Unanticipating The Great Depression and the Great Recession

by Mike Kimel

In Response to Bryan Caplan et. al., Part 2 – Unanticipating The Great Depression and the Great Recession
Cross-posted at the Presimetrics blog.

Last week I noted that Bryan Caplan, like many libertarians (and conservative economists as well), operates under the assumption that the data doesn’t support the Keynesian view of the economy. I put up a few graphs showing he is in error, and that growth rates are, in fact, lower when libertarian and conservative economic prescriptions are followed. But the problem is worse than one of slightly slower growth – that would simply mean we’re all just a little poorer than we otherwise would be. The problem is that every so often, bad policies leads to an outcome worse than just slightly slower growth.

Consider something I wrote back in March of 2008:

Think back to January of 2001. Say you told any conservative or libertarian that there would be what the White House refers to as a “mild recession” later that year. Say you also told that conservative or libertarian that by the beginning of 2008, the economy would have enjoyed years of tax cuts, years of cheap money coupled with low inflation, years of reduced regulation, and a couple (semi-privatized) small wars. Would they have predicted that along the way, real growth would be sub-par, and right now we’d be facing the possibility of a major downturn? Could they have even accepted that combination of facts? Is what we’re seeing a feasible outcome of any conservative or libertarian model?

Sure, we’ve all heard the arguments that the Community Reinvestment Act went a long way toward causing the meltdown, but there are three problems with that. The first is that even if the CRA bore some responsibility, it was passed in 1977, and that wouldn’t change the paragraph above – CRA or no CRA, there were years of tax cuts, cheap money coupled with low inflation, reduced regulation and a couple of semi-privatized wars. If the CRA was the problem and not lack of oversight, presumably the Great Recession would have happened during an administration that, say, did a less thorough job of deregulating and tax cutting. A second problem with blaming the CRA is that the economic mess is due to banks loaning money to people who shouldn’t have borrowed or been allowed to borrow, and there was no policy or law that forced a single organization to make loans it shouldn’t have or any entity to borrow money it shouldn’t have. A third problem is that the Great Recession struck many other countries as hard or harder than the US. One thing that was common about many of the worst hit countries is that they were high on the list of recent (say, in the past ten years or so) success stories as told by the folks who like to blame the CRA for the mess.

In any case, what is interesting that the paragraph I wrote in March of 2008 could have been written in October 1929. Sure, the semi-privatized small wars from the 1920s were mostly in Guatemala, Honduras and Panama, and the eight years of tax cuts and deregulation saw two Republican Presidents rather than one (Harding & Coolidge v. a single Bush), but on the economic front, things were quite similar. Sure, the NIPA data doesn’t go back that far, and the 20s do have a sterling reputation when it comes to growth (the Roaring 20s, dontcha know) but that only goes to show that the folks who were doing well at the time were the ones to write the history books. For everyone else, the Roaring 20s was a period where the economy could barely stay out of recession, denoted by the gray bars below:

Figure 1.

Data sources for the graph are described in the post where the graph originally appeared. And as I noted in that post:

in the 96 months between the end of the 1920 Depression and the start of Great Depression that followed this tax cutting bonanza, the economy was in recession 30% of the time

Incidentally, I can also think of one other period during the past 100 years which can also be described as several consecutive years of deregulation and tax cuts: the Reagan administration. That too ended poorly, though the price for the resulting S&L debacle was only paid during the administration of Bush the Elder, and it was spread over an extended period of malaise so nobody thinks of cause and effect.

All of which brings me back to where I started. The policies advocated by libertarians and economic conservatives not only tend to be accompanied by slower growth in general, as I noted last week, but also tend to precede economic meltdowns. All of which leads to a few possibilities:

1. Libertarians and economic conservatives are dead wrong; policies they advocate should tend to lead to worse outcomes than policies they are against
2. Libertarians and economics conservatives are mildly wrong; in general, whether the policies they advocate are adopted or not won’t have much of an effect on economic growth and its just a coincidence that in periods where their policies are adopted, outcomes tend to be worse
3. Libertarians and economics conservatives are right. As a result, the fact that outcomes tend to be worse in periods where their policies are adopted is just the result of a large number of very unlikely events.

Assuming folks like Caplan actually know what the data says and aren’t advocating positions out of complete ignorance or worse, ill will, they seem to be arguing for position number 3. From a logical perspective, its far less likely to be true than the other two positions. Presumably that should put the onus on him (and those who agree with him) rather than those who advocate a position requiring much less heroic assumptions, such as position number 1.