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Robb: Economic crisis is no Great Depression

Paul Volcker (left) will be a key economic adviser to President-elect Obama. In the 1980s, Volcker, then chairman of the Federal Reserve Board, led the U.S. into a period of prosperity: His raising of interest rates and reining in of inflation has been called "the single most beneficial act of economic policy in the past half century."

Paul Volcker (left) will be a key economic adviser to President-elect Obama. In the 1980s, Volcker, then chairman of the Federal Reserve Board, led the U.S. into a period of prosperity: His raising of interest rates and reining in of inflation has been called "the single most beneficial act of economic policy in the past half century."

During this economic malaise, references to the Great Depression have become ubiquitous.

It is commonly stated that these are the worst economic times since the Great Depression. The 1930s are plumbed about what happened and how to prevent it.

This has always struck me as misplaced. The things that caused the Great Depression – a contracting money supply, tax increases and protectionist tariffs – aren’t present in the current downturn, at least not yet.

Unemployment hit 25 percent in the 1930s and never really got below 10 percent. Unemployment is rising today, but has a long way to go to reach the level or chronicity of the Great Depression.

Moreover, there was an intervening economic event that is usually overlooked. Economic journalist Robert Samuelson does a good job of chronicling it and giving it a name in his recent book, “The Great Inflation.”

Samuelson dates the Great Inflation as the period from the late 1960s to the early 1980s. During that period, inflation climbed from low single-digits to more than 13 percent.

In the 14 years from 1968 through 1982, the economy experienced four recessions. During that 168-month span, the economy was contracting for 49 months – or for more than four years.

In the 300 months of the next 25 years, the economy would be in recession for only 16 months.

Samuelson, in his other writings and public comments, seems to be willing to cut current policymakers some slack in their response to the current economic downturn, since it finds its roots partly in the financial system. The need for government to keep the financial system operating is one of the lessons of the Great Depression.

I, however, find the response to the current economic downturn to have worrisome parallels with the Great Inflation and fear that policymakers are ignoring some of the lessons learned in its taming.

Samuelson attributes the Great Inflation to the conceit by policymakers that they could manage the business cycle through fiscal and particularly monetary policy.

There was a belief that there is a tradeoff between unemployment and inflation. If unemployment was rising to troublesome levels, a little monetary expansion would cure it.

However, that tradeoff proved illusory. Inflation injects uncertainty and uncertainty dampens economic activity, including employment.

Moreover, the monetary tools available were too imprecise to fine-tune business cycles in that way. And once monetary policy was to be deployed for something other than price stability, the political pressure to keep the spigots open was difficult to resist.

The Great Inflation was brought to an end by shock therapy delivered by then Fed Chairman Paul Volcker, with indispensible political backing by Ronald Reagan.

Volcker hiked interest rates and put the brakes on monetary expansion. The country experienced a severe recession, with unemployment reaching nearly 11 percent. But, by 1984, Reagan could run for re-election on the theme that it was morning again in America.

Samuelson calls the Volcker-Reagan fortitude “the single most beneficial act of economic policy in the past half century.”

Today, the country is undergoing two major corrections, from an overinvestment in housing and from overborrowing in general.

The interventions that are occurring go well beyond stopping runs on the banks and keeping the financial system operating.

Current Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson are clearly also trying to manage the corrections – to keep lending rates below what they otherwise would be and stop housing prices from falling as low as they otherwise would.

This may seem to be a strange time to be worrying about inflation. But the Fed is pursuing an extraordinarily expansive monetary policy whose effects cannot be forever masked or contained.

The notion that the Fed can precisely time its unwinding to match economic recovery defies the historical record.

The lessons of the Great Inflation are that the government cannot manage the business cycle and sometimes big corrections need to run their course.

Those are lessons that, if applicable to today’s circumstances, are certainly being ignored.

Robert Robb, an Arizona Republic columnist, writes about public policy and politics in Arizona. E-mail: robert.robb@arizonarepublic.com

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