Recession or depression? Too early to tell

Beneath those broad similarities, though, there are some significant differences between now and the 1930s. Most bank deposits today are insured, preventing panicked depositors from cleaning out their savings and hoarding cash under their mattresses. Two-income families have somewhat softened the blow of rising unemployment. Social Security and Medicare help offset the threat of widespread financial destitution among the elderly that accompanied the Great Depression.

Perhaps most importantly, the modern Fed has responded aggressively to the current crisis as the “lender of last resort.” Economists generally agree that the 1930s Fed, along with the central banks of major U.S. trading partners, made a bad economy worse by adhering too long to a rigid gold standard, which kept the supply of money tight when those bankers should have been working to make loans easier to get.

Still, some economists believe that we may be at greater risk for another depression today than at any time since the last one ended more than 60 years ago. The period since then has come to be described by some as the Great Moderation — a period when economic contractions were shorter and milder than at any time in history. The notion that business cycles have been tamed is backed by the statistics. Between 1945 and 2001, the average recession lasted just 10 months; between 1854 and 1945, recessions lasted 21 months on average.

The 1930s collapse — which was actually two back-to-back recessions — was not the first American depression. Back-to-back recessions in the 1870s (one of which, at more than five years, is still the longest continuous contraction on record) were described as a Great Depression in the years that followed. Economists have a tougher time comparing the depth and severity of earlier economic contractions because they have less data to work with.

While economic data confirm the presence of a Great Moderation, there is less agreement about what brought it about. That makes it more difficult to assess how much risk we now face.

Some economists speculate that with more accurate and timely economic data, central bankers have been able to better manage inflation and interest rates, letting them head off recessions before they get started and curtail them once they do. Others suggest that the dramatic expansion of service industries in the modern economy, together with better inventory controls by manufacturers and retailers, have helped minimize the big inventory buildups that triggered past recessions.

Soss believes the huge expansion of credit throughout the period since the 1930s played a big part in the Great Moderation by smoothing ups and downs in consumer spending.

INTERACTIVE Stimulus plan  Details of the $825 billion stimulus plan proposed by House Democrats working with President Barack Obama.

“You don’t have to wait until after you’ve got a job, and after you’ve got a paycheck, and after you’ve got some savings in order to buy a TV or a car or a house or whatever,” he said. “So you get a smoother flow of saving through the cycle; you get less volatility in economic activity, and your recessions, when they come, are rare and brief and mild.”

The length and severity of the current downturn may be dampened by the government’s massive efforts to fight it, from the $700 billion banking industry bailout to the proposed $825 billion stimulus spending package. But Soss and other economists caution that government intervention — as it was in the 1930s — is a double-edged sword.

“The government experimented so much (in the 1930s) that business sector uncertainty was elevated,” he said. “And that actually inhibited the economy, and I think we have experienced some of that last year.”

That may be one reason banks have been hoarding cash from the bailout, especially if they’re not sure which banks the government will decide are worth saving and which ones it will let fail. The plunge in bank stocks this week has been blamed, in part, on investor uncertainty about whether the government's next move to fix the banking system could involve some form of nationalization that could wipe out private investors' holdings.

More troubling, perhaps, is this recession’s stubborn resistance to the Fed’s multipronged efforts to get the economy moving again. The Fed has let a key short-term interest rate fall to near zero and pumped more than $1 trillion of fresh cash into the global economy through an alphabet soup of programs. But economists say those moves could take six months or longer to have their full impact.

There are signs the government's massive efforts are having an effect. Though banks are still posting huge losses and have slowed lending to a trickle, the broader credit markets are beginning to show signs of thawing. The volume of company-issued debt, for example, recently has begun rising, and the higher interest rates investors had been demanding at the height of the fall panic have begun to ease.

But after flooding the economy with cash, the Fed will face an ever tougher dilemma: How will it drain all that money out of the system before it sparks a new round of inflation, without cutting short any nascent recovery?

“It’s risky, because it’s definitely very inflationary at the end,” said Zarnowitz. “The recent deflation will be replaced by large inflation because there is a tremendous increase in money and credit that is being enacted. So yes, it’s worrisome, but we can’t avoid it. Because without it, we would have a large and continuing recession.”

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