Boom & Bust cycles, the New Deal
and the crisis of 2008
A depression is the low part of the business cycle, or the opposite of prosperity. The business cycle refers to the waves of good and bad times (Boom & Bust) that had plagued industrial economics throughout the 19th century and part of the 20th century.
For many people depressions meant walking the streets looking for work, to others it meant business failure or the loss of banks savings in bank failures. When consumers stopped spending money to buy goods and businesses stopped investing, then money stopped circulating and the nation entered economic paralysis.
The most famous remedy to overcome such economic paralysis was proposed by the English economist John Maynard Keynes.
Keynes maintained that government must not be run like a business, because the rational thing for business to do in the midst of an economic downturn is to cut costs, but this is the worst thing to do from the point of view of the economy as whole as it further reduces spending, resulting in a further spiral into decline.
Instead Keynes proposed increased government spending for such things as relief payments and public works projects during a depression to get the economy rolling again. After that deficit spending should then be stopped.
The Roosevelt administration acted on this idea in an attempt to lift the United States out of the Great Depression of the 1930's.
Roosevelt's 'New Deal' introduced certain features which automatically produced government
deficits during a depression. The social security system, including unemployment insurance, and the income-tax system both are set up so that government revenues fall off while government expenditures increase as a depression gets under way. These were called
Keynsian economists felt that in order to avoid serious depressions we must avoid extremes in the economic system during the prosperity periods. This means that the quantity of check money should not be permitted to increase in a runaway fashion during prosperity, and that the price-fixing activities of monopoly groups should be curbed to avoid upsetting the relationships among the prices for different types of goods.
This economic model helped to level valleys and peaks of business cycles for over sixty years. During those years cyclical depressions were much less extreme and were therefore called recessions.
However, in the 1980's a renewed scepticism of large-scale government intervention led once more to far reaching deregulations. Like in the 1920's the slogan became again : 'Government is dumb, markets are smart'.
Keynsian concepts got rejected, his warning about runaway money supply got dismissed and unregulated credit availabilties induced many people to get into unsustainable debts.
The crisis of 2008
Many banks, freed from the strict regulations of earlier times, offered loans and mortgages to people who could not afford repayements during an economic downturn. Unpayable loans became bad assets for banks and when such bad assets accumulated rapidily many banks were unable to offer any credit which led to a credit freeze in the fall of 2008 and severe economic difficulties. (California, for instance, warned of a looming state bankruptcy within a month, which would have meant state employes could not be paid their salaries)
Since most of the world had adopted the American economic model the financial melt-down of assets-poor banks led in October 2008 to a repeat of a depression-type financial panic. Suddenly economists of all stripes reputiated the economic philosophy of the last 25 years calling for a return to large government intervention and much tougher regulations.
In 1929 the US government had not reacted for three years. In 2008 governments acted more quickly with large financial government cash infusions to failing banks in order to make credit available to both the public and businesses. But the enormous accumulated government and privat debts since the 1980's made a repeat of a New Deal program more difficult and the outcome has so far been uncertain.
Ironically, many economists who heralded the deregulation period of 1982-2008 have now become gloomy forcaster of a long-lasting shrinking economy.