British Academy Conference 16 April 2010
Lessons from the Great Depression for the making of Economic Policy
Speaking note: Christopher Allsopp: New College, Oxford
1. Introductory remarks
Welcome. My role as Editor of the Oxford Review of Economic Policy and as
stand-in for a current economic policy maker (Charlie Bean) in view of purdah
and the election.
I was (we were) delighted when Nick Crafts floated the idea of an academic
conference/workshop combining an ‘editorial’ seminar with a British Academy
forum – with the conference papers to be published by OXREP .
Extremely topical, extremely important from a political economy viewpoint,
and just what OXREP – set up 25years ago - is designed to do. Hallmark: the
best theoretical and empirical analysis of important issues, presented in a
clear, not too technical, policy relevant way. I know it is going to be a great
issue. I also think that the lessons – both positive and negative – are going to
be very important.
I am looking forward to the papers and the more general discussion
2. In general terms, some of the most important lessons are negative. It is known
that much policy this time was conditioned on the imperative of avoiding the
mistakes (and the results) of the great recession. Bernanke is, of course, an
expert, and knew what he did not want. Almost equally important is a much more
recent experience - that of Japan after the bubble burst. The Fed working paper
by Ahearne et al (2002) was almost a road map. Aggressive action (don’t get
there in the first place) right up to quantitative easing. Though the jury is still out
on its effects in Japan – and in the US/UK and elsewhere.
3. There is another comparison that is important – the 1980s recession, triggered by
the Volcker shock. That was due to concern over inflation – essentially it was
intentional. The present great recession is more comparable with interwar – the
US was bothered about deflation not very long ago.
4. But I want to start even further back – the post war order. The inter war period
saw competitive deflations, trade wars, and competitive devaluations. The post
war institutions were designed to avoid all three. To avoid beggar thy neighbour
actions.
5. But what kind of a shock do we see as triggering these actions?
Keynes (Chapter 16) described recessions as arising from ‘a desire for
‘wealth as such’. What did he mean? Clearly it is a stock concept (though it
would imply a big increase in desire to save for a time). These days we would
describe it in terms of the requirement to deleverage.
But why? Swings in future expectations – what looked sensible yesterday
looks crazy today (e.g. after the authorities looked as if they had lost control
after Lehman Brothers? Or after the (unanticipated) Volcker shock). Credit
drying up? Bank failures. Asset price falls.
But the system cannot deleverage. (Matter of accounting!).
But it can try. Cut expenditure? Lower prices? Internationally, stick on tariffs,
competitive devaluation. All these – including the Keyensian multiplier have the
characteristic of the well known prisoners dilemma. (Tariff wars reach ‘Nash’ –
the Keynesian multiplier story breaks the disequilibrium by lower saving –
nonsense in practice since savings actually rise and investment goes down. And
liquidity difficulties make all this worse. And liquidity preference sends interest
rates the wrong way. (And if it doesn’t – there is the risk of deflation – Japan –
interwar). Competitive devaluations work in theory – but dominated by deflation
effect on interest rates if prices cannot jump.
It all sounds fairly familiar as a description of problems that might occur given the
early stages of this recession – I will be interested to hear more about the
interwar period.
6. But what about this recession?
Early worries (Eichengreen and O’Rourke) showed that most things worse than
interwar to start with. But policy different – bail-outs, liquidity provision, M-policy
cut aggressively (Bernanke – and the Japan example), and then fiscal packages,
and quantitative easing.
The expectational effect after Lehman was dire!
Stockbuilding cycle – and world trade. The virulence of the stockbuilding cycle is
a major reason for the (V-shaped) pattern this time.
The policy response. Well known – interest rates, bail-outs, etc. Fiscal stimulus
as lower bound approached. Discretionary fiscal policy not all that large, except
in China.
The cumulative effects of deficits. They offset the desire to deleverage (banks,
companies and households). Finite adjustment – and the private sector should
come back and allow fiscal consolidation as recovery continues (need for
deleveraging falls). Typical pattern, UK in early 1990s. Sweden, (but cautionary
tale from Japan). Deficits have a cumulative effect in allowing the private sector
to ‘deleverage’.
So far, with hesitations and delays, the policy has worked. Some of the real
lessons from the interwar period are surely even more relevant for avoiding bad
policies in the recovery phase.
7. From this point of view – real difference is the TOLERATION of DEFICITS. These
were far larger that the discretionary moves – and reflected the automatic
stabilisers – What would have happened if policy makers had raised taxes or cut
expenditures aggressively to prevent deficits rising?
Deficit swing throughout OECD of about 7% of GDP. (Cf UK 10% in early 1990s,
Sweden even bigger).
This is a major difference from interwar – maybe the difference that made the
difference?
8. In one of the papers later on, Price Fishback , makes a provocative comparison.
He says
Surely, a good question for this conference is how to interpret the marked
difference in fiscal response, then and now. Does it suggest that too much was
done this time? – or does it indicate that without the huge policy response this
time round, we might be facing prolonged depression on an interwar scale?
Finally - to reiterate – what happens to policy now that recovery has started and
governments need to get out of debt?
Will interest rates have to remain low?
Will deficits have to remain high?
And is there a danger of (1) protectionism (2) deflationary policies and (3)
competitive devaluations? Lessons from the interwar period could not be more
relevant.