What Happened to the Depression?

Carnegie Mellon University macroeconomist Allan Meltzer asks a pretty important policy question in yesterday’s Wall Street Journal: What happened to the Depression? A year ago, the vast majority of financial pundits thought the economy was going off a cliff, and that a depression was just about inevitable.

In truth, Meltzer, says, we were never really close to a depression. Steep recession? Yes. Depression? No. The closest analogue to what we are going through is probably the steep recession of 1973-75, but we’re not even close to the mini-depression of 1937-38.

So, why the constant chatter about a depression? Meltzer says uncertainty played a role, as well as the self-serving view of the Obama Administration that wanted to paint itself as the knight in shining armour saving us from economic catastrophe.

A few other observations are worth noting, too, including ideology:

“New York Times columnist Paul Krugman and the International Monetary Fund repeatedly proclaimed that more government spending was a necessity. Most economists now believe that the recession is expected to end before much of the government spending takes hold. And while the improvement in recent GDP data reflects a big increase in government spending, consumer spending declined again in the second quarter. The $787 billion of fiscal stimulus has done little for consumers. Keynesian economists always fail to recognize the powerful regenerative forces of the market economy. The financial press—many of whom share their same political assumptions—endlessly reproduces their beliefs.

“The Federal Reserve also shared this Keynesian viewpoint. It provided unprecedented monetary stimulus, increasing the monetary base by more than $1 trillion. Much of this increase corrected for its major mistake: allowing Lehman Brothers to fail. After 30 years of bailing out almost all large financial firms, the Fed made the horrendous mistake of changing its policy in the midst of a recession. That set off a scramble for liquidity and heightened the public’s distrust in the market.

“This had world-wide repercussions. For four months, many financial markets remained frozen and real activity collapsed. Allowing Lehman to fail without warning is one of the worst blunders in Federal Reserve history. Extrapolation caused many market participants to conjecture that we were in a depression. The New York Times and others piled on, speculating foolishly about the end of capitalism.”

In the end, to the extent a steeper recession may have been averted, it may have been because the Federal Reserve–the monopolist who controls the money supply–offset its own mistake in monetary policy. Monetary policy “fixed” the economic problem it created.

Either way, the so-called stimulus and federal spending did not rescue the economy. Keynesianism didn’t work despite the federal spending urban legend propogated for political reasons by the current administration.

Reason Foundation has published extensively on the pitfalls of the stimulus package and bailouts.