The Great Recession of 2008 and the Sordid Historiography of the Great Depression





Wright is the Nef Family Chair of Political Economy at Augustana College in Sioux Falls, South Dakota. He is the author, co-author, editor, or co-editor of some 30 volumes on business, financial, and policy history, including most recently Bailouts: Public Money, Private Profit (Columbia University Press, 2010) and Fubarnomics: A Lighthearted, Serious Look at America’s Economic Ills (Prometheus, 2010).

Guillermo Rosas and Nathan Jensen, political scientists at Washington University in St. Louis, find no statistical evidence that government bailouts implemented worldwide between 1970 and 2007 ameliorated the length or depth of recessions associated with financial crises.  According to Louisiana State finance professor Joseph Mason, political and bureaucratic in-fighting can reduce the effectiveness of government bailout institutions like the New Deal’s Reconstruction Finance Corporation (RFC).  Governments typically address surface symptoms rather than treat the deeper causes of financial instability, notes University of Alabama finance professor Benton Gup. Bailouts, he adds, increase the chances of future crises by encouraging risk-taking (moral hazard in the parlance of economists).

Given that less-than-stellar record, why are the governments of the world’s largest and most important economies bailing out automobile manufacturers, banks, borrowers, homeowners, insurers, and money market mutual funds?  In part, I believe, because scholars have yet to convincingly synthesize their disparate interpretations of the Great Depression.  Everyone knows enough to want to avoid a repeat of the most traumatic economic episode of the twentieth century but even some high level policymakers appear confused about the Depression’s origins, timing, and eventual demise.

As they are wont to do, scholars debate and guffaw, hem and haw, estimate and guess, pontificate and profess, but they have yet to truly capture the Depression’s intricacies.  Obscuring the view are thick lenses of ideology from the left, the right, the statist, and the libertarian perspectives. In general, scholars present the public and policymakers with two contrasting views of the Depression, one that blames markets and another that points an accusing finger at the government.

Little wonder then that when crisis struck in September 2008, one group of Americans wanted bold government action, a new New Deal, to save the economy and avoid twenty-first century versions of the Joads and Bedford Falls.  But at the same time, another group believed that the government must have caused the mess so they complained vociferously and indiscriminately about all bailout efforts and set out to audit the Federal Reserve.

As a result of its bipolar view of the Depression, a deeply divided America ended up with a confusing hodgepodge of policies, many slathered with pork, instead of policies based on a reasoned analysis of causes and cures.  The U.S. economy has begun to recover, but no sooner or faster than it might have with a much smaller but more carefully focused intervention.  The cost of dodging dodgy claims of an impending repeat of the Depression is itself depressing:  the federal budget deficit and national debt have greatly deteriorated, fear of a bout of 1970s-style inflation or worse is growing, and the moral hazard created by the bailouts and another long period of low interest rates seem destined to puff up yet another volatile asset bubble.  The bailouts got us out of the woods but perhaps by beckoning us into a much larger and more menacing forest.

That need not have been the case.  The Great Depression was not the fault of markets or governments but rather of markets and governments entangled in a tragic death dance.  It was, like so many other FUBAR (fouled up beyond all recognition) aspects of the economy, a hybrid failure, a combination of both market and government failures.  Following the bursting of housing and stock asset bubbles (market failures), the Federal Reserve allowed numerous banks to fail.  The banks had inadequate reserves and capital (market failure) but largely because regulators, unlike in neighboring Canada, severely restricted branch banking (government failure).  Due to the bank failures and subsequent depositor runs (market failures), the money supply dropped precipitously (government failure), leading to deflation and, due to the downward stickiness of wages (market failure), large increases in the real wage bill.  Employers therefore cut workers instead of their pay, driving up unemployment rates which, in turn, increased defaults and hence stress on the already prostrate banking system.  Instead of addressing the root problems directly by stopping the runs and increasing the money supply, the Hoover administration raised tariffs and oversaw the birth of the at first largely ineffective RFC (government failures).

The economy turned up in the second quarter of 1933 because the Roosevelt administration stopped the bank runs with a new federal deposit insurance scheme and increased the money supply and decreased real wages by devaluing the dollar.  Those two policies alone were largely responsible for the years of economic expansion that followed.  Instead of stopping there, however, FDR and his Brain Trust passed a slew of other legislation too well known to rehearse here.  Some policies, like the National Industrial Recovery Act, were economic disasters.  Others, like a reformed RFC, may have been marginally beneficial.  However, the New Deal did not alleviate the economy’s main problem, unprecedented levels of unemployment, and in fact may have perpetuated it by creating uncertainty in the minds of entrepreneurs and other business leaders.

If this more balanced view of the Depression had permeated public discourse, the response to the crisis of September 2008 would have been more measured and precise.  Some intervention was needed to shore up bank balance sheets and prevent a deadly decline of the money supply.  The dire pronouncements of government officials and the costly, scattergun approach to the bailout, however, ranged from unhelpful to outright counterproductive.

Complex events like financial crises have complex causes.  With careful study and an eye to both market and government failures, those causes can be ascertained, explicated, and used to guide future financial system regulations and bailout policies.  If and when we will learn those lessons, however, remains to be seen.


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William J. Stepp - 2/9/2010

Government's failure (the Fed's ignorance of real interest rates) caused the Great Depression, where does that bizarre notion come from except Milton Friedman?

Friedman (and his co-author Schwartz) thought that the collapse in the money supply triggered the Great Depression. You can disagree with that, but their argument was more complex than you are making it out to be ("the Fed's ignorance of real interest rates").

Markets are distorted rather than regulated and rectified by government intervention? Where does this God's eye view of market rationality come from except the University of Chicago?

Robert Lucas had second thoughts about his extreme rational expectations theory, which is what I assume you are referring to; as for his sidekick and efficient markets theorist Fama, he doesn't believe in bubbles, so he evidently doesn't believe in busts either.
By the way, there are lots of economists outside Chicago who believe that government intervention distorts markets, either at the micro level, or in a macroeconomic sense.
They're not all libertarians either.

And, Herr Livingston, you won't find The Collected Works of F.A. von Hayek in a library, but you will find The Collected Works of F.A. Hayek.


William J. Stepp - 2/9/2010

Given that less-than-stellar record, why are the governments of the world’s largest and most important economies bailing out automobile manufacturers, banks, borrowers, homeowners, insurers, and money market mutual funds? In part, I believe, because scholars have yet to convincingly synthesize their disparate interpretations of the Great Depression.

Scholars' interpretations had little to do with the bailout, although I can understand why an academic would think otherwise. It had everything to do with what policymakers thought would be the economic and political consequences of not doing a bailout.
I thought they were wrong to do the bailout at the time (and still do), but I wasn't at the table; and as a libertarian and certified private anarchist, wouldn't have been allowed anywhere near the place.


Robert E. Wright - 2/8/2010

Hey, James, nice to hear from you, though if I didn't know better I'd suspect your comments were a tad ad hominem. Perhaps I only appear to be in Chicago due to a skewed perspective analogous to that famous New Yorker cartoon "View of the World from 9th Avenue"? Or maybe I have been a bit Milty-ish in some contexts in the past as a reaction to the Marxism that still pervades parts of our profession? Be that as it may, the op ed's emphasis on hybrid failures -- recognition of the problems with both markets and governments, esp. when the two interact over long periods -- does accurately reflect the thrust of Bailouts as well as Fubarnomics.


James Livingston - 2/8/2010

Thanks, Bob, for this fair and balanced treatment of the arguments historians and economists have had about the causes and consequences of the Great Depression.

But do give me a break, you're peddling the same "objectivity" that FOX News has made its stock in trade. Government's failure (the Fed's ignorance of real interest rates) caused the Great Depression, where does that bizarre notion come from except Milton Friedman?

Markets are distorted rather than regulated and rectified by government intervention? Where does this God's eye view of market rationality come from except the University of Chicago?

Bob, I know that Uncle Milty (and von Hayek before him) believed that markets were the seat of freedom precisely because they remained impervious to reason and social purpose, but maybe you should just come right out and tell us this is where you stand, too.

That way no one will mistake you for the bemused, objective, above-the=fray, downright folksy guy you perform here. Full disclosure and all, how about it?