Great Depression, current crisis not the same, professor says
Is it different this time? That’s the question Dr. Pawan Madhogarhia tried to answer during a recent program at Penn State Fayette, The Eberly Campus.
Madhogarhia, an assistant professor of finance at Penn State Fayette, compared the current financial crisis to the Great Depression in “Is it different this time – 1929 vs. 2008.”
Madhogarhia reviewed some of the similarities between the Great Depression and the financial crisis in 2008, among which the banking system ceased to function, there was a credit crisis and deflation in home prices.
However, among the dissimilarities, Madhogarhia said, were that the financial crisis in 2008 was global; the jobless rate was 9.8 percent in 2008 as opposed to more than 21 percent in 1929; real gross domestic product shrank; the economy was much larger in 2008 and there was a more integrated global economy in 2008 than in 1929.
“We are living in a much more integrated economy today,” he said.
There also was a stronger attitude toward protectionism during the Great Depression and there were what Madhogarhia called “laizze faire” attitudes on the part of the government then due to “incompetent leadership.”
Household debt also was much greater, Madhogarhia said, adding that from 1998 to 2008 it grew in the U.S. from $5 trillion to $15 trillion. “The savings rate was low during this period as well,” he said.
Another factor in the recent crisis was the use of derivatives, a generic term for a variety of financial instruments. According to one definition, unlike instruments such as stocks and bonds, a derivative is usually a contract rather than an asset. The legal terms of a contract are much more varied and flexible than the terms of property ownership.
Offering some statistics on the growth of derivatives, Madhogarhia said that in December 2006, they totaled $418.1 billion. They increased to about $516 billion by June 2007 and by December 2008 reached more than $591 billion.
“Is this an indication of worse things to come?” Madhogarhia said.
“What lies ahead? We will see a flat economy for some time before it starts to grow. There will be slower credit growth and lower consumption,” he predicted.
Madhogarhia added other things that could slow the economy would be higher government debt, higher taxes, protectionism, higher unemployment, a global recession, lower productivity due to an aging population and slower innovations and capital expenditures.
“These are all ifs and buts,” he said.
Citing Kenneth Rogoff, currently the Thomas D. Cabot Professor of Public Policy and professor of economics at Harvard University, Madhogarhia said the next five to seven years “you won’t see a boom like the years before the crisis.
“If the economy went down very fast, it should come up very fast. Some markets have grown. Some monetary policies the government has employed have been effective. Some people think there is a lot of pent up demand. But are we looking at a new normal for economic growth?” he said.
Prior to the current fiscal crisis, Madhogarhia said annual growth in the U.S. averaged about 3 percent. A new normal might be 2.5 percent, according to the U.S. Congressional Budget Office, he said.
“Maybe for a time we will pick up but then flatten. There will be slow economic growth,” he said.
“The economy will settle into that new trend,” of annual growth at about 2.5 percent.
Madhogarhia predicted there will be gains in heath care and technology.
But public policy measures he thinks will help the economy include stabilizing the housing market, timely withdrawal of the stimulus program and investing in projects to stimulate economic wealth.
“Policy needs to give the economy the inflation expectations it needs. If the stimulus is withdrawn too early because of a fear of inflation, that could lead to grinding inflation.
“A little bit of inflation is desirable, a good thing, maybe 2 to 3 percent,” he said.
Madhogarhia feels the government needs to monitor credit growth and areas of the economy that may appear to be growing too quickly.