What Have we Learned From the Financial Crisis? Part 3: Mario Seccareccia
What follows are comments from a roundtable discussion held at the University of Ottawa on February 28, organized by Mario Seccareccia, and which featured participation from Marc Lavoie, Louis-Philippe Rochon, Mario Seccareccia, Slim Thabet and Bernard Vallageas.
This is Part 3 ofÂ 5Â sequential blog entries.
Professor of Economics, University of Ottawa
Editor, International Journal of Political Economy
I would like to argue that policy makers perhaps learned very little, especially in light of the fact that they have recently acted out the same macroeconomic policy script that was written in the 1930s. However, before discussing what they did, I would like to offer a brief analysis of the experience of the 1930s and that of the current Great Recession.
While there are obvious similarities between the Great Depression of the 1930s and the current Great Recession, the latter has not degenerated into a serious deflationary episode characterized by rising real interest rates, rising real indebtedness and a dangerous deflationary dynamic of falling money wages and prices. Interestingly both crises have their roots in problems of rising inequality and bubbles in asset markets. The recent collapse, beginning in 2007 with the subprime crisis, was triggered by problems in the housing market, which was then transmitted to the banking and financial markets in 2008 and eventually to the real economy by 2009. During the Great Depression, the sequence was somewhat in reverse, with problems beginning in the stock market, which then led to the collapse of the banking sector and then had obvious ramifications in the real economy, including the housing market. Despite some similarities with each recession being preceded by some type of financial crises, by any measure the Great Depression was more severe than the Great Recession.Â
From its peak in 1929 to the trough in 1933, real GDP and employment fell by 30 percent or more in both Canada and the United States. At the same time, real wages rose consistently, initially because prices fell more than wages until 1933, and then because nominal wages began to rise more than prices after 1933. Despite the sharp fall in employment, the reverse movement of real wages served to redistribute purchasing power in such a way as to offset the overall decline in aggregate demand. This was further reinforced by a fall in the personal savings rate until 1933 as households initially sought to maintain their previous consumption norms, despite their fall in nominal income. However, once nominal income and employment began to turn around, the saving rate began to rise after 1933, as households sought to reduce their debt load.
During the Great Recession, the situation was similar in terms of negative fluctuations in output and employment, but these data series displayed only a very mild decline in output and employment after 2007-2008. Indeed in the US, output and employment fell close to 3 and 6 percent respectively, with Canada showing some limited decline in the two series of about 3 percent only during 2009. The collapse in aggregate demand triggered a disinflation in prices but without making any significant dent on money wage growth that continued its inertial slow growth pattern established during the preceding â€œgreat moderationâ€. Hence, unlike the 1930s, real wages continued to rise, but, in this case, because money wages outpaced prices after 2007-2008. There was no massive deflation as during the 1930s. On the other hand, unlike during the Great Depression when the savings rate initially fell, households were so heavily burdened with debt during the recent downturn that, in the face of uncertainty, they quickly raised their saving rate in order to remove some debt off their balance sheets, thereby exacerbating the problem of aggregate demand.
Did policy makers understand the realities of the two economic crises and were the macroeconomic policies that they implemented appropriate for the times? An analysis of the experience of the 1930s would suggest that we repeated some of the same mistakes during the present crisis. In both Canada and the US, the conduct of monetary policy during the Great Depression was not unlike the pursuit of monetary policy during recent years.Â The reaction during the 1930s on the part of the US Fed was to pursue an easy money policy of setting nominal interest rates at their lowest possible levels. In Canada, the Bank of Canada only began its operations in 1935. However, prior to 1935 and since the Finance Act of 1914, discount rate policy was under the control of the Minister of Finance.Â In all cases, the monetary authorities desperately sought to reduce nominal interest rates to very low levels, despite the fact that prices were falling until 1933, which meant that real interest rates were rising until the mid-1930s. This also meant that income was actually being redistributed towards rentiers, thereby somewhat aggravating the Keynesian problem of effective demand. During the recent crisis, the reaction of the monetary authorities was swift, not only in bailing out the banks (as in the US) or providing loan guarantees for the banks (as in Canada); but, more importantly, central banks immediately cut interest rates to their lowest possible levels and pegged them at those low levels. Moreover, with nominal interest rates pegged at their low nominal levels and with an inflation rate that remained positive, real interest rates actually turned negative. While, according to conventional wisdom, this (as well as so-called quantitative easing) provided a stronger monetary stimulus than in the 1930s, this was insufficient seriously to kick-start the recovery. Hence, it was recognized, as in the 1930s, that low interest-rate pegging was an insufficient tool to achieve growth. That was true then as it has been true over the last half decade.
On the fiscal side, it took some time for the fiscal authorities to react with expansionary fiscal measures. Both Herbert Hoover in the US and R.B. Bennett in Canada were seeking to combat the expanding deficit as tax revenues fell and public spending automatically rose after the 1929 collapse. However, by 1932 in Canada, things did begin to change as there was a greater recognition of the need to implement some public works program. In the case of the US, with the defeat of Hoover in 1932 and the coming of Franklin Roosevelt in 1933, there was the ushering of a package of policies commonly referred to as the New Deal that led to significant growth until 1936. With â€œgreen shootsâ€ appearing, the fiscal authorities began to move in reverse gear that caused a double dip recession by 1937, thereby guaranteeing stagnation until the Second World War. In the case of the Great Recession, the fiscal authorities were quick to adopt fiscal stimulus packages with significant deficit spending from the end of 2008 to early in 2010. However, as in the 1930s, once the â€œgreen shootsâ€ started to appear, most Western governments began to reverse their policies by instituting austerity, thus aborting a significant recovery.
What can be seen from this cursory history is that the package of macroeconomic policies was similar in both periods first through deep cuts in interest rates, and then followed by some fiscal stimulus. However, in each of these historical periods, the fiscal authorities pursued policies that would eventually mitigate growth and ensure long-term stagnation.Â The only difference between the 1930s and the current period is that this was repeated and expedited during a shorter period; but the consequence in terms of long-term stagnation is not dissimilar.Â Hence, it can be said that policy makers either learned little, by prematurely withdrawing the fiscal stimulus, or it may be argued, Ã la Kalecki, that they knew the consequences, but they desired this outcome because the balance of political forces at work were not much different during those two eras: with fears of â€œunsustainable debtâ€ and the need to ensure the â€œconfidenceâ€ of the financial markets being a common theme for both historical periods.