Transcript Economic 157b - Yale University

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The Great Depression:
Unemployment
rate (%)
A focal event in
US economic history
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20
16
12
8
Keynes
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1
1928
1930
1932
1934
1936
1938
1940
Housekeeping
Midterm on Wed October 13
11:35-12:50 pm
Sterling Chemistry Lab 110
(NOT Dunham Lab)
Remember open TF office hours
and review sessions (see class
web site).
Final questions?
2
Gilded era of the 1920s
Stability restored to U.S. economy in 1920s after WW I.
Problems surfaced with real estate and stock market booms.
The Great Crash, October 1929
Key Elements in the Great Depression
1929-1933
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•
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Started as standard recession and deflation
Remember world was on gold standard (fixed exchange rate system)
Multiple bank failures through 1933 (standard panic model)
Breakdown of Gold Standard, particularly with Britain’s leaving gold
in 1931.
Collapse of investment and international trade after 1929
Government and Fed took hesitant steps to stimulate the economy
– Federal government wanted to balance the budget (like several
candidates today…)
– Fed was serving too many masters (more on this later)
Output kept falling, and unemployment kept rising
Trough finally reached in 1933, but no sharp recovery
Remember that Keynes’s General Theory not published until 1935:
macroeconomics was born a decade too late.
5
Fear and panic on Wall Street, then and now
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Great Depression (1928-1933)
Great Recession (2007-2010)
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140
120
100
80
60
40
20
1928
1929
1930
1931
2007
2008
2009
2010
1932
1933
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Bank failures and panics, 1931-1933
Real GDP (peak = 100)
108
104
100
96
92
88
84
80
76
Depression
Recession
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68
1929
1930
1931
1932
2007
2008
2009
2010
1933
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On Main Street with unemployment rate…
30
25
20
15
10
5
0
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27
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2007
29
30
31
2010
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33
34
35
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Over-farming the marginal lands and the Dust
Bowl
Economic migration
Migrant worker
High unemployment for a decade
Tales of the labor market in recession/depression:
“I’d get up at five in the morning and head for the
waterfront. Outside the Spreckles Sugar Refinery,
outside the gates, there would be a thousand men.
You know dang well there’s only three or four jobs.
The guy would come out with two little Pinkerton
cops: “I need two guys for the bull gang. Two guys to
go into the hole.” A thousand men would fight like a
pack of Alaskan dogs to get through. Only four of us
would get through.”
Studs Terkel, Hard Times.
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Growth in Key Indicators
Period
1927:10-1929:8
1929:8-1931:12
1931:12-1933:4
H
M1
Real M1
Ind.
Prod.
42.7%
2.0%
6.5%
1.1%
-8.1%
-10.5%
1.4%
-0.9%
0.6%
11.6%
-22.4%
-10.2%
Real
GDP
Inflation
3.8%
-6.7%
-11.9%
-0.3%
-7.3%
-11.0%
H = high powered money.
Periods are:
1. Pre-crash boom
2. From crash to Britain’s leaving gold
3. From gold crisis to trough
Note: rates of change at annual rates.
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Alternative views of the sources of the GD
I.
I.
AS theories: exist but are in my view defective
AD theories
“Expenditure view”: IS or spending shocks
Financial market distress: LM or financial shocks
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IS interpretation of the depression
interest
rate
(i)
IS1929
IS1933
LM
Y1929
Y1933
0
Real output (Y)
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I. The Expenditure Approach: IS Shocks
Were shocks in the IS curve responsible? From NX, C, G?
– Foreign trade, government spending and taxes were
too small
– No exogenous consumption shock
From I?
– Investment decline was the major shock.
– Mechanism is unclear, but probably due to shift to
“bad equilibrium” (panics, risk, high risk premiums,
low investment. A variant of the IS curve shift.)
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II. Financial Market Background
• Central banks generally have to serve three masters in different
mixes over time. This was the Fed’s trilemma in 1928-33.
1. exchange rates (gold standard and convertibility)
2. macroeconomy (inflation, output, and employment)
3. financial market stability (asset prices, panics, liquidity)
• Fed was primarily concerned about (#3) speculation in 1928-29 and
tightened money at that point.
• When depression was underway, Fed was primarily concerned with
defending the gold standard (#1) until 1933 and didn’t expand M
sufficiently.
• From 1933 on, after US depreciated and others left gold, Fed was
divided about how strongly to stimulate the economy because of
poor macro understanding (#2).
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Money in the Great Depression
1.2
1.1
1.0
0.9
0.8
0.7
0.6
0.5
0.4
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29
30 31
32
33 34
35
M1 (1929 = 1)
Industrial production (1929 = 1)
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Friedman and Schwartz and the Monetarist Argument
• Classic study of the Great Depression is Milton Friedman and
Anna Schwartz, Monetary History of the United States, which held
the “monetarist” view.
“Throughout the near-century examined, we have found that: Changes
in the behavior of the money stock have been closely associated with
changes in economic activity, money income, and prices. The
interaction between monetary and economic change has been highly
stable. Monetary changes have often had an independent origin; they
have not been simply a reflection of economic activity.” (p. 676)
• F&S view the depression as primarily driven by “incompetent”
monetary policy caused by decline in money supply.
• Argue that rise in M1 could have prevented Y fall and nipped GD
in bud
• While it is true that M1 fell, it is likely to be a consequence rather
than a cause of the Depression (Tobin).
Monetarism, the Depression, and IS-LM
interest
rate
(i)
LM‘
LM
i**
i*
IS
Y**
Y*
Real output (Y)
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Interest Rates 1920-39
Problem with
LM/monetarist
interpretation:
Safe interest rates
fell in GD!!!
Interest rate (% per year)
10
8
6
4
2
0
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22
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26
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30
3-month T-bill
Fed discount rate (low)
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38
40
Corporate bond rate
Commercial paper rate
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The Fed Discount
rate during
the
Great Depression
Federal Reserve
Discount
Rate
7
6
5
What in the world
were they
thinking?
4
3
2
1
0
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29
30
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32
33
34
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Great Depression and Great Recession
7
Discount rate (1926-1937)
Fed funds rate (2005-2010)
6
5
4
3
2
Compare then
and now!
1
0
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27
28
2007
29
30
31
2010
32
33
34
35
36
37
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Bad equilibrium view of Great Depression
A final approach:
1. Had a huge IS shock due to risk, panics, and sent economy
into a “bad equilibrium” with high risky real interest rates.
2. This forced economy into a liquidity trap (like today), so
that monetary policy was ineffective.
3. Got locked into “bad equilibrium” of deflation, high risk
premiums, fear, and low spending.
4. And that lasted until 1940!
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6
US short-term interest rates, 1929-45 (% per year)
Liquidity
trap in US in
Great
Depression
5
4
3
2
1
0
1930
1932
1934
1936
1938
1940
1942
1944
interest
rate
(i)
IS1933
IS1929
LM1929
= LM1933
LM1939
Y1929
Y1933
0
Y1939
Real output (Y)
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The Roosevelt Presidency (1933-1945)
“We have nothing to fear but fear itself.”
The New Deal Programs
(WPA Sleeping Giant Tower)
Recovery from the Great Depression
• The end of the Great Depression:
– Military mobilization for World War II led to ENORMOUS
increase in G starting in 1940.
– Recovery took off in 1940.
• This Standard IS shift … no puzzle here!
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The rise of the dictators (1917 - )
World War II (1931-1945)
Military spending takes off…
The end of the depression …
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.6
15
10
Pearl Harbor
Germ invastion Austria, Czech
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.5
Germ invasion France
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Germ. invastion Poland
WW II
.4
.3
.2
5
.1
0
.0
30
32
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40
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Unemployment rate
Defense spending/GDP
Federal expenditures/GDP
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48
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interest
rate
(i)
IS1939
IS1945
WW II
LM
Y1945
0
Y1939
Real output (Y)
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Can you see why macroeconomists emphasize the importance of fiscal
policy in the current environment?
“Our policy approach started with a major commitment to fiscal
stimulus. Economists in recent years have become skeptical about
discretionary fiscal policy and have regarded monetary policy as a
better tool for short-term stabilization. Our judgment, however, was
that in a liquidity trap-type scenario of zero interest rates, a
dysfunctional financial system, and expectations of protracted
contraction, the results of monetary policy were highly uncertain
whereas fiscal policy was likely to be potent.”
Lawrence Summers, July 19, 2009
Implication of the Recovery
• Recovery from GD required an increase in high-employment
federal deficit of 20-25 percent of GDP
– Would be equivalent of $3 trillion deficit today!
• The magnitude of the fiscal shock required for recovery
suggests that no minor M or F expansion would cure GD
quickly.
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Summary
• The depth and severity of the Great Depression remains one of the
continuing debates of macroeconomics.
• Probably no simple approach can explain the entire story
– Warning: avoid the seduction simplicity of monocausal approaches.
• Perhaps a complex situation where combination of factors piled up
to produce a “perfect storm” of macroeconomics:
– bad luck (boom of 1920s and bust of 1929)
– poor institutions (gold standard and fragile banking system)
– poor international coordination (legacy of WW I)
– inadequate understanding of macroeconomics (before Keynes’s theory)
– inept policy response (cling to gold standard, no fiscal response)
– bad dynamics (panic, high risk premia, deflation, and liquidity trap)
• Can it happen again? To answer need to understand how
macroeconomic theory and institutions have evolved.
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