The Journal Games Out Depression Scenarios

I like this Wall Street Journal piece today looking at the odds of entering a depression, what that would mean, and what it would look like. I think we need more of this forward-looking stuff asking where we might be headed and spelling out what that might mean.

Here’s the lede for the page-two piece:

In the wake of the biggest financial shock since 1929, economists say the odds of a depression are less than 50-50 — though still uncomfortably high.

The amazing thing for me is I only had a very tiny vestigial bit of shock reading that. Somehow the capacity for startling, though grievously wounded, is still lurking in my brain even after all the events of the last eighteen months.

It’s long been interesting that there’s no real definition of a “depression” beyond the old saw about it’s a recession if your neighbor loses his job and a depression if you do. Defining depression is like defining obscenity—you know it when you see it.

But there are some non-official rules of thumb, reporter Justin Lahart writes:

There is no consensus definition for “depression.” Harvard University economist Robert Barro defines it as a decline in per-person economic output or consumption of more than 10%, and puts the odds of a depression at about 20%. Many economic historians say the line between recession and depression is crossed when unemployment rises above 10% and stays there for several years.

Sounds reasonable.

But then Lahart writes:

The current recession, though severe, is not at depression levels now. Unemployment in February was at 8.1%, not as bad as in the early 1980s — the last time the idea of a depression was being kicked around seriously, when it remained over 10% for 10 months. In the Great Depression it reached 25%.

But real unemployment is almost certainly worse than 8.1 percent. It’s hard to compare current employment statistics to past ones because the government has changed the way it calculates unemployment. It now doesn’t include people who have given up trying to find work. Plus, changes in how business employee people have made it harder to calculate unemployment.

Fifteen years ago, the Bureau of Labor Statistics quit counting people who stopped looking for work in the previous month. As Haley Sweetland Edwards wrote over at Campaign Desk last month:

That change in definition is particularly important because we’ve seen lots of comparisons between unemployment today and unemployment in the early ’90s. But, since the definition of “unemployment” has changed in the meantime, it’s an apples and oranges situation.

A more accurate number for our 21st century economy may be the U-6, which includes the people counted in the conventional unemployment figure, plus the “hard-core unemployed” who’ve given up looking, as well as those only able to find part-time work. That number stands at 14.8 percent, up 5.3 percentage points from a year ago.

Another problem with comparing unemployment to the levels reached in the 1930s and 1980s is that we’re comparing to those downturns’ peak rates. We don’t know yet where unemployment will peak in this one. Comparing our current recession to when the Great Depression started, we’re only to early 1931 at this point, when unemployment hit 15 percent. The rate didn’t peak until two years later, at 25 percent (The Journal does have a decent chart attached to the story overlaying employment and other economic trends with those of the Depression).

But as Lahart writes, there are reasons to believe we won’t see 25 percent unemployment:

Paul Kasriel of Northern Trust put the odds of a depression at just 1% because of the aggressive lending by the Federal Reserve and the fiscal stimulus just beginning to hit the economy. “There are just too many powerful countercyclical policies in place that will prevent the worst-case scenario,” he says.

Today’s government response is a far cry from the early 1930s, when the Fed raised interest rates, the infamous Smoot-Hawley Tariff Act crushed trade and Treasury Secretary Andrew Mellon’s prescription for the economy was “liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.”

“The Great Depression was a mass of policy errors that made it worse,” says historian and investment consultant Peter Bernstein, 90. “This time we have our fill of policy errors, but at least they’re not making it worse.”

So, at least so far our bumbling Bush/Obama, Pelosi/Boehner, Geithner, and Bernanke aren’t Hoover, Smoot/Hawley, Mellon, and Young. Comforting!

I also like that Lahart talks to some real old-timers who not only know what they’re talking about regarding the economy and history, but who actually lived through the Depression—including 84-year-old economist Robert Solow, 93-year-old economist Paul Samuelson, and 94-year-old economist Anna Schwartz. It’s a good tack.

The economy now has so-called automatic stabilizers, which not only protect people somewhat from the downturn, but which also help keep the economy moving.

And then there are the social-safety-net programs that emerged after the Great Depression to blunt the blows. “There were no unemployment insurance, no food stamps, none of the automatic things that maintain some income for people who are out of work,” says former Massachusetts Institute of Technology economist Robert Solow, a Nobel laureate.

And a good close:

As a University of Chicago student during the Depression, Mr. Samuelson remembers attending economic lectures that seemed completely out of step with the times, based on laissez-faire principles that stopped making sense after the 1929 crash. “I was perplexed because I could not reconcile the assignments I got from these great economists with what I heard out the windows and I heard from the street,” he says.

Starting in the 1980s, the U.S. saw an extraordinary period of economic quiescence, where growth was steady and policy makers dealt with financial crises handily. Economists began to doubt the possibility of a financial crisis so severe it would upend the economy. And that left them as blindsided as their counterparts when the crisis came 80 years ago.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.