Transcript Great Depression and the New Deal

Great Depression and New Deal
• Great Depression is unique in US economic
history
– Large fall in GDP
– Length of depression.
– 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
Between 1929
and 1933, real
GDP had
fallen 29%.
By 1932
investment
had fallen to
1% of GDP.
Events of the Great Depression
• NBER dates beginning in August 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)
• Stock Market Crash October 1929
• Recession of 1929-30 was not unusual by
historical standards
Events of Great Depression
• Banking panics and failures started in Oct
1930 and continued to Dec 1930
– Harvest failure in Midwest
• Failure of Bank of United States in New York –
Dec 1930
• 2nd Wave June 1931-December 1931
– Bank failure in Europe, Britain goes off gold
standard. ( Great Depression is world wide event.)
• 3rd Wave- December 1932 –March 1933
• President Roosevelt declares national bank
holiday, March 6, 1933
• Result is decrease in money supply and faith in
banking system
• Unemployment is 25 % by March 1933
Response to Bank Failure
• Before Fed, banks would suspend payments,
(bank holiday), 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
Monetary Explanations
• Friedman and Schwartz
• When Fed did not step in as “Lender as Last
Resort” in Banking Panics result was huge
decrease in money supply
– 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
• Firms make investment decisions based on
real rates
Why didn’t the Fed act?
• Fed felt bank failures were due to poor
management, not panics
• No statistics available for economy as a whole.
• 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, i.e.
make money by simply holding it because prices
are decreasing.
• Not clear Fed’s understanding of Monetary
policy was great enough to act in the was FS
said they should
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
A
P
B
P2
1. A decrease in
aggregate demand . . .
Aggregate
demand, AD
AD2
0
Y2
Y
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 because of
information problems
Gold Standard Problems cause decline
in Net Exports
• 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 must
import but will not do this
– Smoot- Hawley Tariff passed in June 1930
– Exports and imports are less than 10% of GDP
Decline in Investment
• Firms loose confidence
• Real interest rates are high
• Keynes- “Animal Spirits”
A Fall in Aggregate Demand in LR
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
Why does AS not shift back?
• AD keeps shifting down (more than one
reason for the shift)
• Adjustment in AS comes when people’s
expectations adjust. Too much uncertainty
prevents this
• Something prevents prices from adjusting
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
• FDIC created in 1934 to insure bank deposits
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