Calculating a hypothetical depression

While there’s been a fair amount of chatter about the possibility of the current contraction turning into a full-blown depression comparable to the Great Depression for some time now, I haven’t seen too many explications of what that would mean in statistical terms. And while I’m extremely skeptical of the statistical approach to economics given the incredible number of assumptions and estimates involved, it’s an interesting exercise.

From the high point of the economy in 1929, it took four years for the economy to contract 45.6 percent. That was an average of roughly 11 percent per year, although it was the second and third year that bore the brunt of the contraction. The economy began growing again at a 17 percent rate (!) in 1934, but it still took 12 years to get back to the 1929 peak.

If 2008 marks the beginning of a comparable depression – and if there’s going to be a depression, the size of the boom would appear to indicate that it’s going to be a comparable one at a minimum – that would mean that the US economy is due to contract from 13.7 trillion in 2007 to 7.5 trillion in 2012. GDP per capita would decline from $45,850 to around $24,064 if population growth continues at the present rate.

This would reduce the average US living standard to one that is similar to current Israel, Greece, and Portugal. That’s obviously not a good thing, but it’s hardly the Dust Bowl of yore. The problem, of course, is if the wealth calculations are no more accurate than derivative risk management, it could be worse.

At present, real GDP is forecast to contract only 0.3 percent in Q3 2008. So, obviously the contraction appears to be off to a slow start. The panic demonstrated by world leaders, however, tends to cause one to suspect that either the statistics are unreliable or they’ll start looking much worse in the near future. In any event, it’s probably not a bad idea to plan out what you would need to do in order to live on one-half your present income.