Barro Estimates 20% Chance of Depression

Robert Barro is a Harvard economist who specializes in issues of macroeconomics and economic growth.

(p. A15) 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 research is described in “Stock-Market Crashes and Depressions,” a working paper Jose Ursua and I wrote for the National Bureau of Economic Research last month.)

The bottom line is that there is ample reason to worry about slipping into a depression. There is a roughly one-in-five chance that U.S. GDP and consumption will fall by 10% or more, something not seen since the early 1930s.
. . .
In the end, we learned two things. 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. The U.S. had stock-market crashes in 2000-02 (by 42%) and 1973-74 (49%) and, in each case, experienced only mild recessions. Hence, if we are lucky, the current downturn will also be moderate, though likely worse than the other U.S. post-World War II recessions, including 1982.
. . .
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.

For the full commentary, see:
ROBERT J. BARRO. “What Are the Odds of a Depression?” Wall Street Journal (Weds., MARCH 4, 2009): A15.
(Note: ellipses added.)

Barro’s co-authored textbook on economic growth is:
Barro, Robert J., and Xavier Sala-i-Martin. Economic Growth. 2nd ed: The MIT Press, 2003.

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