Transcript Great Depression

Great Depression
• Great Depression is unique in US economic
history
– Severity and the length
– It takes a decade for per capita gdp to exceed
1929 level
year
Real gdp
Gdp deflator
Real gdp per
capita
1929
$977.0
10.61
$8,016
1930
$892.8
10.22
$7,247
1931
$834.9
9.16
$6,725
1932
$725.8
8.09
$5,809
1933
$716.4
7.87
$5,700
1934
$794.4
8.31
$6,281
1935
$865.0
8.48
$6,792
1936
$977.9
8.57
$7,629
1937
$1,028.0
8.94
$7,971
1938
$992.6
8.68
$7,637
1939
$1,072.8
8.59
$8,188
1940
$1,166.9
8.69
$8,832
Events of the Great Depression
• NBER dates beginning in August 1929
• Stock Market Crash October 1929
• From August to Oct, industrial production fell
from 114 (1935–39 = 100) to 110 for a decline
of 3.5 percent (annualized percentage decline
= 14.7 percent)
• Continued to fall to 100
• Fell an additional 21 % in 1930
Events of Great Depression
• Recession of 1929-30 was not unusual by
historical standards
• Banking panics and failures started in Oct
1930 and continued to Dec 1930
– Harvest failure in midwest
• 2nd Wave June 1931-December 1931
– Bank failure in Europe, Britain goes off gold
standard
• 3rd Wave- December 1932 –March 1933
• Result is decrease in money supply and faith in
banking system
• Unemployment is 25 % by March 1933
Cause of Bank Failures?
• Before Fed, banks would suspend payments,
clearing house banks would lend money to
failing banks
• Fed was suppose to do this but did not
• Argument made was speculative ventures
should not be bailed out
• Treasury Secretary Andrew Mellon, advised
President Hoover to “Liquidate labor, liquidate
stocks, liquidate the farmers, liquidate real
estate.” “It will purge the rottenness out of the
system. High costs of living and high living will
come down. People will work harder, live a
more moral life. Values will be adjusted, and
enterprising people will pick up the wrecks
from less competent people”
• This did not happen. Economy did not
rebound.
• Causes of Great Depression
– Monetary explanation
– Non-Monetary
– Gold standard
Monetary Explanations
• Friedman and Schwartz
• Fed does not step in as “Lender as Last
Resort” in Banking Panics causes huge
decrease in Ms
– Banks hold more reserves
– People put less money in banks
• Each banking panic makes this worse
Quantity Theory of Money
• Monetary theory tells us what effect changes
in money supply have an economy
• The basis of the quantity theory is the
equation of exchange:
• MV=PY
Quantity Theory of Money
• M=money supply
• V=velocity
– Velocity is how often money is turned over or
used
• P=price level
• Y= real income
Quantity Theory
• If we assume just V is constant or stable,
• The equation of exchange (MV=PY) that if M
increases, PY (nominal income )will increase.
• If deflation is anticipated, when M falls, P will
fall
• If deflation is not anticipated Y will also fall
– In this case money supply is not falling because of
direct action by fed, panics difficult to anticipate
Nominal vs Real interest rates
• Fisher equation R= r+∆P/P or r=R- ∆P/P
• In deflation real rate is higher than the
nominal rate
• Nominal interest rates are low, but the real
rates were high
• Fed did not understand this, did not attempt
to lower real rates
• Result was reduction in output
– Reduced investment
– Opportunity cost of holding money is negative
Criticism of Monetary Hypothesis
• Not clear Fed’s understanding of Monetary
policy was great enough to act in the was FS
said they should
• Not clear if it can explain long term
Non-Monetary Views
• Most can be explained in context of simple AD
AS model
The Long-Run and Short Run Equilibrium
Price
Level
Long-run
aggregate
supply
Short-run
aggregate
supply
A
Equilibrium
price
Aggregate
demand
0
Natural rate
of output
Quantity of
Output
Copyright © 2004 South-Western
Shifts in AD
• The four components of GDP (Y) contribute to the
aggregate demand for goods and services.
Y = C + I + G + NX
• Consumption
– Expected future income or wealth, taxes
• Investment
– Investors confidences, taxes, lower interest rates
• Government Purchases
– Government decides to spend more or less
• Net Exports
– Recession abroad
A Fall in Aggregate Demand in LR and SR
2. . . . causes output to fall in the short run . . .
Price
Level
Long-run
aggregate
supply
Short-run aggregate
supply, AS
AS2
3. . . . but over
time, the short-run
aggregate-supply
curve shifts . . .
A
P
B
P2
P3
1. A decrease in
aggregate demand . . .
C
Aggregate
demand, AD
AD2
0
Y2
Y
4. . . . and output returns
to its natural rate.
Quantity of
Output
Copyright © 2004 South-Western
Possible causes of Decrease of AD
• Consumption
– Decline in wealth due to stock market crash
– Pessimistic expectations as depression drags on
– Credit market problems (Fisher, Bernanke)
• Deflation increases value of debt from 1920s
• Reduces the value of banks assets
• Increased cost of credit intermediation
Gold Standard Problems
• Begins in period 1870-1914
• Gold Standard functions like a pegged
exchange rate system
• For this system to work, countries must let
their money supply change with gold flows
– If exports>imports, gold flows in, Ms↑, P ↑
– If imports>exports, gold flows out, Ms ↓, P↓
• Britain is dominate country, willing to do this
• WWI all countries go off gold standars
WWI ends
• Britain is no longer dominant economy, US is
unwilling to be the leader
• European countries are indebted to US, to pay loans
must export more than they import, means US, Ms
↑, P ↑ but US will not do this
• Problems with the exchange rates when countries go
back on the gold standard
– Old rates do not reflect new reality
– New countries which did not exits before
– General chaos
Recovery
• Economy hit its trough in March 1933, month
FDR took office
• New Deal
– National Industrial Recovery Act (NIRA )passed
June 1933
– Agricultural Adjustment Act (AAA)
– Both were designed to increase prices by allowing
firms to collude and paying farmers not to
produce
• Other new deal programs
– Works Progress Administration (WPA) created
temporary jobs
• New Deal spending is large by standards of the
time, but no consensus in the literature that it
had a large effect
• Roosevelt was not a Keynesian, felt the
problem was with the structure of the
economy.
• 1933 US goes off the gold standard, begins to
increase money supply
• Friedman and Schwartz identify this as crucial
change
Why is recovery so slow?
• Ohanian and Cole , JPE, August 2004
• Go back to NIRA
– Allowed business to collude to raise prices
without any prosecution from antitrust as long as
workers had a collective bargaining agreement
– Allowed workers to demand 25% increase in
wages
Unemployment
• Unemployment goes down, but official rate is
still high in the 1940s
Adjusted rate includes temporary jobs
• If wages are higher than equilibrium, unemployment
will increase
• If prices are higher than equilibrium, surplus
• NIRA was declared unconstitutional in 1935
• FDR found ways to get around it
– Antitrust cases dropped 50%
– Increase in collective bargaining
• Find wages and prices 25% higher than they should
have been
Other New Deal Issues
• What explains pattern of New Deal Spending?
• Roosevelt stated goals were relief, recovery
and reform
• More aid does not go to states with lowest per
capita income.
– South does not get as much
• Some evidence of political motivation
Recovery is underway by the time US
enters WWII
WWII
• Recovery is underway by the time US enters
WWII in 1941
• Major changes to the Economy
– Increase in government intervention (Private
industry mobilized in support of war effort)
– Wage and Price controls
– Increase labor force participation of women
• Concern about economic performance after
war ends in 1945.
What happens?
This is real gdp
with a log scale.
Increase in economic
growth.
Why do we see increase in growth
rate after WWII?
• Different international institutions.
– Bretton Woods conference results in instituitions
to make multilateral economic cooperation easier.
• GATT, World Bank, IMF etc
• US does not attempt to collect war debts
• Increase in rate of technological change
Application of science to
technological problems
• Starts during WWII
• Variety of different institutions involved
– Government
– Universities
– Private firms and research labs
• Lots of diversity