The phrase “worst since 2008” keeps coming up recently in terms of the falling stock market and other economic indicators, a sign of the peril facing the world economy as a result of the coronavirus outbreak.
That naturally raises the question of whether the current economic situation is actually similar to the 2008 crisis. The truth is, the situations are extremely different. American recessions each tend to be different. We generally don’t make the same mistake twice in a row, but more broadly, policymakers have gotten pretty good at managing the economy. When recessions do happen, it’s usually because of some unusual circumstances that pose a slightly different set of trade-offs and uncertainties.
So our current economic woes don’t really have much in common with the ones that sparked the Great Recession — except that they are economic woes. In 2008, a banking crisis and the loss of housing wealth was the root of the problem. Today, the problem is direct losses of income for people and businesses hurt by coronavirus-related public health measures.
It’s difficult to predict whether today’s problems will prove to be milder or more severe than what we saw last time because that will largely depend on the quality of the policy response. It should be possible to put a floor under the economy and ensure any downturn is brief, but it should have been possible to do that in 2008 too. The problem, fundamentally, is that policymakers didn’t do enough then. And it’s not clear that they’ll move fast enough now.
All unhappy economies are ultimately alike
Recessions and recoveries are called the “business cycle” by economists, and once upon a time they genuinely did follow a cyclical pattern.
In the 1940s, ’50s, and ’60s as unemployment fell, America’s once-strong labor union movement grew bolder and bolder in the wage demands it made in America’s economy, which once upon a time was dominated by industrial work and experienced limited international competition.
Those higher wage demands led to higher prices for manufactured goods, which, at the time, were a large share of a normal person’s annual purchases. Those price increases led the Federal Reserve to raise interest rates to head off or reduce inflation, which led to lower purchases of houses and durable goods (big stuff like cars, furniture, and appliances), which led to layoffs and a reduction in wage pressure.
There was a recession in 1945, then another one in 1949, another in 1953, another in 1957, and another in 1960. These recessions were all short and mild, started by interest rates getting too high and ended by interest rates being cut.
In the modern day, manufacturing is less important, unions are weaker, and the Fed is better at calibrating its rate hikes to avoid provoking recessions. Recessions, in turn, have become both rarer and weirder.
- In the summer of 1990, Iraq invaded Kuwait, hoping to combine Kuwait’s oil reserves with Iraq’s and become a kind of Persian Gulf superpower. The United States, hoping to avoid that, sanctioned Iraq, dispatched troops to Saudi Arabia, and assembled an international coalition to attack Iraq and secure Kuwaiti independence. The effort to prevent Saddam Hussein from dominating global oil production generated a huge disruption to production that caused a recession, exacerbated in some regions by the largely simultaneous wind-down of Cold War defense procurement.
- Over the year 2000, the value of overhyped technology stocks began to crash, leading eventually to a much broader stock market collapse. Lots of middle-class people got sucked into quasi-hobbyist investing during the late-1990s boom, and the stock bust left people with less wealth, leading to a broad decline in spending. That was exacerbated by layoffs at technology companies and a sharp reduction in investment in physical installation of fiber optic cables.
- In the second half of 2007, house prices started to decline nationally. That led to a decline in housebuilding (which cost jobs) and a slowdown in consumer spending (due to the lost wealth, similar to what happened in the previous recession). Initially, this seemed to be a not-so-bad situation, as many workers who lost jobs transitioned into manufacturing. But there turned out to be a financial house of cards built atop the presumption that a broad national decline in house prices was impossible, so we got a banking crisis, a stock market crash, a collapse of small-business credit, and all kinds of other problems.
There’s no real common thread to any of this other than “something bad happens, spending falls, and then there’s a recession.”
The key thing is that in all cases, the effects of a recession end up being broad and generalized. People hang on to their cars for longer rather than replacing them, so auto manufacturing goes down. People do less discretionary travel and businesses keep a closer eye on expenses, so airlines go down. Everyone pinches pennies a bit on their meals and consumer packaged goods purchases, so big retailers lose sales and reduce staffing. It becomes a downward spiral such that ultimately, the origin of the recession doesn’t matter nearly as much as policymakers’ ability or inability to put a floor under things and spur spending.
A common thread: Rate cuts won’t work
One traditional way to put a floor on things is to have the central bank cut interest rates.
Lower interest rates mean it is cheaper to borrow money. Lower interest rates also lead to higher expectations of future inflation, meaning it is more expensive to hoard money. The latter effect gives people who have money a strong incentive to go trade that money for stuff — a new washing machine, a new couch, whatever. The former effect gives people who are optimistic about the future more opportunity to act on that optimism with borrowed money. People can buy houses, get cheap car loans, or secure financing to expand their business.
Because the most recent recession was so severe, even cutting interest rates all the way down to zero wasn’t enough to revive the economy. That led the Federal Reserve to experiment on and off with less orthodox strategies like quantitative easing, but it mostly left the country looking to Congress for help in the form of fiscal stimulus.
Initially, stimulus was forthcoming — first with a Bush/Pelosi initiative to send checks to everyone and then with the Obama administration’s larger recovery act. These moves were large in terms of the absolute amount of money spent, but relatively small compared to the scope of economic need. And after the 2010 midterms, the federal government went in the opposite direction with congressional Republicans insisting on spending cuts.
Today’s situation is somewhat different. Interest rates had gone up as the economy started to recover from the Great Recession, but they were still at a very low level by historical standards when the coronavirus outbreak hit. So there is very little room for additional rate cuts. And while low interest rates do help an ailing economy, they really don’t help the people who are most in need.
There is need again for fiscal measures from Congress, and a need to understand that this situation is likely to recur in the future.
This is the new normal
The low interest rates that prevailed at the end of the Bush administration and the beginning of the Obama administration lasted much longer than most experts had predicted. By the end of Obama’s term in office, Jason Furman, then the chief economist at the White House, was pointing out that this “surprising” persistence of low rates was in fact a pattern that had recurred across business cycles.
Under the circumstances, perhaps it was time to stop being taken by surprise that rates were not bouncing back as rapidly as people thought.
The exact reasons interest rates keep trending lower are not perfectly understood. But the pattern exists across all rich countries. And in general, rates are higher in rich countries with relatively rapid population growth (Australia, Canada, and to a lesser extent the United States) and lower in rich countries with slow population growth (Germany and especially Japan). This suggests to me that worldwide declining interest rates are related to the global decline in birthrates.
But whatever the reason, persistently low interest rates mean we can’t count on central bank rate cuts to end recessions.
So even though the sources of recessions can be very diverse, the same basic problem is likely to keep recurring. A particular problem in the United States is that the Republican Party appears to believe fiscal stimulus is a good idea if and only if there is a Republican president in the White House. That’s why Democrats would be smart, both for their political self-interest and for the good of the country, to insist that any stimulus include provisions to automatically kick back in whenever future need arises.
Causes of recessions are unpredictable. But the cures are easier to see in advance, and the prudent thing for Congress to do is to act to stop not just the coming recession but the one after that as well.