What Could Have Been

A recent report shows how government intervention helped avert 'Great Depression 2.0.'

October 10, 2010

Has government action hurt or helped the economic recovery?

With fast-approaching elections, critiques of the government’s response to the financial crisis are increasingly critical. These critiques are likely to shape election outcomes and will greatly influence future policy responses, the economic environment, and credit union operations.

Difficulties abroad (especially the European sovereign debt crisis) and challenges at home (a sputtering economic recovery) have cemented the view, for some, that the policy response to the Great Recession was a big mistake. Critics view the response as ineffective, misguided, or both. Extremely weak labor market growth makes it easier for detractors to argue that policy makers bailed out Wall Street and essentially ignored Main Street.

Another view considers how close to complete economic meltdown we were as the crisis grew. In a recent report, “How the Great Recession Was Brought to an End,” economists Alan Blinder of Princeton University (and a former Federal Reserve vice chairman) and Mark Zandi, of Moody’s Analytics, attempt to measure what “could have been.”

Blinder and Zandi find that the aggressive, bipartisan response to the financial crisis probably prevented a depression by significantly slowing the decline in gross domestic product (GDP), saving about 8.5 million jobs, and preventing the devastating effects of a deflationary spiral.

Policies including the government fiscal stimulus, bailouts of financial companies, bank stress tests, and the Fed’s purchase of mortgage-backed securities to lower interest rates probably averted “Great Depression 2.0,” Blinder and Zandi note.

Their analysis shows if the Bush and Obama administrations hadn’t acted, GDP would have been -7.4% in 2009 and -3.7% this year. Instead, the 2009 contraction was only -2.4%, and they suggest GDP will grow 2.9% in 2010.

The unemployment rate, they reckon, would have averaged 11.2% in 2009, 15.2% this year, and 16.3% in 2011, without the aggressive government response. Instead, the annual averages will remain below 10% in each of those years. Their modeling suggests that lacking government intervention, by the time employment hit bottom, 16.6 million U.S. jobs would have been lost—about twice as many as actually were lost.

The much-maligned $700 billion Troubled Asset Relief Program (TARP) played a significant role in preventing a collapse of the U.S. financial system, they add. In addition to restoring stability to the financial system, TARP helped end the free fall in the auto and housing sectors. Blinder and Zandi estimate the cost to taxpayers will be a small fraction of the amount initially granted by Congress (probably less than $100 billion), with the bank-bailout portion of TARP likely to turn a profit.

The government’s equity investments in large banks were necessary to end panic and the recession, they add. And the Fed’s stress tests on big banks essentially ended the financial panic.

Collectively, the cost of these programs has been high. Government debt as a percentage of GDP is near modern-day highs, an issue that must be resolved. But attempts to solve that problem (either through higher tax rates or lower government spending) would be ill-advised at this point.

In fact, with the economy still weak, more government support might be needed. To keep the recovery on track, the Obama administration will attempt to extend former President Bush’s tax cuts for families making as much as $250,000 a year, while phasing in increases for those earning more.

Blinder and Zandi paint a grim but largely accurate picture of what could have happened without the substantial policy response during the crisis. But serious risks remain.

While depression has been averted, voters—many of whom continue to hunt for jobs—will play a big role in future policy response (or nonresponse). A vote for decreased government spending at this critical time could weaken the recovery. And it could slow the recent improvement of credit union operating results.

MIKE SCHENK is vice president, economics and statistics, for the Credit Union National Association. Contact him at 608-231-4228.