As noted, Martin Wolf and Eichengreen and O'Rourke both highlight the much stronger counter-cyclical macroeconomic policy response of the present day as a major positive difference with the Great Depression. Here we only supplement their discussion with some additional observations on policy responses.

A key difference between the 1930s and the current crisis is the role of the gold standard as a deflationary force. In the 1930s, most economists and policy makers saw the gold standard as the guarantor of economic stability. However, adherence to the gold standard proved to be quite dysfunctional under the economic conditions of the early 1930s. The U.S. Federal Reserve, for example, dramatically raised its rediscount rate in 1931 in response to Britain's devaluation (in conformity with standard classical theory), fostering a significant reduction in the supply of money and further compromising the health of the banking sector. This, in turn, helped to transform a significant recession into the Great Depression.

The danger of repeating the trajectory of the 1930s because of dysfunctional monetary policy reactions is less today, with the prevalence of flexible exchange rate regimes between major economies (such as between the United States, the euro zone, and Japan), and also for a significant number of developing economies. Policy makers now have greater autonomy to target monetary policy at domestic activity and inflation/deflation concerns. The rapid and comprehensive intervention by monetary authorities in the present recession is reflected in the dramatic expansion of central bank balance sheets shown in figure 5. Policy makers have used almost every conceivable policy tool to provide support for troubled financial sectors: capital injections, direct purchase of troubled assets and discretionary lending by the Treasury, central bank support with Treasury backing, liquidity provision, guarantees, upfront government financing, and sometimes outright nationalization and liquidation of financial institutions. The volume of such support has been unprecedented, reaching about 50 percent of advanced economy GDP.

Figure 5. Central Banks' Total Assets (12/29/06 = 100)


In addition to support for the financial sector, policy makers have generally accepted – though some reluctantly – the need for significant fiscal stimulus policy action. In most cases, G20 countries have adopted discretionary fiscal stimulus measures that reached 0.5 percent of their average GDP in 2008, 2 percent in 2009, and a projected 1.5 percent in 2010 (figure 6). Most analysts recognize that policy responses have been effective in avoiding a financial collapse and in at least providing some underpinning for global demand, although there remain vigorous debates over how effective monetary and fiscal stimulus will ultimately prove. In addition, there are significant concerns about how and when to design "exit policies" from the current stimulative monetary and fiscal policy stance and about the potential for longer-term weakening of fiscal positions as a result of current policies.