Even before the Covid-19 crisis began, the global economy was not in good shape, and nor was economic theory. The biggest economic crisis since the Great Depression began late in first decade of the 21st century. Called the “Global Financial Crisis” (GFC) in most of the world and the “Great Recession” in the USA, it saw unemployment explode from 4.6% of the US workforce in early 2007 to 10% in late 2009. Inflation turn into deflation— inflation of 5.6% in mid-2008 fell to minus 2% per year in mid-2009—and the stock market collapsed, with the S&P500 Index falling from 1500 in mid-2007 to under 750 in early 2009. The economy recovered very slowly after then, under the influence of an unprecedented range of government interventions, from the “cash for clunkers” scheme that encouraged consumers to dump old cars and buy new ones, to “Quantitative Easing”, where the Federal Reserve purchased a trillion-dollars-worth of bonds from the financial sector every year, in an attempt to stimulate the economy by making the wealthy wealthier.
This crisis surprised both the policy economists who advise governments on economic policy, and the academic who develop the theories and write the textbooks that train the vast majority of new economists. They had expected a continuation of the boom conditions that had preceded the crisis, and they in fact believed that crises could not occur. In his Presidential Address to the American Economic Association in January 2003, Nobel Prize winner Robert Lucas declared that crises like the Great Depression could never occur again because “Macroeconomics … has succeeded: Its central problem of depression prevention has been solved, for all practical purposes, and has in fact been solved for many decades. (Lucas 2003 , p. 1 ; emphasis added).
That’s not quite so much of a gotcha as some might think. Because of course we didn’t have a rerun of the Great Depression. Largely because policy makers like Ben Bernanke understood what Milton Friedman had been saying (in A Monetary History of the United States) about what caused the Great Depression – bad monetary policy.
Do note what the Lucas claim was – not that we have banished recessions, not that we’ll never have economic slowdowns or economic bad times. But that we’ll not have economic collapses like the Great Depression. Which we didn’t have, even though we could have done, and largely we didn’t because macroeconomics had advanced in understanding why depressions occur and what is necessary to avoid them doing so.