Distinguished Speaker Seminar: Barry Eichengreen - From Great Depression to Global Credit Crisis: Similarities, Differences and Lessons

Barry Eichengreen, George C. Pardee and Helen N. Pardee Professor of Economics and Professor of Political Science at the University of California in Berkeley, Research Associate of the National Bureau of Economic Research in Massachusetts, and Research Fellow of the Centre for Economic Policy Research in London, gave a lecture at an ADBI Distinguished Speaker Seminar on 3 March 2010 in Tokyo.

Mr. Eichengreen's presentation was drawn from two papers: From Great Depression to Global Credit Crisis: Similarities, Differences, and Lessons which he co-authored with Miguel Almunia, Agustín S. Bénétrix, Kevin H. O'Rourke, and Gisela Rua; and The Slide to Protectionism in the Great Depression with Douglas Irwin. He briefly tracked the 2008 crisis and compared it with the one in 1929.He then assessed the policy responses following these two events, and concluded by offering some implications for present-day policy issues.

Mr. Eichengreen pointed out that while both crises originated in the US, their effects reverberated globally with varying degrees of impact depending on the countries' policy responses and pre-crisis circumstances. Striking similarities stood out in both crises: downward trends were observed in trade and capital flows, commodity and equity prices, and production.

There are, however divergences. Unlike the prolonged economic slump following the 1929 crisis, the global economy has already turned a corner only months into the 2008 crisis. While falling industrial output in 1929 was concentrated in Europe and North America, as industrial production has spread around the world in recent decades, the fall in output was ubiquitous in the first year of the 2008 crisis. The fall in world trade was also initially deeper than 1929 levels before recovering, even without the protectionist backlash. The world stock market index also dropped more steeply, that the rally since March 2009 only put the trend back on track with the comparable stage of the 1929 crisis.

Evidently, policy responses between the two crises were different. This time, governments promptly implemented loose monetary and fiscal policies. Money supply has been growing well into the 2008 crisis. Both advanced and emerging economies are also more willing to run deficits as a result of expansionary fiscal stimuli.

Mr. Eichengreen raised the following questions: If the freefall has now abated, what has been the role of policy? Does the effectiveness of fiscal and monetary policy depend on the financial nature of the crisis and exceptional economic environment it created? In particular, should we think that monetary policy may not work in an environment of near zero-interest rates and dysfunctional banking systems, and that fiscal policy may even be more powerful than in other circumstances since households are credit constrained and banks are not lending? To answer these questions, Mr. Eichengreen used pooled annual observations from 27 countries from 1925–1939, totaling 400 observations. The results of the four strategies employed to analyze the data unequivocally pointed in the same direction—that fiscal policy, where applied worked in the 1930s. Multipliers are large, as one would expect in an environment of near zero-interest rates and significant excess capacity. There is also slightly weaker evidence that monetary policy was effective, which is inconsistent with the liquidity trap story. He argued that it reflects the importance of activist monetary policy in eliminating expectations of ongoing inflation.

In terms of trade policies which raised tariff rates significantly in some countries, Mr. Eichengreen factored in the international monetary arrangement of the 1929. He found that countries that kept their currencies fixed to the gold standard imposed trade restrictions to limit foreign trade, shifting demand toward local to mitigate swelling unemployment. Others that abandoned the gold standard and allowed their currencies to depreciate gained competitiveness at the expense of neighboring countries. Thus, they did not resort to trade protection.

His findings led him to conclude that to avoid protectionism, it is necessary to stimulate the domestic economy. He added, however, that the implications of this measure are more subtle. He noted that in the 1930s stimulus meant monetary stimulus, which benefited the initiating country at the expense its trading partners. Today, countries have been applying fiscal stimulus that can also benefit their neighbors. But the initiating country, seeing neighbors who are free riding, has an incentive to resort to protectionist measures. Now it is the active country not the passive country, as in the 1930s, that has an incentive to destroy trade.