Reconsidering the "2020s as 1940s" Analogy
Trying to figure out why one reflation was also a growth miracle, while the other one was not.
Consider the following capsule history:
Following a period of soaring inequality, trade imbalances, indebtedness, and asset prices, the global economy falls into a crisis.
The initial downturn is painful, but what is particularly surprising to many is the weakness of the subsequent recovery.
Part of this can be explained by the hamfisted response of governments, which squeeze their private sectors with tax increases and spending cuts in misguided attempts to rein in budget deficits.
More generally, the problem is that the outstanding stock of excessive debts—which had been so important in fueling growth before the crisis by financing everything from Florida real estate developments to European public spending—remains high relative to debt-servicing capacity.
A decade-plus after the pre-crisis peak, employment rates remain below where they were before and national income (real and nominal) remains far below where reasonable people had expected—yet many experts now believe this is the best we can do.
Unsurprisingly, prolonged economic weakness proves politically toxic and undermines democratic stability in the U.S. and Europe.
Then, there is a global emergency, and governments in all of the major economies respond with massive amounts of borrowing and spending.
While the new global emergency is profoundly destructive, it also encourages a range of useful innovations. Moreover, the public sector’s response has the unexpected benefit of restoring the private sector to health by driving down joblessness, reflating incomes, and shrinking real debt burdens.
Eventually, the emergency ends, leaving much of the world set to enjoy decades of sustainable rapid increases in living standards.
This is a reasonably good description of ~1921-1950. But points 1-8 also describe the world from ~2002-2020.
History never repeats1, but the parallels between the 1920s-1940s and the 2000s-2020s were intriguing enough to me that I spent a good portion of early 2021 trying to learn more about what happened in the U.S. in the 1940s and what that experience might teach us about the aftermath of the pandemic. (Among other things, I had the chance to dig through the Barron’s archives, which made for fascinating reading.)
Two years ago, I was optimistic that the U.S. was poised for a post-pandemic boom thanks to the combination of hard-won productivity gains, refreshed household and business balance sheets, and the pre-existing legacy of idle workers, plant, and equipment. My reading of the 1940s experience suggested that there would be some temporary price spikes as consumers and producers shifted from “wartime” (hand sanitizer, furniture, and home gyms) to “peacetime” (restaurants, schools, and doctors’ visits), but that most of the extra nominal spending would translate into higher real output. Many others shared some version of this view, which was embedded in the official forecasts of the IMF, the OECD, and the Federal Reserve.
The time scales are not the same, but so far this optimistic scenario has yet to play out. In fact, Fed officials now believe that Americans will be substantially worse off in the years ahead compared to what they had expected on the eve of the pandemic.
I do not have a straightforward answer for why things went awry. But I thought it could be helpful to re-examine the 1940s episode in light of the past two years in search of what might be the most relevant differences.