Thursday, September 10, 2009

The Worst Economic Times Since the Great Depression? A Reality Check.

This article is from the RIIB blog of May 1, 2009.

We hear often that these are the worst economic times since the Great Depression. Certainly, these are the worst economic times in a generation. If you’re under the age of 40, these likely are the worst economic times that you can remember. The last serious recession in North America occurred in the early 1980’s. It was caused by a “credit crunch” engineered by North America’s central banks in their fight against entrenched inflationary expectations.

How does today’s credit crunch induced recession compare to the one of the 1980’s? Let’s look at the numbers. In early 1980’s, Canada’s unemployment rate peaked at 13percent after rising 80 percent above the 7.2 percent rate in December 1980 when the recession began. In today’s recession, unemployment in March was 8 percent, up from 5.8 percent about a year ago. If the hike in unemployment were eventually to match the 1980s peak, unemployment will rise much further, to about 10.5 percent.

What about stock market values? During November 1980, the value of the TSE Index averaged approximately 2400. It fell almost to 1400 by July 1982, a decline of more than 40 percent, and did not return to 2400 until the beginning of 1985. This decline in the TSE Index is similar to the decline we have already seen in the past few months.

While it’s too early yet to say much about the decline in real GDP in the current recession – it declined only in the last quarter of 2008 and likely will decline again this quarter – the recession of the 1980’s saw a 5 percent decline between June 1981 and December 1982. We will have to see quite substantial declines over the next several quarters to match this.

The other features of the early- 1980s recession included extremely high interest rates – the Bank of Canada rate hit 21 percent in August 1981 – and extremely high inflation – the inflation rate in 1981 averaged more than 12 percent. This translates into extremely high real interest rates. In the current recession, both real and nominal interest rates are extremely low, as is inflation.

Finally how do these indicators compare to the Great Depression? Over the four year period from 1929 to 1933 real GDP dropped 43 percent and by 1933 the unemployment rate had hit 37 percent. The good news is that it is extremely unlikely that Canada’s economy will approach anything like these numbers. We can credit some of this to the fact that economists learned from the experiences of the Great Depression that expansion of the money supply is critical during times of financial crisis. Current US and Canadian monetary policies are based on this learning and aim to prevent the kind of economic and financial market meltdowns that occurred in the United States during the Great Depression.

Are these monetary policies paying off? Already, we are seeing some hopeful signs. The TSX has risen over 20 percent from its low about 2 months ago. The housing market in the US is beginning to stabilize, with both sales of new and existing homes rising and price declines slowing. In Canada, retail sales rose nearly 2 percent in January. While Canada is certainly not out of the woods, it looks as though we are on track for a recession of a magnitude that is similar to, or even less severe than, that of the early 1980s.

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