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What do the recoveries after downturns like those relating to the 1918 flu pandemic and the financial crisis that began in 2007 have in common, and how likely is it that this recovery will be like either of those recoveries?

Ellis Tallman
Ellis Tallman, Research Director and Executive Vice President

As appeared in the Cleveland Fed Digest's Ask the Expert on 06.30.2020

Issue #35 | June 30, 2020

We have to be somewhat cautious about drawing analogies between the 1918 flu pandemic or the financial crisis and the current crisis.

The 1918 flu really affected working-age people, mainly males between the ages of 15 and 45, and struck as we came out of World War I, which left a big hole in the labor market. Many soldiers died in the war, and we had a large proportion of that demographic die from the 1918 flu in the United States. That is very different from what we have now; the largest proportion of the population dying from COVID-19 in the United States is people like me, people older than 55 moving from work into retirement.

The recession in 1920–1921 that followed the flu crisis is largely perceived as having happened because of extremely tight monetary policy—the Federal Reserve’s actions, over the span of months, made it more expensive to borrow money. Flu-related restraints—for example, people’s keeping their kids home from school—weren’t as extensive and didn’t affect as many industries as COVID-19 affects today; back then, the economy was mainly agricultural and industrial and included fewer high-contact service businesses.

The recovery that followed—the Roaring Twenties—was very robust, thanks largely to the end of “the war to end all wars,” the recovery from it, and the demographics of the time. It was also a time of worldwide expansion and innovation—think of radio broadcasts, the discovery of penicillin as well as insulin (for type 1 diabetes), and the bread slicer (and electric toaster). The population in 1918 was much younger, generally, than the US population today, with a smaller proportion of the working-age population nearing retirement. I don’t think our recovery from the COVID-19 pandemic will be that similar to the one enjoyed during the Roaring Twenties, especially with the uncertainty regarding progress in the battle with the coronavirus worldwide.

In the financial crisis and Great Recession of 2007–2009, we had financial excess and a banking structure and system in weak condition. There were financial imbalances—for example, people who were highly indebted and owed more on their houses than their houses were worth and businesses that couldn’t make a go of it and filed for bankruptcy. The realization that very few real assets backed many loans undermined confidence in the financial system. A lot of people suffered big consequences, and they hesitated to get back into making purchases financed by debt, such as mortgages, and taking on risk more generally. People questioned whether the Western financial market structure was viable without reform, and the equivalent of a financial lockdown ensued: Reforms such as Dodd–Frank made it so people and companies were less able to take out so much debt that it put others at risk. Growth slowed, but indebtedness became a more credible indebtedness, one backed with assets of comparable value to the amount of debt. As a result, our banking system was much stronger going into the current crisis.

Partly because the financial system now is healthier than it was in 2009, there are people who think this recovery will be quicker than the Great Recession’s recovery. I think we’re all recognizing that a pandemic is something few expected, and we’re trying to figure out what paths forward make sense in environments where COVID-19 is spread and still lurks. We are facing the potential for lasting changes in our industrial structure; there are a number of businesses that could permanently lose many of their customers because the services the businesses offer can’t be made safe enough to encourage customers to use them. I feel for people whose livelihoods depend on such businesses. How is the economy going to rebound from the loss of these jobs? It’s just so hard to think about how many people are really suffering right now. The longer that people fear being exposed to the virus during economic activity (restaurants, entertainment, travel, etc.), hindering or preventing a recovery to previous “normal” levels, the more painful it will be.

In my own judgment, the recovery from this sharp decline will not take the form of a V—quickly up after a quick drop—but it may not be as slow and sluggish as the recovery after the 2009 recession; it could be somewhere in the middle. Today’s huge layoffs are, for the most part, temporary. This recovery will hinge on the virus, the shutdowns associated with it, and the rational responses of consumers and businesses to lay low and cut back activity to avoid contact and spreading the virus. Plenty of people seem eager to get back to something resembling normal activities, and it is unclear whether that is possible without creating a second wave of infection that strains healthcare capacity and leads people to step back from normal economic activity again.

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Ellis Tallman is research director and executive vice president at the Cleveland Fed. He leads the Bank’s Research Department, whose economists have been working during this pandemic to publish data about where the economy stands and to study policy responses to the pandemic-related shutdown. Tallman’s own research focuses on US historical episodes of financial crises and policy responses, economic forecasting, and macroeconomics.


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