Transcript Modern Economy 1919-1930

Modern Economy
1919-1930
US role in World Economy
• The result of US industrial expansion is US is
over taking Great Britain as an economic
power.
• US is leader in manufacturing in the world by
1913, Britain has fallen to third.
Manufactured goods become a larger percentage of
exports and a smaller percentage of imports.
US role in World Economy
• US does not act like a world economic power
• Foreign Policy is isolationist
– No interest in being involved in European power struggles
– Limited interest in exerting influence in south America and
Caribbean
• Economic Policy is protectionist
– Tariffs increase during Civil War
– Remain high until 1900
– Desire to protect US industry
Changes in US Economy
• US population is becoming more urban.
Changes in US economy
• More goods bought in market than produced
at home
• Changes the way goods are sold
– Product differentiation
– Advertising
• As incomes increase, more spending on
manufactured goods, less on food
Significant developments
• Increase in the size and functions of
government. Result of populist movement is
increase in regulation
– Antitrust
– Regulation of natural monopolies
• Grain elevators
• Railroads, ICC
• Electricity and Gas
– FDA
• Federal Reserve system is set up with the
hope that the bank will intervene to stop
panics
– Not clear everyone agrees with this
• Income tax is established in 1913
• WWI increases government intervention
WWI
• WWI begins in Europe in 1914
– Assassination of Austrian Archduke Ferdinand by a
Serbian revolutionary in Sarajevo.
– Russia, France and Britain vs Germany and
Austria-Hungarian empire
– United States policy is isolationist
• does not enter war until 1917 in response to German
U-boat attacks on merchant shipping
WWI
• Increase government regulation and spending
during WWI
– Draft
– Wage and price controls
• Cost of WWI to US while small compared to
cost to nations involved in Europe are still
significant to US government.
Financing World War I, 1917–1919
Most the expenditures financed through borrowing.
Financing WWI
• Increase in demand for armaments produced
in the United States
– Not just for US troops, but also for other allies.
– Paid for by loans made from US banks to allied
nations
Consequence of WWI
• At the end of WWI, US is clearly the dominant
world power.
– European nations on the continent suffer large
casualties and losses of capital.
– German and Austria-Hungarian empire are
dismantled into large number of smaller countries
– Britain’s Navy and merchant shipping suffers large
losses.
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 standard
WWI ends
• Britain is no longer dominant economy, US is unwilling to be
the leader
• Treaty of Versailles
– Requires Germany to repay large amount of money
• 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 in 1925
Exchange rate problems
• Old rates do not reflect new reality
– British pound is over valued by 10%
• British exports are more expensive, import less
• British trade surplus which had been important source of foreign investment
declines
• Can only continue to do this if interest rates in US remain low.
Consequences of WWI
• Even though US is dominate power, both economically and
militarily, it still does not act as if it is
• Foreign policy is still isolationist
• Trade policy is protectionist
• Immigration restrictions
– Consequence of union activity
– Starts with restrictions like literacy and financial restrictions and ends
in 1921 with Emergency Immigration Act which restricts the number
of people entering to 3% of the people of that nationality residing in
US in 1910.
Immigration, 1910–1929
Economic Growth
• Some controversy about growth rate of real GDP
during WWI
– Christina Romer’s estimates suggest less growth than
official statistics
• Real GDP grows 4.7% per year between 1921-1929,
unemployment is 4%
– Recession 1920/21
• Almost half the world’s industrial output between
1925 and 1929 was produced in the US
year
Real GDP
GDP deflator
Per capita GDP
1920
$687.7
12.85
$6,460
1921
$671.9
10.95
$6,191
1922
$709.3
10.35
$6,445
1923
$802.6
10.64
$7,170
1924
$827.4
10.51
$7,251
1925
$846.8
10.70
$7,311
1926
$902.1
10.75
$7,684
1927
$910.8
10.49
$7,652
1928
$921.3
10.57
$7,645
1929
$977.0
10.61
$8,016
Was this growth result of macroeconomic policy?
Federal Reserve Policy
• What was it? Not clear that it was to increase
economic growth
• Federal Reserve Act 1913 gave Fed control of
reserve rates and rediscount rates
– rediscount rate is what the Fed will pay to by a
banknote due in the future now
– Fed could originally only loan to banks by buying
short term loans
Federal Reserve Policy
• Fed increases the discount rate in 1920
• Possible shift in 1924 to idea the Fed should
use open market operations to stimulate
economy in rescession
• Not only were its goals unclear, Fed had
limited information
– No gdp estimates
– No unemployment statistics
• Income distribution is more unequal
– 1922 top 1% have 13.4 % of income
– 1929 top 1 % have 14.5% of income
• Boom in building sectors
– Value of new construction goes up from 6.7 billion
in 1920, 12.1 billion in 1925, 10.1 billion in 1929
– Evidence of oversupply by mid 20s
• Automobiles and other consumer durables are
booming, table shows percent of families with
durables over time
Electric
lights
Inside
plumbing
Washing
machines
Car
1900
3
15
<1
<1
1910
15
<1
1
1920
35
20
8
26
1930
68
51
24
60
Automobile Industry
• In 1899 56 cars were produced, by 1920 more
than 25 % of US families own a car.
• Increase in ownership caused by decrease in
price
– Henry Ford’s use of assembly line
– Price of a Ford car fell 80% from 1909-1929
Consumer Credit
• Along with increase in consumer durables,
there was an increase in consumer credit
• Consumers could purchase an item by paying
a down payment and making payments over
time.
• These loans were secured (unlike general
store credit) but still risky.
Goods Families Purchased on installment
(1918–1919)
Labor Market Changes
Increase in education levels. Not clear to what extent this is a cause of economic
growth or a consequence.
Continued difference between the South and the rest of the country.
Farm sector is depressed
• Farm price increased during WWI, then fell
• Between 1920-1929, farm income dropped by
21%
• Increase in costs, interest rates, taxes
– Taxes per acre increased 40%
• Farm output as a % of GDP went from 18% to
12.4%
Financial Sector
• Stock prices increased throughout this period
1920
100
1921
105
1922
129
1923
125
1924
150
1925
183
1926
188
1927
240
1928
320
1929
276
1930
192
• President Hoover and members of Federal
Reserve felt stock price increase was a bubble
• Common to buy stocks on margin
– Banks are loaning money to investors based on
assumption that prices will go up
• Fed sent letter on February 2, 1929 to Federal
Reserve banks. :
The board has no disposition to assume authority to interfere with the
loan practices of member banks so long as they do not involve the Federal
reserve banks. It has, however, a grave responsibility whenever there is
evidence that member banks are maintaining speculative security loans
with the aid of Federal reserve credit. When such is the case the Federal
reserve bank becomes either a contributing or a sustaining factor in the
current volume of speculative security credit. This is not in harmony with
the intent of the Federal Reserve Act, nor is it conducive to the
wholesome operation of the banking and credit system of the country.
(Board of Governors of the Federal Reserve 1929: 93–94, quoted from
Cecchetti, 1998)
Fed Actions
• Attempts to stop speculation
– Raises discount rate from 3 to 5 percent
– Sells large quantity of securities
• This is a deflationary policy.
• Rising interest rates make it difficult for
European countries who need to borrow.