How does our ‘Great Recession’ compare to ones from the past?

Published in Real Clear Markets.

A prominent economist opened his book, The Great Recession, with this observation: “In the years ______, the world economy passed through its most dangerous adventure since the 1930s.”  This should sound familiar. “Its world-wide character and the associated bankruptcies and financial disturbances,” he added, “made this episode the long-awaited postwar economic crisis.”  But what years was Otto Eckstein in fact describing, so how do you fill in the blank in the first quotation?  The correct answer is the great recession of 1973-75. (How did you do on the quiz, esteemed Reader?)

“The capitalist process progressively raises the standard of life for the masses,” wrote the ever-provocative Joseph Schumpeter, but “It does so though a series of vicissitudes.”  Further, “Economic progress, in capitalist society, means turmoil.”  If Schumpeter is right that progressively raising the standard of living for ordinary people requires vicissitudes and turmoil, then cycles of booms and busts do not just happen, but are necessary in theory to economic progress.  They certainly do seem unavoidable so far.  Empirically, recessions are reasonably frequent.  In the last 100 years, there were 18 recessions in the United States, thus on average about once every 5 1/2 years. In the last 50 years, there have been seven recessions or on average once about every seven years.

Many recessions are shallower, but there are occasional great recessions.  How does “our” great recession—that of 2007-09– look relative to some of its predecessors?  Specifically, we compare it to the great recessions of 1981-82, 1973-75, and 1937-38.

The 2007-09 great recession led to a U.S. unemployment rate peak of 10.6%.  This was surely bad, but not as bad as the 11.4% which followed the 1981-82 bust.  The unemployment rate in 1973-75 got to 9.1%.  The great recession of 1937-38 was far worse, with unemployment peaking at about 20%.  (These unemployment rates are not seasonally adjusted.)

For 2007-09, 477 financial institutions failed in the five years from the onset of the great recession.  For 1981-82, the comparable number is 625 financial institution failures.  In the five years after 1973, there were 46 failures, but it is possible that the whole banking system was insolvent on a mark-to-market basis.  There were 262 failures in the five years after 1937.

In terms of peak-to-trough drop in real GDP, 2007-09 is the second worst of our examples.  In order of increasing severity the aggregate real GDP changes were:  1981-82, -2.8%; 1973-75, -3.1%; 2007-09, -4.2%; and estimated for 1937-38, -18%.

These great recessions had very different inflation experiences.  In 1973-75, in addition to the high unemployment, the U.S. suffered from painful double-digit inflation rates, with an annualized average of 10.9% on top of the other problems.  In 1981-82, the inflation rate was 5.2% along with recession, compared to 1.8% in 2007-09.  In 1937-38, they had deflation, or an inflation rate of -1.9%.

Then there is the cratering of the stock market in each case.  As measured by the peak to trough percentage drop in the Dow Jones Industrial Average, “our” great recession was the worst, with a 52% drop.  In 1937-38, the drop was 48%.   The DJIA fell 39% in 1973-75, and 20% 1981-82.  All painful, to be sure, especially if you were on margin.

Short-term interest rates fell dramatically in all four great recessions, but from very different levels.  Three-month Treasury bill yields started the 1981-82 great recession at the remarkable level of 15% and fell to 8.1%, the biggest change in number of percentage points.  The biggest drop measured as a percentage of the initial level was our 2007-09, in which three-month bill yields dropped from 3% to 0.18% or by 94%.  In 1973-75, these yields went from 7.8% to 5.5%, which sounds still very high to us now.  The lowest trough in rates was in 1937-38, when three-month bills went down to 0.05% from 0.41%.

In sum, the great recession of 2007-09 has predecessor great recessions.  These were worse in some ways, less bad in other ways, and present different combinations of painful problems.  All were severe downers.  But great recessions and ordinary recessions notwithstanding, on the trend the enterprising economy keeps taking income per capita ever higher, “progressively raising the standard of life for the masses” over time. If there is some way to do that without the cycles, it has yet to be discovered.