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Lessons from the Great Depression
 
 PUBLISHER                  Allan Von Mehren, Cheif Analyst    PUBLISHED       23/02/09
 
 CONTACT DETAILS      +45 33 44 80 55 alvo@danskebank.dk
 
 VIEW PAPER                Click here
 
Overview  
This fantastic twelve page research looks at the Great Depression in the 30's and the similarities with the current financial crisis.
 
It also explains why these economic shocks are going to be different this time round and what to expect as a government response.
 
  • Gain insight into the causal factors for recessions
  • Look at the key lessons understood by governments. Are we better off?
  • How are monetary and fiscal policies featured in the recovery strategy?
  • Full dialogue on the economic indicators with outstanding charts

 

<Read The Paper Here>

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Lessons

There are several lessons outlined in the paper and in relative depth.  These have been summarised below:

Lesson 1 – Strong policy response

One of the key lessons from the Depression is that a financial crisis cannot be left alone. It has to be fought with all possible measures in order to stop a negative spiral of rising bankruptcies and foreclosures, bigger losses in the banking system.

 

Lesson 2 - Deflation must be avoided

The higher the leverage the larger the negative of deflation, as it leads to a strong rise in real debt. As incomes fall the debt to income level rises and debt service costs as a share of income also goes up. In order to avoid a deflation trap, monetary policy must be eased to ensure that money growth is high enough for prices to keep rising, and for inflation expectations to stay in positive territory.

 

Lesson 3 – Deleveraging process is long & painful

A long period of high credit growth leaves over-leverage and a lot of excess in the financial system. The experience of the 1930s shows that deleveraging following a credit boom can be long and very painful. The deleveraging process today is likely to be extended for a long time and it is important to continue to take measures to smooth this transition period.

 

Lesson 4 - Deposit insurance

A key reason for the wide extent of bank runs during the Depression was probably the lack of deposit insurance. Today, deposit insurance is in place and the amount insured by the state has been increased to avoid runs on the banks.

 

Lesson 5 - Countries leaving the Gold Standard first were also the first to escape the Depression

The countries leaving the Gold Standard first were able to ease monetary policy and devalue their currencies.

 

This helpd them fight deflation and get out of the depression.   This gives extra credence to the argument that easing monetary policy is important to avoid delfation and support demand. 

 

Lesson 6 - Protectionism adds to the downturn

The Depression is a lear example of how protectionism can make bad things worse as countries try to protect their home markets at the expense of other countries.  However, while protectionism was probably not a dominant factor it seems inevitable that it contributed to the downturn.