U.S. Economy

The Neglected Lessons of a Lost Decade

In some ways, the financial crisis was worse than the Great Depression.

An early casualty.

Photographer: Chris Hondros/Getty Images

Ten years on, it's possible to say that -- in some ways -- the financial crisis of 2007 to 2009 did more economic damage than the Great Depression of the 1930s. Yet the response of our elected officials still leaves much to be desired.

Consider a few data points:

  • As of mid-2017, U.S. economic output per person was up just 6 percent from 2007, in inflation-adjusted terms. In a typical decade, per-capita output increases by about 20 percent. 1
  • As of 2015 (the most recent data available), the inflation-adjusted income of the median U.S. household had declined 2 percent from 2007. Black households fared even worse, suffering a decline of about 5 percent. 2
  • Even the rich didn’t fare as well as many people think. As of 2015, the income threshold for the top 1 percent was more than 15 percent lower than in 2007, adjusted for inflation. 3

At first glance, this doesn't seem quite as bad as the Great Depression, which economists have traditionally viewed as the worst episode in U.S. history. From 1929 to 1939, real output per capita increased 3 percent, slightly less than the 6 percent we’ve seen in the past decade. 4

But 1939 was different in one crucial way: Back then, with the unemployment rate at about 10 percent, the Federal Reserve recognized that the economy was operating well below potential and hence still had a lot of room to grow. Now, by contrast, Fed officials worry that, with unemployment close to 4 percent, the economy may have already reached or exceeded its potential -- meaning they view the damage done by the crisis as being permanent.

What should this experience teach us about economic policy? It suggests that financial crises and the responses to them can have highly persistent adverse effects on economic potential. The risk of such large costs means that policy makers must have better safeguards in place, and be willing to respond vigorously through monetary and fiscal stimulus when crises nonetheless happen.

So what's happening along these lines? The Trump administration’s nominee to be vice chair of supervision and regulation at the Federal Reserve wants to make the big banks’ stress tests less stringent -- and that’ll make a financial crisis more, not less, likely. In a speech last summer, Fed chair Janet Yellen suggested that the Fed’s planned response to a recession would lead to elevated unemployment for many years. 

In short, I see little evidence that policymakers have learned the lessons of the last decade. I hope that situation will change before another crisis occurs.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

  1. Federal Reserve Bank of St. Louis: https://fred.stlouisfed.org/series/A939RX0Q048SBEA.

  2. Table H-5, https://www.census.gov/data/tables/time-series/demo/income-poverty/historical-income-households.html.

  3. The top 1 percent is in terms of taxpayer units.  The source is Table A-5 of the Piketty-Saez income inequality tables, available here: https://eml.berkeley.edu/~saez/.

  4. It is worth keeping in mind, though, that per-capita real GDP was more than five times higher in 2007 than in 1929.  Slow growth in the 1920s cut much closer to the bone than in the 2010s.

To contact the author of this story:
Narayana Kocherlakota at nkocherlako1@bloomberg.net

To contact the editor responsible for this story:
Mark Whitehouse at mwhitehouse1@bloomberg.net

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