Depression Scares Are Hardly New - A Commentary by Professor Robert Shiller
"Depression Scares Are Hardly New"
By Professor Robert J. Shiller
Published in the New York Times on May 3, 2009
Read the article in its original context on the New York Times website.
What is the chance that the current downturn will morph into another Great Depression? That question has been preoccupying people for months.
The popular mood has a huge impact on the economy, so itís worth noting what many people seem to forget: Depression scares come and go. And by one authoritative measure, the current outbreak of concern has been surprisingly mild.
The University of Michigan Surveys of Consumers have included in their regular measurements this specific question about fear of a prolonged depression:
"Looking ahead, which would you say is more likely ó that in the country as a whole weíll have continuous good times during the next five years or so, or that we will have periods of widespread unemployment or depression, or what?"
The Michigan surveyors produce a confidence score from the answer to this question. (It is one of the five ingredients in their combined Index of Consumer Sentiment, which is much more widely followed.) A high score on the question means that the answers tilted toward continuous good times, with a low score tilting toward unemployment or depression. Since 1960, the average score has been 94.
If we define a depression scare as any time the score is below 65, there have been four such scares since 1951. They were in the periods from 1974 to 1975, during which 47 was the lowest score; from 1978 to 1982, with a low of 41; from 1990 to 1992, with a low of 54; and from 2008 to 2009, with a low (to date) of 59. Note that so far, at least, the worst reading in the current scare has not been as bad as those of the previous episodes.
In each case, the scareís significance is further confirmed by electronically counting in news databases the number of articles containing the word pair ďgreat depression.Ē There were huge peaks in the count during these periods.
A study of the Michigan survey data published in 2004 by Nicholas Souleles at the Wharton School of the University of Pennsylvania has confirmed that individual answers to the depression question can help in consumer-spending forecasts. He concluded that people who answered this question more positively tended to have bigger increases in spending.
The good news is that from March to April this year, the score on this question jumped to 81, from 63, implying that the scare has ended, at least for now.
But that upward trend cannot be trusted to continue. Historically, big jumps in the score have tended to reverse themselves in later months. When peopleís fear reaches depression level, the underlying emotion seems to persist for years, despite occasional oscillations.
That is probably because fear of a depression seems to be related to a fundamental world view, and not just to the latest economic indicator, which may temporarily reduce anxiety.
A review of prominent events in the depression scares of 1974-75 and 1978-82 suggests that they stemmed at least in part from a sense that inflation was dangerously out of control. During both periods, inflation moved into the double-digit range. There was widespread concern that the Federal Reserve had no good options and might need to plunge the economy into a depression to control inflation.
And in these two periods, energy crises ó the first and second "oil shocks" ó contributed to the negative outlook.
The scare of 1990-92 had a different profile. Ravi Batraís best-selling 1987 book, "The Great Depression of 1990," did not cause that scare, but some of its predictions were vindicated by events: There was the biggest one-day stock market crash ever, in 1987; a real estate bust after a boom; widespread savings-and-loan failures; and a government bailout. The financial system seemed unstable, and there was concern that domestic jobs were threatened by the new trend of outsourcing.
Like its predecessors, the current depression scare is characterized by serious problems that wonít easily go away. After the bursting of bubbles in the stock market and housing market, balance sheets everywhere are out of whack, and millions of people are insolvent. So itís hard to expect that there will be a sudden and impressive recovery of confidence.
But why is this new depression scare apparently weaker than the others, as measured by the confidence scores? Why arenít people reporting more fear these days, since there are far more stories of business failure or near failure than there were during the other scares?
One can only speculate. Now that oil prices have moderated, itís possible that most people have less vivid worries than they did in 1974-75 or 1979-82 because their economic problems are not evident every time they shop or drive their cars.
During those earlier two scares, out-of-control inflation was widely visible, but today many people havenít personally experienced rising unemployment and foreclosures. And itís possible that the optimistic tone of the president and the Fed has assuaged some fears, and that people might believe that the government is fixing their problems.
This time, the reasons to fret about a possible depression may seem less concrete. For most people, the worries that consume economists and accountants, about things like bank stress-test results or the "OIS-Libor spread," are rather hard to comprehend.
As Franklin D. Roosevelt famously said during the Great Depression, "the only thing we have to fear is fear itself." Letís hope that is true, and that the relative complacency in the general population is good news for the economy. Letís not expect any sudden return to full confidence, but instead hope that a real crisis of fear may be avoided if government policy succeeds.
Robert J. Shiller is professor of economics and finance at Yale and co-founder and chief economist of MacroMarkets LLC.