Edited by Dan Morrell

What examples from history can we reflect on as we begin to address the economic impacts of the COVID-19 pandemic and prescribe solutions for policy and private enterprise?

I want to start with the Great Depression of the 1930s, because it’s the economic crisis against which all others are typically compared. Importantly, one of the most striking things about the Depression, according to observers both at the time and since, is that economic activity was collapsing despite there being plenty of productive capacity.

In illustrating this point in a book on macroeconomics that I wrote a number of years ago, I quoted three people: President Herbert Hoover, who was the US president when the Great Depression started; President Franklin Roosevelt, who succeeded him and was from the other major political party; and John Maynard Keynes, who was a British economist and one of the leading economic thinkers of the time. Despite their differences, their assessment was remarkably similar; that is, how odd it was that there was no shortage of productive capacity and yet economic activity was collapsing. As President Hoover famously said in October, 1930, “the fundamental assets of the nation have been unimpaired." How was it possible that the economy was breaking down when the fundamental assets of the nation, as he put it, were sound?

Upon taking office in 1933, President Roosevelt said something quite similar: “Our distress comes from no failure of substance. We are stricken by no plague of locusts. Plenty is at our doorstep, but a generous use of it languishes in the very sight of the supply.”

Remarkably, Keynes says much the same thing—that the economic calamity did not stem from a shortage of capital or labor. He said it was not due—and this is really quite striking since we’re now in a pandemic—to earthquake, or famine, or war. Those are all things that would destroy productive capacity. He said instead that the economic crisis was due to “some failure in the immaterial devices of the mind.”

What did he mean by that? I think there’s a fairly broad consensus that people can become pessimistic about the economy and that this can do real damage. The pessimism may be rational; individuals, in their daily lives, may see economic problems that even economists don’t see. Or the pessimism may not be entirely rational; it might just be the product of some kind of anxiety of unknown origins.

Rational or not, if people begin to become pessimistic about their economic future and the economy in general, one of the first things they typically do is start scaling back on consumption—and this can be the start of a classic demand-side recession or depression. Producers (businesses) realize they’re going to have less demand for their products in the future, so they start contracting their operations. That means laying people off. Now you’re really in a downward spiral because the people who are laid off may reduce their consumption sharply, which will provoke further business contraction, and so on. And even those workers who have not been laid off—the vast majority—have more reason to be worried than before (because of rising unemployment), more reason to expect a weakening economy and a threat to their earning power, and thus more reason to reduce consumption still further.

Many people think that this is an important part of what was going on in the 1930s. And Keynes said that if you want to solve a problem like this, you have to rely especially on fiscal policy. The idea was that policymakers have to send a signal to people that there will be demand in the future and things are going to get better. The way to send that signal, in his view, was through deficit spending. If the government borrowed heavily and spent the money, that would send a signal of rising demand; consumers would perhaps decide to spend more—possibly just a little bit at first—and firms might decide to expand production as well, and back and forth, driving a recovery in output and employment. In this way, the downward spiral of contracting consumption and business activity could be converted into an upward spiral of economic expansion.

The heart of the problem in the 1930s, in other words, was not a shortfall in productive capacity—too little labor or too little plant and equipment, due to a famine or earthquake—but rather a shortfall in demand due to “some failure in the immaterial devices of the mind.” That was a leading diagnosis of the Great Depression, and many observers offered a similar diagnosis for the Great Recession that took root in connection with the financial crisis of 2008-2009. Consequently, the policy response focused, at least in part, on aggressive monetary and fiscal policy to stimulate demand—to prevent the extreme downturn we saw in the Depression, and to get the economy moving forward again.

Unfortunately, I think there’s a real danger now of people looking back to those major economic events, assuming we’re facing more or less the same problem now, and then wanting simply to reuse the same playbook—maybe in even a larger and more extreme way. It’s what in military circles people call “fighting the last war.” This is a familiar trap, when military planners become so obsessed with the last war that they focus all of their planning on what they should have done to defeat the enemy in that war, without realizing that their current adversary is adjusting, changing, and developing new technologies to fight the next war. Falling into this trap is potentially devastating, leaving you unprepared to fight the actual war that you’re going to face. And I’ve been worried for many months now—since at least mid-March—that in trying to fight the current economic crisis, arising out of the pandemic, too many economic policymakers are in danger of fighting the last war.

The simple fact is that today we have a very, very different crisis than what we saw in either the Great Depression or the Great Recession. Certainly, there are some similarities: there are some elements of a standard demand-side crisis, and we need to be attentive to those. But the problem we are facing today goes far beyond a breakdown in demand, so it is unlikely that big shots of fiscal and monetary policy will be sufficient.

Instead, the problem we have to deal with has as much to do with the supply side as the demand side. That's very different from the 1930s. Additionally, the demand-side problem that we’re facing now is fundamentally different from the demand-side problem that we faced back then.

First, on the supply side, why has production fallen? It’s at least in part because people—at varying times across the country—either haven’t been allowed to go to work (because of pandemic-related lockdowns) or have been too afraid to go to work (because of fear of getting sick). This caused a contraction of supply because people were effectively kept home from work, which reduced productive capacity.

Second, if you look on the demand side, why have people reduced their consumption? Part of it may be that they’re nervous about the economic future, as we’ve seen in past economic crises, but I think a big part of it is actually a tangible barrier rather than a behavioral one. If you're in a lockdown or if you’re nervous about going out and being around other people, you’re less likely to go out and shop, to consume, and this directly undermines the demand side. It’s not simply that you want to reduce your consumption because you’re worried about the economy faltering and your income declining, which is the traditional demand-side story, but that you feel a barrier to going out at all, which undercuts both demand (consumption) and supply (production).

And this is exactly what we've seen. The evidence suggests that while there is certainly some traditional behavioral piece to the demand-side problem—that is, people scaling back because they are nervous about the economy and their economic prospects—a very large share of the problem seems to be these more tangible (in some cases physical) barriers to consumption and production. Part of the evidence for this is that when the barriers have been removed, when the lockdowns have been eased, you’ve actually seen economic activity recover quite quickly. The problem is that, without the proper safeguards in place, the spread of the virus seems to recover quickly as well, which in turn leads to further rounds of closures and social distancing, and further economic contraction.

So, bottom line—and I think this is obvious—the pandemic has created tangible barriers on both the supply side and the demand side of the economy (that is, barriers to both production and consumption). Inevitably, demand is also being compromised along more traditional Keynesian lines, as people grow anxious about their income going forward. But at this moment, and certainly up until now, my guess is that the tangible barriers have been the main source of injury to the economy.

Why does it matter? It matters because the policies we’ve typically used to address a traditional demand-side downturn won’t be sufficient if the problem actually lies elsewhere. We would, in a sense, be fighting the last war. Aggressive deficit spending may help in a number of ways, but it won’t solve the tangible barriers to production and consumption that the pandemic has imposed. So it won’t be enough to turn a downward spiral into an upward spiral, as in the past.

To be sure, large scale government spending is needed to prevent individuals and families from falling into poverty during the pandemic, and to prevent firms (especially small ones) from falling into bankruptcy. Federal funds may be absolutely essential for some of these purposes, for mitigating the impact or limiting the damage, and helping to prevent a financial crisis (which unfortunately remains a real possibility). But will such spending send a signal that you can go out and consume again, or that you can safely go back to work? If people are basically locked down or if they’re too afraid to go out because of the virus, I'm not sure there’s any amount of fiscal policy that’s going to solve that problem. The only thing that’s going to solve that problem is solving the health issue itself. I’ve been saying this since March, when I first discussed the economic implications of the pandemic with my MBA students.

As I said then, it’s important to provide relief to those who need it, as a way of lifting people up and limiting the damage—and preventing the current economic crisis from getting dramatically worse, or triggering a financial collapse. But equally important, in my view, is investing as much as we possibly can to defeat the virus—through massive investments in PPE, hospital capacity, effective treatments, a vaccine. These investments are necessary to save lives, first and foremost. But the scale and speed of these investments in public health also have tremendous economic implications, because we can’t truly solve the economic crisis until we bring the outbreak under control. Unfortunately, our federal spending to date hasn’t nearly reflected this. If you look at how roughly the first three trillion of emergency spending was allocated, the amount spent on public health wasn’t really that large—at least in comparison to everything else. The focus on individuals, families, and small businesses and their employees made sense. But some of the larger corporate bailouts really should have taken a backseat to further investments in public health.

People use the phrase “fiscal stimulus” to describe the federal spending, but that’s a misnomer in this context, and possibly quite a dangerous one. As I’ve said, traditional deficit spending won’t be nearly sufficient when people are afraid to go out or are legally barred from going out. Again, we can’t really solve the core economic problem without solving the health problem. Large-scale spending to mitigate the damage is essential. But assuming fiscal policy alone will be enough—that it will be sufficient to trigger an upward spiral—is simply fighting the last war.

Beyond this, we also need to think about what happens when the health crisis ultimately is brought under control. There’s a real possibility that by that point, we will have succumbed to a Keynesian style or demand-side crisis, where people and firms are actively scaling back spending because they’ve concluded that the economic future is bleak. If so, we’d want to be sure we have enough fiscal capacity at that stage to be able to respond if needed, so we have to be careful not to use up all of our fiscal weapons now. And it’s not only a question of money, it’s also a question of political will. That is, if we've spent however many trillions of dollars on this first phase, when we get to the next phase, will we be prepared—both economically and politically—to go forward with the kind of fiscal stimulus that might be needed then?

So I worry that we’re at risk of “fighting the last war.” History is a wonderful teacher. Many of the lessons from the Great Depression—especially regarding monetary policy—helped policymakers prevent another Great Depression in 2008–2009. But sometimes recognizing how the present differs from the past is as important as recognizing the similarities. And I think that’s where we are right now. The current crisis differs in fundamental ways from either the Great Depression or the Great Recession, and we need to be profoundly mindful of that. There are some important similarities, of course, but focusing only on the similarities would be a catastrophic mistake.

Could we look to the flu pandemic of 1918 to 1919 for a more analogous situation to draw lessons from?

I’m not sure that we can draw a direct lesson about economic policy from that period for a couple of reasons. For one thing, as the country has grown richer and our capacity to deal with some of these problems has increased, our tolerance for loss of life is lower—as it should be. So certain policies that might have been acceptable then wouldn’t be acceptable now. To be sure, there may be some important economic lessons there, but I would be rather cautious about this exercise.

That said, there may be another type of lesson that we should draw from the experience in 1918–1919. In fact, during the health emergency of those years as well as the economic emergencies of the Great Depression and the Great Recession, there is a remarkable similarity on one dimension that we should definitely take note of. In each of these emergencies, the crisis erupted, then paused, and then returned again with even greater intensity. Importantly, in each case, when the pause occurred, many people (including many policymakers) thought it was over and let down their guard, and then the crisis came back with a vengeance.

You can see that in 1918. The outbreak was serious in the spring, it slowed significantly in the summer, and then it came back far worse in the fall—and many people were desperately unprepared when it did.

In 1929, you had the big crash in the fall, but by the early spring of 1930, the market was already back up to about 75 percent of its peak. And then, seemingly without warning, the bottom fell out, which only compounded the sense of uncertainty and fear.

We saw something quite similar in 2008. Bear Stearns failed in March of that year, which obviously reflected a very serious financial situation. By later that spring, however, things had calmed down considerably and many policymakers concluded that the Fed’s rather unorthodox intervention had largely solved the problem. I remember talking with people at the time and saying, “Look, something similar happened in 1930—a temporary pause in the crisis. Maybe we better be cautious about this.” Unfortunately, the respite wasn’t used as effectively as it could have been—for creating a resolution mechanism to manage the failure of large financial institutions, for example—and by late summer, as you know, Fannie and Freddie were in deep trouble, and in September, Lehman failed and the whole financial system soon seemed on the verge of collapse.

The point is that we need to stay vigilant, even if the crisis seems to be abating. I can’t stress this enough.

David Moss is the Paul Whiton Cherington Professor of Business Administration whose books include A Concise Guide to Macroeconomics and Democracy: A Case Study

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