Amid rising unemployment, with nearly 17 million Americans filing recently for unemployment benefits, and with nearly 30% of the economy now idled, many economists are suggesting that COVID-19 could lead to another Great Depression. I disagree for one important reason: the massive doses of liquidity and federal expenditures being injected into the economy.
For example, on Thursday, the Federal Reserve announced it is providing up to $2.3 trillion in additional loans to support the economy, including funding to assist households and employers of all sizes. This is on top of $5 trillion in liquidity already promised by the Fed, as well as the $2 trillion federal stimulus package that includes such measures as expanded unemployment benefits and stimulus checks of up to $1,200 per person.
Sorry we're CLOSED due to COVID-19. Foldable advertising poster on the street
Such emergency measures are the exact opposite of what occurred during the Great Depression, when liquidity was actually reduced and there was no fiscal stimulus for the first several years of that steep economic decline. For that reason alone, it seems nearly impossible for the U.S. to fall into a depression today. The only possible trigger would be massive fiscal and monetary policy errors — and that is not what we’re seeing.
Former Federal Reserve Chairman Ben Bernanke holds the same view, calling projections that the current economic downturn will become as severe as the Great Depression “not a very good comparison.” He added: “This is like a natural disaster, and the response is more like an emergency relief than it is a typical stimulus or anti-recessionary response.”
What the Data Say
Among those who expect a repeat of the Great Depression, the basis for their conclusion is the magnitude of some current economic forecasts, such as unemployment rising to above 30% or U.S. GDP falling by more than 20%. These were the kinds of worrying percentages seen during the Great Depression. But even if these contractions in employment and output are realized, this is not the correct way to think about a depression.
A recession is defined as two consecutive quarters of economic contraction, which is called negative economic growth. In contrast, a depression is defined by negative economic growth and rising unemployment over a sustained period of time.
To put this in perspective, during the Great Depression, the U.S. economy declined by almost 50% over four years: from GDP of $103.6 billion in 1929 to GDP of $56.4 billion in 1933. Year by year, GPD shrank as follows: -8.5% in 1930, -6.4% in 1931, -12.9% in 1932, and -1.2% in 1933, until it finally turned around with a strong rise of +10.8% in 1934 with the advent of the New Deal. Meanwhile, the unemployment rate during this period was in double digits for ten years, from 1931 to 1940, and peaked at 24.9% in 1933.
Lessons from the Great Depression
The mistakes in fiscal and monetary policies during the Great Depression have been studied for years by economists and economic historians. The consensus is that errors in fiscal and monetary policies made in the 1930s exacerbated a bad situation into something far worse. Most notable among those errors were the Fed’s initial reduction in the money supply and then doing too little to prevent bank failures in the early 1930s. Moreover, there was no fiscal expansion by the government, until the New Deal went into effect in 1933.
The missteps of the 1930s were the “lessons learned” for modern policymaking. As a National Bureau of Economic Research paper observed, “In contrast to the 1930s, the Federal Reserve, guided by Depression scholar Benjamin Bernanke, has flooded the banking system with liquidity since fall 2008. The Bush and Obama administrations fought the downturn with tax rebates in 2008 and 2009. The… Obama administration and the Democratic Congress pushed through a fiscal stimulus package that has driven the federal deficit near 10 percent of GDP, the largest peace-time deficit in American history.”
Aggressive steps to stimulate the economy and dramatically increase liquidity are once again being taken. For example, the Federal Reserve is now venturing into new territory, such as purchases of corporate bonds, with exposure to both investment-grade and riskier high-yield securities. By buying corporate debt, the Federal Reserve is directly increasing much-needed liquidity in the corporate debt market.
The Look Ahead
On balance, it appears conceivable that the shutdown of the U.S. economy because of COVID-19 could result in a recession with negative economic growth lasting more than two quarters. However, a depression with several years of steep economic contraction is highly unlikely because of the fiscal and monetary policies now put in place.
One potential wildcard is when then the U.S. economy is reopened. Most likely, we will see a gradual reopening soon, while social distancing and wearing of face masks are used to limit exposure to the virus. It seems unlikely that the economy would remain shut down for an extended period of time, such as until a vaccine is developed, which could be 12 to 18 months away, according to most projections.
In the meantime, what will keep the U.S. economy afloat is the coordinated efforts by Treasury and the Fed to increase liquidity and put more money into the hands of businesses and consumers. Not only will this stave off any potential for a depression, it will also provide the dry powder of liquidity to stimulate consumer purchases and reignite the economy in the months ahead.
