Transcript GD_2013_v2_postx

The Great
Depression
(1929-1941)
Housekeeping
Midterm on Wed October 9 11:35-12:50 pm
Law School Auditorium
(NOT Dunham Lab)
TF office hours
Review sessions Mon and Tues night (see class web site).
Final questions?
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Key Elements in the Great Depression
1929-1933
• Started as asset price bubble and burst in 1920s
• Gold standard hamstrung central banks from expansionary
actions.
• Collapse of investment and international trade after 1929
• Multiple bank failures through 1933 (standard panic model)
• Unclear why so deep and persistent: low level equilibrium?
• No effective fiscal policy until 1940
• Trough finally reached in 1933, but no sharp recovery
• Recovery came only with fiscal expansion in World War II
3
Prelude to the Great Depression: Asset bubble
The asset bubble of the 1920s
Stock market wealth/GDP (1918 = 100)
300
250
200
150
100
50
0
1920
1925
1930
1935
1940
4
The Great Crash, October 1929
Bank failures and panics, 1931-1933
GDP Gap in Depression
Actual/Potential GDP
1.1
1.0
0.9
0.8
0.7
0.6
1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939
Cumulative loss in postwar recessions (%-years)
50
45
40
35
30
25
20
15
10
5
0
8
Cumulative loss of Great Depression (%-years)
250
200
150
100
50
0
9
High unemployment for a decade
High unemployment for a decade
30
25
20
15
10
5
0
1928
1930
1932
1934
1936
1938
1940
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Economic migration
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 in October 1931
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
Classical theories:
• Basically a variant on real business cycles
• Complicated story for another time. Bottom line is
that it can’t explain the major movements
Keynesian theories:
• Expenditure view: IS or spending shocks
• Financial market distress: MP or financial shocks
• Low-level equilibrium trap
15
IS interpretation of the depression
interest
rate
(r)
IS1929
IS1933
MP
Y1929
Y1933
0
Real output (Y)
16
I. The Expenditure Approach: IS Shocks
Were shocks in the IS curve responsible?
– Foreign trade, government spending and taxes were
too small to cause depression
– No apparent exogenous consumption shock
– Investment decline was the major shock.
• Panics, high risk premiums, low output, unstable
dynamics
• Shift to “bad investment equilibrium” clearly at
work
17
Investment accelerator at work
100
1929
Investment
80
60
40
20
0
700
1933
800
900
1,000
1,100
GDP
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II. Financial Markets and the Depression
• Central banks generally have to serve three masters in different
mixes over time. This was the Fed’s trilemma in 1928-33.
1. financial market stability (asset prices, panics, liquidity)
2. exchange rates (gold standard and convertibility)
3. macroeconomy (inflation, output, and employment)
• Fed was primarily concerned about (#1) speculation in 1928-29 and
tightened money at that point.
• When depression was underway, Fed was primarily concerned with
defending the gold standard (#2) 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 (#3).
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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)
Money in the Great Depression
1.2
1.1
1.0
0.9
0.8
0.7
0.6
0.5
0.4
28
29
30 31
32
33 34
35
M1 (1929 = 1)
Industrial production (1929 = 1)
36
21
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
Monetarism, the Depression, and IS-MP
interest
rate
(i)
MP‘
MP
i**
i*
IS
Y**
Y*
Real output (Y)
23
Problem with monetarist interpretation of Depression
Tobin wrote severe critique of Friedman and Schwartz.
Problems:
• While it is true that M1 fell, it is likely to be a consequence
rather than a cause of the Depression (Tobin).
• Interest rates fell rather than rose (much like today).
• While Fed might have done more, hard to see how they caused
the Depression
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Interest Rates 1920-39
Problem with
monetarist
interpretation:
Safe interest rates
fell in GD!!!
Interest rate (% per year)
10
8
6
4
2
0
20
22
24
26
28
30
3-month T-bill
Fed discount rate (low)
32
34
36
38
40
Corporate bond rate
Commercial paper rate
25
Fed interest rates:
Great Depression and Great Recession
7
6
Depression
5
4
3
2
1
Today
0
1926
1928
2008
1930
2010
1932
2012
1934
1936
1938
1940
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Bad equilibrium view of Great Depression
A final approach:
1. Began with asset price bubble and high leverage.
2. Then had huge IS shock due to risk, panics, deflation, and
the result was high risky real interest rates.
3. This forced economy into a liquidity trap (like today), so
that monetary policy was ineffective.
4. Government was too small to have effective fiscal policy.
5. Got locked into “bad equilibrium” of deflation, high risk
premiums, fear, low investment, and low spending.
6. 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
MP1929
= MP1933
MP1939
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 rise of the dictators (1917 - )
World War II (1931-1945)
Military spending takes off…
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!
34
The end of the depression …
30
.6
15
10
Pearl Harbor
Germ invastion Austria, Czech
20
.5
Germ invasion France
25
Germ. invastion Poland
WW II
.4
.3
.2
5
.1
0
.0
30
32
34
36
38
40
42
44
Unemployment rate
Defense spending/GDP
Federal expenditures/GDP
46
48
35
interest
rate
(i)
IS1939
IS1945
• Stimulus was 25% of
GDP.
• Equivalent to $4
trillion/year stimulus
package
WW II
Y1945
0
Y1939
MP
Real output (Y)
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Implication of the Recovery
• Recovery from GD required an increase in highemployment 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 seductive simplicity of monocausal
approaches.
• Perhaps a complex situation where combination of factors
piled up to produce a “bad depression equilibrium”
• Size of WW II stimulus suggests that no ordinary monetary or
fiscal policy could have quickly ended the depression.
• Can it happen again? To answer need to understand how
macroeconomic theory and institutions have evolved.
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