The Panic of ’08: Recession Cause or Effect?

The financial panics of last September and October will always be part of the story of this recession, just as bank failures are always part of the Great Depression story. But recent research questions the claim that the financial panics themselves contributed to their contemporaneous and severe employment downturns.

In his academic research, Ben S. Bernanke blamed part of the Great Depression of the 1930s on banking panics. And this time last year (at the height of the panic in the commercial-paper market) he was telling President Bush that if “we don’t act boldly, Mr. President, we could be in a depression greater than the Great Depression.” A lot of taxpayer money was spent based on this theory.

Some recent research supports an alternative view: that those financial panics did not cause depressions, but are merely symptoms of deeper economic forces.

The U.C.L.A. economics professor Lee Ohanian’s recent paper has looked at monthly data from the 1930s and finds that bank failures came well after manufacturing establishments had sharply dropped their work hours. Moreover, the banks failing during the initial panics were known to be weak. Whatever brought those weak 1930s banks down had already hit the manufacturing sector hard.

The timing was different in this recession — the largest employment drops seemed to come immediately after the financial panic — but a recent paper by Ravi Jagannathan, Mudit Kapoor and Ernst Schaumburg of Northwestern argues that the coincidence is just as misleading. They argue that the changing global economy — with more employment of residents in developing countries like China — created a glut of savings in those countries, and was destined to reduce employment in developed countries regardless of whether there had been a financial panic.

The foreclosure crisis is not fully behind us, and the time may come again when it looks like “banks are in trouble.” When that time comes, will taxpayers still believe Mr. Bernanke’s theory that they are better off financing bailouts than letting a bank panic run its course?

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About Casey B. Mulligan 76 Articles

Affiliation: University of Chicago

Casey B. Mulligan is a Professor in the Department of Economics. Mulligan first joined the University of Chicago in 1991 as a graduate student, and received his Ph.D. in Economics from the University of Chicago in 1993.

He has also served as a Visiting Professor teaching public economics at Harvard University, Clemson University, and Irving B. Harris Graduate School of Public Policy Studies at the University of Chicago.

Mulligan is author of the 1997 book Parental Priorities and Economic Inequality, which studies economic models of, and statistical evidence on, the intergenerational transmission of economic status. His recent research is concerned with capital and labor taxation, with particular emphasis on tax incidence and positive theories of public policy. His recent work includes Market Responses to the Panic of 2008 (a book-in-process with Chicago graduate student Luke Threinen) and published articles such as “Selection, Investment, and Women’s Relative Wages,” “Deadweight Costs and the Size of Government,” “Do Democracies have Different Public Policies than Nondemocracies?,” “The Extent of the Market and the Supply of Regulation,” “What do Aggregate Consumption Euler Equations Say about the Capital Income Tax Burden?,” and “Public Policies as Specification Errors.” Mulligan has reported on some of these results in the Chicago Tribune, the Chicago Sun-Times, the Wall Street Journal, and the New York Times.

He is affiliated with a number of professional organizations, including the National Bureau of Economic Research, the George J. Stigler Center for the Study of the Economy and the State, and the Population Research Center. He is also the recipient of numerous awards and fellowships, including those from the National Science Foundation, the Alfred P. Sloan Foundation, the Smith- Richardson Foundation, and the John M. Olin Foundation.

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1 Comment on The Panic of ’08: Recession Cause or Effect?

  1. This is a dishonest article, Casey. The Ravi Jagannathan, Mudit Kapoor and Ernst Schaumburg does not say that the losses of employment we have had over the past 12 months were the inevitable cause of “global imbalances” and had nothing to do with the banking crisis. Rather, they are saying that the underlying causes of the crisis reflect greater structural challenges– namely, a rise in the global labor force (the supply of capital) without a corresponding rise in the demand for global end goods and services. That is true. What they are not saying, however, is that the job market has nothing to do with the health of the banking system.

    So many people have said we should have not done anything and just “let the crisis run its course.” I wish more than anything in the world that we could go back to last fall and create an “alternate reality” where we do just let things run its course and let the banks fail.

    We would see (1) a collapse in the commercial paper market, (2) bankruptcy of large sections of the Dow & S&P, including giants like GE, (3) as these companies go bankrupt, they liquidate rather than restructure in court due to lack of DIP financing, (4) 2-3 million job losses per month if we are lucky, (5) $3+ trillion deficits IF the government attempts to maintain statutory limits, (6) mass sovereign defaults all over the developing world, (7) probably another world war somewhere down the line.

    I would like the world to see that and then say don’t bail out the banks. Let the populists rant and rave then. Unfortunately we have one world, and I’d rather see Ben Bernanke get beat up by the newspapers, blogs and politicians than see that reality come about. Good day, Casey Mulligan.

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