The Great Depression was a classic downturn reminiscent of the depressions seen in the 19th Century, which caused a great deal of concern for economists like John Maynard Keynes.

Nevertheless, there are important differences. We don’t have the massive and soul-destroying 20%+ unemployment seen during that era. There were no automatic stabilizers built into the economy. The effects of the Great Depression were exacerbated by problematic policy response. Today we have many policy tools available to avoid a repeat of the Great Depression.


Fiscal and monetary policy saves the day?
In short, there is no exact historical parallel to today. The current downturn has two unique characteristics: a high degree of financial stress and global reach. The closest might be 1929. Unlike 1929, policymakers have many more tools to combat the current crisis. No doubt today's authorities will make their own mistakes and the efficiency of some programs will be less than perfect. (FDR's New Deal didn't always work either). Nevertheless, the level of global awareness and sense of urgency and purpose by fiscal and monetary authorities around the world should prevent this downturn from becoming a repeat of the Great Depression.

I believe that the current situation is best characterized as a cross between Japan's Lost Decade and German re-unification. Richard Koo of Nomura Research says that the world can learn the lessons of the 1990s from Japan. He believes that the correct response is an aggressive expansionary fiscal policy which can be summed as "spend, spend and spend until it hurts" (see his webcast here, it's long but well worthwhile). Koo’s prescription is an echo from a previous era, when Keynes advised FDR to do the same thing.

President-elect Obama seems to be listening to the likes of Koo. In his weekly address, he appears to be calling for a New Deal style stimulus package:

I have already directed my economic team to come up with an Economic Recovery Plan that will mean 2.5 million more jobs by January of 2011 — a plan big enough to meet the challenges we face that I intend to sign soon after taking office. We’ll be working out the details in the weeks ahead, but it will be a two-year, nationwide effort to jumpstart job creation in America and lay the foundation for a strong and growing economy. We’ll put people back to work rebuilding our crumbling roads and bridges, modernizing schools that are failing our children, and building wind farms and solar panels; fuel-efficient cars and the alternative energy technologies that can free us from our dependence on foreign oil and keep our economy competitive in the years ahead.

In addition, we have a Fed Chairman whose life work was the study of the Great Depression and he has made it clear that he intends to avoid the policy mistakes of that era.