How Low Can We Go?

The Financial media and economics blogosphere is full of wonky goodness this week  with all kinds of forecasts of the economy.  The big question is how bad will it get?  The secondary questions deal with economic forecast assumptions built into the Obama Budget.  Are they overly rosy or realistic?  I’ll save the wonkiest battle for last even though it is the most interesting.   It is between Mankiw and Krugman (with me agreeing with Mankiw for a change on a technicality) but it’s based on some pretty high level math so let’s start with the the least technical shot across the bow of  the good ship Hopey Changey.

Robert Barro has the most blunt assessment of the big question in this week’s WSJ.  His opinion piece just asks the question out right.  What Are the Odds of U.S. Depression? Barro is a member of what you could possibly call the elite team of economists in the country.  His credentials and CV are impeccable.  His record of academic publishing is unassailable.  He teaches at Harvard.  He also tends to be a voice from the right.   However, he’s presenting research in this opinion piece so this isn’t based on dogma, but some high level number krunching.   He’s actually put the probability of a ‘great’ depression at 20%.

The bottom line is that there is ample reason to worry about slipping into a depression. There is a roughly one-in-five chance that U.S. GDP and consumption will fall by 10% or more, something not seen since the early 1930s.

Our research classifies just two such U.S. events since 1870: the Great Depression from 1929 to 1933, with a macroeconomic decline by 25%, and the post-World War I years from 1917 to 1921, with a fall by 16%. We also assembled long-term data on GDP, consumption and stock-market returns for 33 other countries, sometimes going back as far as 1870. Our conjecture was that depressions would be closely connected to stock-market crashes (at least in the sense that a crash would signal a substantially increased chance of a depression).

I’d really suggest you buck up and actually read his story line about his data because it is very interesting.  He basically looks back at periods when there were severe stock market crashes (like now) and looks at trends.  His database is not restricted to US history but includes severe recessions and depressions from 34 different countries.

His assessment of forecasts is based on looking at the Fed scenarios.  He tips his conservative bent at the end of this quote by basically saying none of the policies we’ve seen to date are going to do much.  I highlighted his proposed time line.  He does think we’re going into a situation that will be worse than the 1980s recession but most likely not as bad as the Great Depression of the 1930s.

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