Can Talk of a Depression Lead to One? - A Commentary by Professor Robert Shiller
"Can Talk of a Depression Lead to One?"
By Professor Robert J. Shiller
Published February 22, 2009 in the New York Times
Read the article in its original context on the New York Times website.
People everywhere are talking about the Great Depression, which followed the October 1929 stock market crash and lasted until the United States entered World War II. It is a vivid story of year upon year of despair.
This Depression narrative, however, is not merely a story about the past: It has started to inform our current expectations.
According to the Reuters-University of Michigan Survey of Consumers earlier this month, nearly two-thirds of consumers expected that the present downturn would last for five more years. President Obama, in his first press conference, evoked the Depression in warning of a “negative spiral” that “becomes difficult for us to get out of” and suggested the possibility of a “lost decade,” as in Japan in the 1990s.
He said Congress needed to pass an economic stimulus package — as it ultimately did — to prevent this calamity.
The attention paid to the Depression story may seem a logical consequence of our economic situation. But the retelling, in fact, is a cause of the current situation — because the Great Depression serves as a model for our expectations, damping what John Maynard Keynes called our "animal spirits," reducing consumers' willingness to spend and businesses’ willingness to hire and expand. The Depression narrative could easily end up as a self-fulfilling prophecy.
The popular response to vivid accounts of past depressions is partly psychological, but it has a rational base. We have to look at past episodes because economic theory, lacking the physical constants of the hard sciences, has never offered a complete account of the mechanics of depressions.
The Great Depression does appear genuinely relevant. The bursting of twin bubbles in the stock and real estate markets, accompanied by huge failures of financial institutions and a drop in confidence, has no more recent example than that of the 1930s.
This isn’t the first time that the Great Depression has become an active story. It also was heard during the recession of 1981 and 1982, which resulted in unemployment rates of nearly 11 percent.
Hyman Minsky wrote a 1982 book, Can 'It' Happen Again?, that raised the possibility of a new depression. But the widespread perception then was that the decline was caused by the Federal Reserve, which had clamped down on the money supply to end out-of-control inflation. Depression fear did not take off.
The Great Depression also received some attention after the market crash of 1987. But then the stock market crisis was widely perceived as having been caused by a technical strategy called program trading, and again there was no huge banking crisis or loss of confidence.
This time is different: the Great Depression appears truly relevant, and many people have been spooked by the story. To understand the story’s significance in driving our thinking, it is important to recognize that the Great Depression itself was partly driven by the retelling of earlier depression stories. In the 1930s, there was incessant talk about the depressions of the 1870s and 1890s; each of those downturns lasted for the better part of a decade. Christina Romer, now the chairwoman of President Obama’s Council of Economic Advisers, has shown that the unemployment rate stayed above 10 percent for each of the five years from 1894 to 1898.
In his influential 1909 book, Forty Years of American Finance, Alexander Dana Noyes (who would later be financial editor of the New York Times) argued that the depressions of the 1870s and the 1890s might have lasted much longer, except for accidents of history — a "European famine and a bumper crop at home" which stimulated the domestic economy through its agricultural sector.
Early in the Great Depression, people were concerned that, as one observer put it in 1931, we may "pass through a long period of mediocre business activity like that of the 1890s."
Also early in the Depression, Forrest Davis worried in What Price Wall Street? that weakness after the panic of 1907 might have led to a prolonged depression if not for the accident of the World War. In 1932, a review of this book in the Times lamented that Mr. Davis had given us "no especial assurance that any of the traditional accidents can save us once more. The last war showed how terrible the next war will be."
Should President Obama have reinforced the Great Depression story? Perhaps he had to take that risk to promote the economic stimulus plan, and not just hope for some accident to save us. The story was already entrenched in our consciousness, and will be with us until we see a real, solid boost from the stimulus package and its likely successors.
Robert J. Shiller is professor of economics at Yale and chief economist at MacroMarkets LLC. He and George A. Akerlof are the authors of Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism (Princeton University Press).