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Wednesday, March 04, 2009

Barro: What are the Odds of a Depression?

Robert Barro's world is pretty scary. He believes there's a non-trivial (20%) chance that a depression is ahead, and that none of the "policies already in place and those likely forthcoming will be helpful" in preventing it:

What Are the Odds of a Depression?, by Robert Barro, Commentary, WSJ: Central questions these days are how severe will the U.S. economic downturn be and how long will it last? ... Could we even experience a depression (defined as a decline in per-person GDP or consumption by 10% or more)?

The U.S. macroeconomy has been so tame for so long that it's impossible to get an accurate reading about depression odds just from the U.S. data. My approach uses long-term data for many countries and takes into account the historical linkages between depressions and stock-market crashes. ...

The bottom line is that there is ample reason to worry about slipping into a depression. ... Periods without stock-market crashes are very safe, in the sense that depressions are extremely unlikely. However, periods experiencing stock-market crashes, such as 2008-09 in the U.S., represent a serious threat. The odds are roughly one-in-five that the current recession will snowball into the macroeconomic decline of 10% or more that is the hallmark of a depression.

The bright side of a 20% depression probability is the 80% chance of avoiding a depression. ... In this relatively favorable scenario, we may follow the path recently sketched by Federal Reserve Chairman Ben Bernanke, with the economy recovering by 2010. On the other hand, the 59 nonwar depressions in our sample have an average duration of nearly four years, which, if we have one here, means that it is likely recovery would not be substantial until 2012.

Given our situation, it is right that radical government policies should be considered if they promise to lower the probability and likely size of a depression. However, many governmental actions -- including several pursued by Franklin Roosevelt during the Great Depression -- can make things worse.

I wish I could be confident that the array of U.S. policies already in place and those likely forthcoming will be helpful. But I think it more likely that the economy will eventually recover despite these policies, rather than because of them.

    Posted by on Wednesday, March 4, 2009 at 12:24 AM in Economics | Permalink  TrackBack (0)  Comments (40)


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