Is our policymakers learning?

In his Newsweek column, Fareed Zakaria proposes eliminating the Depression analogy to describe our current situation: 

Over the last six months, the doomsday industry has moved into high gear. Economists and business pundits are competing with each other to describe the next Great Depression. Except that the world we live in bears little resemblance to the 1930s. There is much greater and more widespread wealth in Western societies, with middle classes that can withstand job losses in ways that they could not in the 1930s. Bear in mind, unemployment in the non-farm sector in America rose to 37 percent in the 1930s. Unemployment in the United States today is 8.9 percent. And government benefits—nonexistent in the ’30s—play a vast role in cushioning the blow from an economic slowdown.

The biggest difference between the 1930s and today, however, lies in the human response. Governments across the world have reacted with amazing speed and scale, lowering interest rates, recapitalizing banks and budgeting for large government expenditures. In total, all the various fiscal–stimulus packages amount to something in the range of $2 trillion. Central banks—mainly the Federal Reserve—have pumped in much larger amounts of cash into the economy. While we debate the intricacies of each and every move—is the TALF well -structured?—the basic reality is that governments have thrown everything but the kitchen sink at this problem and, taking into account the inevitable time lag, their actions are already taking effect. That does not mean a painless recovery or a return to robust growth. But it does mean that we should retire the analogies to the Great Depression, when policymakers—especially central banks—did everything wrong.

I really, really want Zakaria to be correct here.  And I’m not covinced that he’s necessarily wrong — these are probabilistic calls.  That said, there are a few things that worry me about his logic.

The big question is whether and how much learning has actually taken place in the world.  Zakaria asserts that policymakers have learned their lessons from the Great Depression and won’t do the things that are so stupid that they exacerbate a serious downturn into something worse. 

Well… maybe.  This proposition makes three pretty big assumptions.  The first is that the measures that have been thrown at the downturn to date actually help to arrest the fall and spur growth.  One certainly hopes that this is correct, but given the current state of the financial sector, that’s far from a forgone conclusion. 

Second, it presumes that central bankers will be able to know roughly when it is time to clamp down on easy credit without triggering either double-digit inflation or a a double-dip depression.  Here I am much less sanguine.  This is no slight against Ben Bernanke, Jean-Claude Trichet, or Zhou Xiaochuan, all of whom are Way Smarter Than I Am.  It’s just that no central banker has really mastered this kind of maneuver. 

Third, the mistakes of the past are not the only kind that worry me.  Never underestimate the ability of policymakers to devise completely new and novel ways of screwing things up. 

One final note.  Zakaria commits a sin I’ve seen a lot recently, which is to compare the state of the U.S. economy during the absolute depths of the Depression with its current state.  If you do this, then Zakaria’s right — we’re nowhere near as bad off as we were then.  But I’m not sure this is the fair comparison.  If you compare how the U.S. looks at the beginning of the great depression with how we’re doing now, the comparison looks more apt.  And if we head into double-dip territory, then we’re looking at several years of low to negative growth. 

If we have multiple years of flat or negative growth, then I truly do think all bets are off.  The more desperate the situation looks, the more likely policymakers will revisit ideas that might seem stupid now — rank protectionism, beggar-thy-neighbor inflation — but won’t seem so stupid in the future.