal Reserve Board. The Fed increased interest rates in 1928 and 1929, trying to stop stock speculation. Instead, business and consumer spending dropped, and that helped start a recession in the summer of 1929, even before the stock market crash.

Banks got scared and quit lending. The Fed wouldn't increase bank reserves, so real interest rates shot upward. That cut business spending more. Banks began to fail, because their borrowers couldn't repay loans, and because depositors started bank runs. The Fed refused to act as a lender of last resort—the very thing it had been created to do—and allowed one-third of all banks to fail. Household savings vanished or were tied up in court, and consumers cut their spending. Businesses lost their relationships with their old bankers and had a hard time convincing new bankers to lend. Business spending dropped still more.

That's all different now. Fed chair Ben Bernanke knows that the Fed helped cause the Great Depression. He's determined not to let that happen again. The Fed has cut interest rates. It's pouring money into the banking system. So is the Treasury. So far that hasn't helped much, but it will. (If it doesn't, we'll have to let the Fed off the hook for the Great Depression.) This time, we've got the Federal Deposit Insurance Corp. insuring bank deposits up to $250,000. If a bank does fail, most household savings are safe.

The second strand of thinking about the Depression blames events that cut consumer and business spending directly. The stock market crash made businesses uncertain about future sales. They cut their payrolls. The crash reduced people's wealth. People had to cut their spending to start saving for retirement all over again.

Then the Hoover administration tried to balance the federal budget by raising taxes. That reduced spending, too. They tried to get people to buy from U.S. businesses by raising tariffs on imports, with the Smoot-Hawley Tariff Act. Imports fell, but exports did, too, as other countries raised their own tariffs. World trade dried up.

That's (mostly) all different now. The administration cut taxes this spring, and both presidential candidates want to cut them more. We've got unemployment insurance to help support people who lose their jobs. Social Security may have long-term funding problems, but it's solid now. Those checks will support consumer spending.

We may see some calls to balance the federal budget. That's a good idea—once the economy recovers. But not now. There may be support for trade restrictions, too. Remember Smoot-Hawley!

The third strand of thinking about the Depression looks to international finance. The gold standard was collapsing. Most countries left gold and let their exchange rates float. But we tried to support the value of the dollar by raising interest rates. Now there are no fixed exchange rates to support, and the governments of the world appear to be cooperating to address financial problems.

Why is this not 1929? Because policymakers won't make those same mistakes, and many programs put in place during the Depression are still around. The Fed will support the banks, taxes will not be increased, and (with any luck) no one will try to balance the budget or restrict trade. Deposit insurance, unemployment insurance and Social Security will support spending.

If we don't repeat the Great Depression's policy mistakes, we won't repeat the Great Depression, either.

 

 

Writer: Larry DeBoer
Editor: Olivia Maddox