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Commentary: How Bad Can It Get? The Great Depression as a Benchmark for Economic Hardship

In another commentary, my colleague Professor John Lapp discusses the federal government’s efforts to keep the economy from falling any further. You might ask: How bad can it get? When it comes to financial markets and the economy more generally, the Great Depression serves as the benchmark for “bad.” Using a few economic indicators – the stock market, unemployment rate, real GDP, and bank failures – let’s see how bad things would have to get to match that matchless era of woe our parents or grandparents told us about.

The Dow Jones 30 Industrials Index is down 25 percent for 2009, and it is off more than 50 percent from its 2007 peak, placing it in a range not seen in more than a decade. By comparison, the Dow punctuated the Roaring Twenties by peaking at 381 during the first week of September 1929. It did not close at or above that figure again until November 24, 1954 (that’s 9,213 days, counting leap years.) The index bottomed out at 41 in July of 1932, for a peak-to-trough decline of 89 percent. A similar decline today would put the Dow at 1,558. That’s a whole new level of bad.

p. Currently, the U.S. unemployment rate stands at 8.1 percent, its highest level since 1984. In contrast, between 1931 and 1939, the unemployment rate never fell below 14 percent, and incredibly, for four consecutive years (1932-1935) it never fell below 20 percent. To reach 20 percent today, an additional 31 million workers would have to lose their jobs.

In the fourth Quarter of 2008, real GDP declined by 6.1 percent, and for the year (from fourth quarter to fourth quarter), it fell by 0.8 percent, which is not out of line with the declines in other post-World War II recessions. Compare that with the performance in the early 1930s: Real GDP declined by 8.6 percent in 1930, 6.4 percent in ’31, and 13.0 percent in ’32. A 13 percent decline today would represent a lost of another $1.9 trillion in economic activity.

Finally, let’s look at bank failures. In recent years, the United States averaged about one bank failure a year. By that standard, 2008 was a catastrophic year with 25 bank failures. But by the standard of the Great Depression, 2008 did not look so bad. Between 1930 and 1935, 10,000 banks failed. Of course, there were many more banks in 1930 than there are today. However, roughly one in three banks failed during the Great Depression. If one-third of the banks fail during the current downturn, then that would mean we’ll watch 2,500 banks go under, a hundred times the number that failed in 2008.

They say that there is no such thing as a small war to those who fight them. Similarly, there’s no such thing as a mild recession to someone who loses a job. But viewed from the Delphic perspective of macroeconomics, we still have a long way to go before we dust off the words “Great” and “Depression” for use during the current downturn. Just ask your grandparents.

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Commentary: Can We Avoid Another Great Depression? Government Policies to Limit the Economic Damage