Response to Meltzer on Depression comparisons
- Monetary policy
[Greg Ip] IN MY many years of reporting on the Federal Reserve, I have turned more times than I can count to Allan Meltzer. Volume One of his history of the Federal Reserve (he’s still working on Volume Two) is one of the most thumbed books on my shelf, and I consider him one of the leading authorities on 20th century economic history. Naturally I was intrigued by his criticism of comparisons between the current period and the Great Depression in the Wall Street Journal.
It’s a fascinating piece but I have several qualms with it. First, it’s marred by a factual error. The accompanying table says GDP fell 4.9% in the 1973-75 recession, more than the 3.8% drop in the current recession. But GDP data gets revised a lot and the most recent version shows GDP fell only 3.2% in 1973-75. I asked Allan about the error and he replied:
Mea culpa. I relied on some work done a while ago by one of my assistants. I didn’t check, as I should have. But, the point doesn’t change if we use 3.2% … for 1973-75. This is NOT anything like 1929-32 or 1937-38 and people should stop saying that it is. Surely you can see that there is a world of difference between 42 months of decline and 25% unemployment without any safety net and what we ‘ve experienced. The Obamaites and their friends overstate what they inherited from Bush. Journalists and economists are wrong to mislead—yes mislead—and frighten people into believing we were headed for depression. When Reagan was president, journalists pounced on every statement looking for errors. What has happened to them?
I still have a problem with his argument, though. No one credible that I know of says the current recession is as bad as the 1930s; they are saying it’s the worst since the 1930s, and based on what we know to date, that’s a factual statement. The current recession’s GDP drop of 3.7% ties with the drop recorded in 1957 as worst since the 1930s. A comparative table produced by the Minneapolis Fed, and Mr Meltzer’s own data on the unemployment rate, make a pretty convincing case that considering a variety of metrics—GDP, nonfarm payroll employment, the unemployment rate, duration—the 2007-2009 recession will ultimately prove to be the worst since the 1930s.
Let’s set aside this argument over semantics, though, and address the substance of his argument. He says that based on what we know now, this recession is on a par with those of 1973-75 and 1981-82, and does not justify the extraordinary policy interventions, including large, multi-year fiscal stimulus, that have been justified by invoking the specter of the Great Depression.
I disagree. The recessions of 1973-75 and 1981-82 differ crucially from 2007-2009 in that they were both induced, and ultimately ended, by monetary policy. The 1970s Fed may be remembered as a milquetoast, but the fact is that Arthur Burns raised the fed funds rate from 5% (using monthly averages) at the end of 1972 to 13% in 1974. The real rate (when trailing core inflation is subtracted) peaked at 7% in August 1973, a few months before the recession officially began, and ultimately fell to minus 6% by early 1975. Similarly, Paul Volcker took the ed funds rate to 19% in July 1981, then dropped it to 9% by the following November. The real rate fell from 10% to 4%. In both cases, the economy responded to such a dramatic swing from tight to easy monetary policy as you’d expect—with a severe recession then a strong recovery. (The surge in oil prices in 1973 certainly hurt the economy, but the Fed’s response to that surge was far more important.)
By contrast, the severity of this recession results from the collapse of an asset and credit bubble for which monetary tightening, if it had any role, was merely a catalyst; at its peak in 2007, the real fed funds rate only reached 3%. It is now minus 1.5%, and can go no lower because the nominal funds rate is effectively at zero. Indeed, the real rate might start to rise in the coming year if inflation drops.
It’s possible that dropping the fed funds rate to zero and taking no further action may have been enough to turn the economy around. But that would have been a pretty big risk. When conventional monetary policy is out of ammunition, it is logical to look to aggressive, discretionary fiscal and unconventional monetary policies (such as intervening in credit markets and quantitative easing) to cut off the tail risk of a far worse slump. You can argue over whether these policies have been implemented in the most effective way possible, but the case for using them seems indisputable, which was not the case in previous post-war recessions.
The original article is linked here.