ESSAY/ ROBERT J.SHILLER

Can talk of an economic depression actually lead to one?


People everywhere are talking about the Great Depression, which followed the October 1929 stock market crash and lasted until the United States entered World War II. It is a vivid story of year upon year of despair.

This Depression narrative, however, is not merely a story about the past: It has started to inform current expectations.

According to the Reuters-University of Michigan Survey of Consumers in February, nearly two-thirds of consumers expected that the present downturn would last for five more years. President Obama, in his first news conference, evoked the Depression in warning of a“negative spiral”that“becomes difficult for us to get out of”and suggested the possibility of a“lost decade,”as in Japan in the 1990s.

He said Congress needed to pass an economic stimulus package - as it ultimately did - to prevent this calamity.

The attention paid to the Depression story may seem a logical consequence of our economic situation. But the retelling, in fact, is a cause of the current situation - because the Great Depression serves as a model for our expectations, damping what John Maynard Keynes called our“animal spirits,”reducing consumers’willingness to spend and businesses’willingness to hire and expand. The Depression narrative could easily end up as a selffulfilling prophecy.

The popular response to vivid accounts of past depressions is partly psychological, but it has a rational base. We have to look at past episodes because economic theory, lacking the physical constants of the hard sciences, has never offered a complete account of the mechanics of depressions.

The Great Depression does appear genuinely relevant. The bursting of twin bubbles in the stock and real estate markets, accompanied by huge failures of financial institutions and a drop in confidence, has no more recent example than that of the 1930s. This isn’t the first time that the Great Depression has become an active story. It also was heard during the recession of 1981 and 1982, which resulted in unemployment rates of nearly 11 percent.

Hyman Minsky wrote a 1982 book,“Can‘It’Happen Again?,”that raised the possibility of a new depression. But the widespread perception then was that the decline was caused by the Federal Reserve, which had clamped down on the money supply to end outof- control inflation. Depression fear did not take off.

This time is different: the Great Depression appears truly relevant, and many people have been scared by the story.

It is important to recognize that the Great Depression itself was partly driven by the retelling of earlier depression stories. In the 1930s, there was incessant talk about the depressions of the 1870s and 1890s; each of those downturns lasted for the better part of a decade.

In his influential 1909 book,“Forty Years of American Finance,”Alexander Dana Noyes argued that the depressions of the 1870s and the 1890s might have lasted much longer, except for accidents of history - a“European famine and a bumper crop at home”which stimulated the domestic economy through its agricultural sector.

Early in the Great Depression, people were concerned that, as one observer put it in 1931, we may“pass through a long period of mediocre business activity like that of the 1890s.”

Also early in the Depression, Forrest Davis worried in“What Price Wall Street?”that weakness after the panic of 1907 might have led to a prolonged depression if not for the accident of the World War.

Should President Obama have reinforced the Great Depression story? Perhaps he had to take that risk to promote the economic stimulus plan, and not just hope for some accident to save us. The story was already entrenched in our consciousness, and will be with us until we see a real, solid boost from the stimulus package and its likely successors.