Monday, September 22, 2008

1929 vs 2007

People are comparing the ongoing financial crisis in USA with the international crisis of 1929. In 1929 and the following years there was a sharp increase in unemployment in the USA and other countries at the same time economies were strongly contracting. In 2008, one year after the begining of the present crisis, unemployment is not increasing sharply in the USA and the contraction levels of economies in Europe are yet just as normal as the contractions in every other cyclical downturn. More importantly, three weeks ago, OECD presented growth forecasts for the US economy for this year and they were actually far from being bad: 1.8%. One year after the begining of the crisis, the country where the crisis originated is actually growing!

Maybe in the two or three next years the real economy will suffer a bigger impact from the present problems of the US financial system. But for now, USA is still growing. Many big European economies are about to have zero or slightly negative growth, but that's just normal along any business cycle.

Thus, at least for now, the 2007 crisis is very, very far away from the economic disaster of 1929-33. And as time is passing and new shocks hit the US financial system, actually a cold perspective on the facts shows that the US economy is reacting very well. Measures taken by the Fed and the US Secretary of the Treasury are undoubtedly of a nature of urgency and a little despair but the main fact is that the forecasts for the economy show an expansionary scenario.

Now, in macroeconomics, phenomena of self-fulfilling expectations are actually common. A self-fulfilling expectations phenomenon is some scenario that comes true mainly because people were expecting that to happen. Say, if people, for some unreasonable motive, belive there will be a systematic banking crisis, they might withdraw all their money from all banks. But by doing so, a crisis will actually take place - even if there was no good motive in first place for people having the expectation of a systematic crisis.

In the case of the present crisis, exaggerated beliefs about how bad the scenario is might lead to the worsening of that scenario. Thus, the somewhat desperate measures of the Fed/Treasury, eventhough might be seem unrecomendable, are positive and may be necessary in so far as they transmit confidence to the private sector and help dissolve any negative beliefs that might be too negative.

Assessing the quality and need of the short-term actions of the Fed/Treasury must also take into account their effects on keeping expectations at a healthy level. This is as much important as assessing them from the points of view of efficiency and justice. Finally, in the aftermath of the crisis, it will also be very important to clarify how exceptional those measures were - otherwise some undesirable precedents might inform the process of building expectations in the future.


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