Making It Multiple Choice

One of the great mistakes of America’s war in Vietnam was to allow a bad analogy to drive policy-makers’ thinking about what was at stake. Although it scarcely seems possible in retrospect, in the 1960s you heard over and over again that the war there was designed to prevent “another Munich.”

American opposition to the various Vietnamese insurgent factions, most of whom were avowed communists, and to their great power backers, the Soviet Union and China, was said to be the equivalent of what could have been achieved if only the British and their allies had stood their ground in 1938, when Hitler demanded sovereignty over the German-speaking regions of Czechoslovakia. What a lot of bunk!

It is may be that all the talk since 2008 of the specter of a second Great Depression may have been a similar blunder.

That’s the possibility hinted at last week by Barry Eichengreen, of the University of California at Berkeley, in a provocative presidential address to the Economic History Association meeting in Boston – the possibility “that the comparison between the events of 2008-09 and the Great Depression was exaggerated, leading policymakers to overreact.”

I say hinted because, under the circumstances, his message was a matter of some delicacy. Introducing Eichengreen was his friend and Berkeley colleague, the ebullient Christina Romer. The former chair of the Council of Economic Advisers, Romer noted that, at one point in her recent service, she had asked President Obama himself why he had chosen her. “Because you’re an expert on the Great Depression,” the president replied.

In the weeks after Lehman Brothers failed, in September 2008, the Great Depression quickly became the standard analogy for interpreting events, Eichengreen noted, citing quantitative evidence from Google Trends. Saltwater and freshwater theorists vied to explain the crisis, working top-down from their models. It is no surprise, they quickly disagreed. At that point, said Eichengreen, the argument from history took over.

“In the absence of a theoretical consensus, the analogy with the Great Depression moved policymakers toward a shared understanding of the problem. It offered a guide to action…. It provided a ready diagnosis and an implied set of do’s and don’ts.”

Sure enough, after the November election, Obama chose Lawrence Summers, of Harvard University, and Romer as his principal economic advisers, and within a short period of time the Administration’s policy became the standard Keynesian response to a rapid decline in spending: chiefly a massive federal spending plan in the name of stimulus

Eichengreen, himself an expert on the sources of the Depression (Golden Fetters: The Gold Standard and the Great Depression), contributed to creating this shared framework in the wake of the crisis. A Tale of Two Depressions, with Kevin O’Rourke, of Trinity College Dublin, a short commentary designed to highlight similar collapses of global industrial production after June 1929 and April 2008, shattered records for page-views on the influential VoxEU site when it appeared in April 2009. (Two subsequent updates backed off the initial strong language).

There were, in fact, other historical episodes that might have illuminated policy choices differently, Eichengreen noted. The Panic of 1907 was one, he said. The Crisis of 1873 was another. In the first, “J.P. Morgan organized a lifeboat operation that resembled in important respects the 2008 rescue of Bear Stearns by none other than J.P. Morgan & Co.” In the second, “an investment boom and bust like that of the period leading up to 2007” gave way to an unusually long slump.

But then neither event connected to the present crisis in nearly as many ways as did the narrative of the 1930s. That story had everything: an asset bubble, a banking crisis, currency problems, a breakdown of world trade, stubborn unemployment, arguments over deficits and monetary policy. And so the Great Depression became the crisis analogy of choice. Besides, said Eichengreen, cognitive scientists had identified other reasons why events less remote in time might have been preferred.

There is, however, another possibility. It is that the historians were as confused as everybody else in the crisis, and didn’t bring their best work to the debate. Eichengreen described his own efforts to keep track: “Like many people, I spent an inordinate amount of time in 2008 and 2009 scanning the press and the Internet in a desperate effort to make sense of a news flow full of economic and financial events the like of which I had never seen, and attempting to assemble them into a coherent whole.”

It is true that there was not much lucid talk about alternative experiences that might have suggested different policy responses, but there was some. Eichengreen cited a pair of University of Virginia researchers, Robert Bruner (dean of the Darden Graduate Svchool of Business Administration) and Sean Carr, who presciently published The Panic of 1907 in 2007, but who otherwise were scarcely heard from again on the topic, at least in policy realms. He mentioned the efforts of a pair of historians, Ellis Tallman, of Oberlin College, and Eltus Wicker, of Indiana University, who produced Banking and Financial Crises in United States History: What Guidance Can History Offer Policymakers? for the Federal Reserve Bank of Cleveland.

But he overlooked the paper on banking panics and the then-threatening situation by Gary Gorton, of Yale University, given to the meeting of central bankers at Jackson Hole in August 2008, and later published as Slapped by the Invisible Hand. However much this bank-run view has gained currency among market participants – see, for example, George Soros’ analysis last week in the New York Review of Books, Does the Euro Have a Future? – there is no evidence that it played much of a part in the counsels of the Obama administration.

All of which suggests an intriguing possibility – a counterfactual, as the historians say. What if, after he was elected, instead of hiring Summers, who had become the Clintons’ principle economic adviser, Obama had reached across and hired the prominent macroeconomist who was perhaps the brightest button on Sen. John McCain’s campaign sleeve? That would be Kenneth Rogoff, of Harvard University, whose stature has risen more rapidly since then than any other economist in the world. Rogoff cannot say he saw the panic coming, I think. But when it came, he and his research partner, Carmen Reinhart, of the Peterson Institute for Internhational Economics. grasped its significance quickly and argued that the slump (they called it a “contraction”) would be prolonged. Reinhart and Rogoff’s book, This Time Is Different: Eight Centuries of Financial Folly, was a regular catalogue of different historical analogies to be tried on for size..

Thus Eichengreen has done the world a favor by challenging his fellow historians in particular – and economists in general – to a wave of self- examination. Was the comparison with the Great Depression exaggerated? Why the paucity of alternative templates with which to reason? Why does economic history get such short shrift from the profession – in undergraduate and graduate education, in policymaking and public debate? What are the chances that the relationship will shift a little, in the historians’ favor, now that the importance of their craft has been demonstrated by the way it which the argument from history trumped theory?

At one point in his lecture, Eichengreen put it like this: “Like many members of this audience, I suspect – I have had colleagues tell me how lucky I am to be teaching history, since this relieves me of having to revise my lectures in light of events.

“We always knew better. Now maybe they do as well.”

3 responses to “Making It Multiple Choice”

  1. This column is fundamentally misleading. Obama’s Keynesians thought this contraction was far less severe than the Great Depression.

    But Rogoff was ahead of most economists in identifying the similarities between the Great Depression and this contraction. Indeed, that this argument was persuasive goes a long way to explaining Rogoff’s increased visibility.

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