The Public Interest

Former Reagan economist Bruce Bartlett notes some similiarities between the Great Depression and this, the “Great Recession:”

“Unfortunately, the current crisis is caused by the same deflationary forces that caused the Great Depression. Monetarists dismiss this argument on the grounds that the money supply has not only not fallen, but in fact has risen sharply. At the end of September, the money supply (M2) was up by $523 billion over a year earlier–a substantial increase. For this reason, they dismiss the idea that government stimulus was necessary to get the economy moving again.

What my monetarist friends forget is that that the money supply impacts GDP through the velocity multiplier. Normally, it is around 1.9. But it fell to 1.86 in the third quarter of 2008, 1.76 in the fourth quarter, 1.7 in the first quarter of 2009 and 1.69 in the second quarter before rising a bit to 1.72 in the third quarter.

This may not sound like much, but a decline of 10% in the velocity ratio has exactly the same macroeconomic effect as a 10% decline in the money supply. If velocity were still at 1.9, third-quarter GDP would have been $15.8 trillion instead of $14.3 trillion. In other words, there would be no recession.

Getting velocity to rise presents policymakers with the same problem they had in the 1930s and requires the same solution: Government spending has to compensate for the falloff in private spending, which should be $1.5 trillion higher based on M2 of $8.3 trillion at the end of September.

The main differences between today’s crisis and the Great Depression is that the deflationary pressure is less than a third of what it was in the 1930s and policymakers today reacted much more swiftly and more appropriately than they did after 1929. Those who think the government should have done nothing risked turning the current downturn into another Great Depression. Thankfully, their advice was ignored.”

You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.