The Verdict Is In: Recovery from Economic Crises is Greatly Improved by Informed Monetary and Fiscal Policies


Contrary to Some Popular Views, the U.S. Learned from the Great Depression; Novel Policy Approaches Reduced Impact of Great Recession and Produced Speedier Recovery, say Norton Reamer and Jesse Downing, authors of a New Book, Investment: A History

BOSTON (February 2, 2016) – The actions taken by the U.S. Federal Reserve (the Fed) and U.S. Department of the Treasury following the 2007-2008 U.S. stock market crash were, in the end, a brilliant response to a truly frightening financial crisis and incipient major economic collapse. The economic impact of the crisis, while severe, was clearly contained. America experienced the gravest economic setback in 80 years, but one whose duration and magnitude fell far short of the country’s experience in the 1930s.

“I don’t think any other country can claim as brilliant a use of the economic toolkit as what was brought to bear in the United States,” says Norton Reamer, co-author of Investment: A History (Columbia Business School Publishing, February 2016). Reamer is also the founder and long-time CEO of United Asset Management, and former CEO of Putnam Investments. His co-author, Jesse Downing, is an investment professional in Boston.

“The historical record clearly shows the superiority of the response to the Great Recession versus the Great Depression,” says Reamer. “And every day now, one can look at the world around us and see the efficacy of what we have endorsed in the book: a novel and successful response by U.S. policymakers, which can easily be contrasted with less successful methods employed by other governments, particularly in Europe.”

ACTIVIST APPROACH PREVAILED – HELPING U.S. WEATHER THE STORM

Reamer and Downing express disappointment that a significant percentage of Americans seem to have drawn incorrect conclusions about the crisis of 2008, both the efficacy and intended purpose of America’s response. They argue that the successful U.S. response validated the role of activist monetary and fiscal policy in the face of severe economic crises. Moreover, they believe that the primary focus of activist policies undertaken by the Fed, and both the Bush and Obama Administrations, was democratic in nature: focused on stabilizing employment, consumption levels and broad economic performance, and benefiting the broadest possible segment of the population.

“While some of the ‘bailouts’ did help large financial institutions, the primary focus of government’s Olympian efforts was not on saving bankers, CEOs, and tycoons,” says Downing. “We believe that America was witnessing ‘democratization’ at work. Government leaders took an active hands-on approach to making sure that middle-class and working-class Americans were not devastated by unemployment the way they were in the Great Depression. Their activist approach and laudable results stand in stark contrast to the approach advocated by many free-market thinkers, who believe that a hands-off approach by government is the optimal response to cyclical economic crises.”

DEPRESSION V. RECESSION: NEW POLICY TOOLS PRODUCE BETTER RESULTS

Reamer and Downing dedicate a chapter in their book, Investment: A History, to two cataclysmic economic events: the Great Depression and the Great Recession. In contrasting the policy responses to these two crises, they illustrate important progress in economic theory and increased effectiveness of remedial measures. Policymakers today better understand the importance of staving off deflation and drops in aggregate demand and supply, and activist monetary and fiscal policies help democratize the national response to crises.

“Looking at these two crises side by side reveals that the U.S. has become more proactive and more effective in addressing cyclical economic problems,” says Reamer. “Government has also brought a more broadly democratic focus to national economic policy.”

Reamer argues that analysis of these two crises reveals the critical role played by radical, innovative central bankers – Benjamin Strong (in the lead-up to the Great Depression) and Ben Bernanke (in managing the fallout of the Great Recession). He says that both central bankers took calculated but bold steps to maintain order in the economy and the market, and in doing so, often took no shortage of political heat. Sadly, Strong did not live to see the critical moments of the earlier crisis and his skills were not available after 1928.

“Some people rail against what the Fed did during and after 2008, but U.S. economic management was based on decades and decades of understanding how economics works,” says Reamer. “Their detractors claimed at best that their policies would not succeed and at worst that they would wreak irreparable havoc upon the financial system. As history is likely to see it, these detractors were shortsighted in their criticisms.”

WHY IT MATTERS: WE ARE ALL CONNECTED AND AT RISK FROM FUTURE FINANCIAL METLDOWNS

Today, due to financial innovation, virtually all parts of the real economy are dependent to some degree upon the financial markets. As a result, risk is socialized and spread from the balance sheets of a few to the balance sheets of many, according to Reamer and Downing.

“Socializing risk through financial markets has created a common source of risk for many more economic agents than would otherwise be involved,” says Downing. “This is perfectly fine as long as the potential risk is properly understood beforehand. But if the nature of the risk is not correctly understood, many economic agents can become distressed all at once, because they are all exposed to this common source of risk.” At the same time, Reamer and Downing argue that human behavior has not changed, and is not likely to change. They say that policymakers today have shifted their focus toward employment and consumption management, and are disinclined to accept dramatic dislocation as a natural and healthy purging of economic excess. Yet there is little evidence of public restraint or caution once confidence in economic success has built up in the system: i.e., future meltdowns are still highly probable.

“Once an economic cycle has delivered notable financial rewards to the business community and the general population, we still see excessive confidence, excessive greed, excessive speculation and excessive carelessness by many market participants,” says Reamer. “This human frailty doesn’t ever seem to change, and the tendency for the system to become more permissive during periods of prosperity has not changed either. This proclivity shows in both legislation and regulation, as rules are often pared back once a boom is underway.

“In the end, thanks to the use of modern fiscal and monetary tools, the Great Recession was quite different from the Great Depression,” says Reamer. “The fiscal stimulus may have been a little too small, too short lived and too oriented towards tax cuts. But it still helped, and the monetary response was robust enough to aid the economy in moving out of the recession. We learned many important lessons from the Great Depression, which helped us through the recent crisis. From the Great Recession we learned that informed activist efforts work, and often we are not hampered by the modest use of fiscal tools as much as a lack of political will, which can stand in the way of a faster and more robust recovery.”

To arrange a conversation with Mr. Reamer and Mr. Downing, please contact Eric Mosher at Sommerfield Communications, Inc., at eric@sommerfield.com or 212-255-8386.