The Great Depression 19291933 1939.ppt by longze569

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									The Great Depression
     1929-1933
The Defining Moment
         Why ―Great‖ Depression
Ben Bernanke: ―To understand the Great Depression is the
Holy Grail of macroeconomics. Not only did the Depression
give birth to macroeconomics as a distinct field of study, but
also---to an extent that is not always fully appreciated—the
experience of the 1930s continues to influence
macroeconomists; beliefs, policy recommendations and
research agendas…..We do not yet have our hands on the
Grail by any means…..‖(JMCB, 1995)
        Rex Tugwell
   (advisor to Roosevelt)
 ―The Cat is out of the Bag.
 There is no invisible hand.
  There never was. If the
depression has not taught us
  that we are incapable of
 education…..We must now
  supply a real and visible
 guiding hand to do the task
     which that mythical,
nonexistent, invisible agency
 was supposed to perform,
       but never did.‖
         The Prelude 1919-1929
• U.S. enters the war late. (1917-1918)
  effects on U.S. economy relatively small
  compared to European economies.
• Huge damage and disruption to European
  economies.
• Real GDP = 100 in 1913. In 1919,
  UK=101 France=75 Germany=72 US = 116
• Inflation! Price level = 100 in 1914. In 1918
  UK=210 France=213 Germany304 US=164
• Huge climb in Debt/GDP ratios.
              Consequences
1. World War I---9.5 million deaths. Loss of a
   generation (UK 1m, France 1.4m, Germany 2m,
   US 114,000)
2. Destruction of physical capital especially
   Belgium and northern France
3. Distortion of patterns of production, trade and
   consumption (e.g. high wartime prices for
   commodities—boom and collapse in U.S.
4. High cost of war. Estimated $208 billion.
5. Political and economic borders of Europe are
   redrawn.
6. Inter-allied war debts and German reparations.
        Inter-Allied War Debts ($ billions)
     (Kindleberger,The World in Depression

                                                       France

                           4.0                 3.0

                    4.7                                             3.5
United States               United Kingdom

                                                     8.1
                          3.2

                                                     Other Countries

    To pay principal and interest, war devastated economies would
    have to run balance of payments surpluses.
         German Reparations
• John Maynard Keynes (1919) Reparations
  were a ―policy of reducing Germany to
  servitude for a generation, of degrading
  the lives of millions of human beings, and
  of depriving a whole nation of happiness.‖
  They were ―abhorrent and detestable.‖
• Étienne Mantoux (1946) Reparations not
  excessive, destructive or uncollectible.
• The French paid in 1815 and 1871---‖Le
  Boche Paiera‖
    The magnitude of reparations
                   Indemnity Percent Share of
                    (billions) of One    Debt
                               Year's   Service
                                GDP     to GDP
France 1815-1819   FF 1.65 to 18 to 21 1.2 to 1.4
                   1.95
France 1871        FF 5.0        25        0.7
Germany1923-1931 DM 50           83        2.5
Vichy 1940-44    FF 479          111       2.6
Germany1953-1965 527 US$         7.7       0.4
Japan 1955-1965  1486 US$        3.0       0.8
Solution---the Dawes Loan 1924
• German Hyperinflation.
• Dawes Loan---begins series of loans---
  U.S. provides funds and funds for
  investment around the globe.
• New York as central of global finance—not
  London
        Return to Gold Standard
        ―Status Quo Antebellum‖
• No problem for U.S.—huge balance of payments
  surpluses and gold
• U.K. deflates and returns to gold in 1925 at old
  parity £1 = $4.86. But overvalued. Depressed
  economy.
• France with near hyperinflation returns to gold in
  1926 at a new parity (old $1= 5FF now $1 = 25.5
  FF) Undervalued currency. Booming economy.
• Germany’s hyperinflation---returns to gold at
  near purchasing power 1925.
• Major imbalances---brittle equilibrium.
    Adjustment under restored gold
        standard more difficult
• International capital markets are revived---
  generally free.
• International labor flows almost
  eliminated—immigration restrictions
• Increased protectionism
• Less wage flexibility. Wage now seem
  sticky even with high unemployment
U.S. Economic Prosperity in 1920s
•   No trend inflation
•   High productivity growth
•   1922-1929, GNP grew at 4.7%,
•   Unemployment averaged 3.7%.
•   Fed accommodated seasonal demands for
    credit and attempted to smooth economic
    fluctuations. (2 brief recessions)
            Some basic numbers
•   Peak August 1929, Trough May 1933
•   Real GDP falls 39%
•   Real Consumption falls 29%
•   Prices (GDP deflator) falls 23%
•   Unemployment Jumps:
    – 3.2% in 1929
    – 25% in 1933 (21%Darby)
    – 17% in 1939 (17% Darby)
• Banking Collapse
    – July 1929, 24,504 banks, $49 billion deposits.
    – December 1932, 17,802 banks, with $36 billion.
    – After Bank Holiday March 1933, 11,878 banks with
      $23 billion deposits.
  Key American Role in World Depression
• Based on
  industrial
  production
  GD starts in
  most
  countries at
  the same
  time
• But it is
  larger and
  longer in the
  U.S. Romer
  (1993)
Worst in the U.S.
• For the U.S.,
  Industrial
  Production
   – Biggest drop in
     first year
   – Biggest drop
     peak to trough
   – Biggest drop in
     the last year.
• However, turning
  points are very
  similar
      Understanding the Great Depression:
            Its Evolution by Phases
                                                                          Real GDP, 1920-1941

1.   Booming Strong Economy in 1920s
                  140


2.   Beginning Shocks, 1928-1929
                  130
3.   Aggravating Shocks, 1930-1933
4.   Rock Bottom and Recovery, 1933-1936
                  120


5.   The 1937-1938 Recession
                  110

6.   The Recovery, 1939-1941
                1929=100




                           100



                            90



                            80



                            70



                            60
                                 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941
 Understanding the
 Great Depression:
Four Basic Questions                                                    Real GDP, 1920-1941

                         140

1.   Why it Began?
                         130
2.   Why so Deep?
3.   Duration?           120




4.   Recovery?           110
              1929=100




                         100



                          90



                          80



                          70



                          60
                               1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941
      Understanding the Great Depression:
            Its Evolution by Phases
1.     Booming Strong Economy in 1920s…but
     a) It’s the Roaring Twenties!
     b) No trend inflation
     c) High productivity growth
     d) 1922-1929, GNP grew at 4.7%,
     e) Unemployment averaged 3.7%.
     f) Fed accommodated seasonal demands for credit and
         attempted to smooth economic fluctuations. (2 brief
         recessions)
     g) BUT: Weak American Agriculture: low prices, high debt,
         weak banks
     h) BUT: Weak Europe: reparations, debts to U.S., slow
         growth, gold standard fragile (overvalued £, UK slumps)
         and (undervalued FF, France booms)
     i) BUT: U.S. Stock market boom halts foreign loans to
         Germany, Eastern Europe and Latin America
     Understanding the Great Depression:
           Its Evolution by Phases
2.        Beginning Shocks, 1928-1929
     a)     Spring 1927 U.S. expansionary monetary policy to ease pressure
            on the British balance of payments. Critics assert policy too easy,
            and allows stock market boom to ignite
     b)     Fed tightens policy in 1928 (discount rate 3 ½ to 5%, and there is
            little increase in total money or credit for 1928-1929.
     c)     U.S. stock market boom begins March 1928.
     d)     Commercial paper market vanishes
     e)     No new lending to Germany, Austria and rest of work in
            1928….Germany slides into a recession.
     f)     Fed tries to ―jaw-bone‖ market down. Criticizes brokers loans.
     g)     July 1929 raises discount rate from 5 to 6%.
     h)     But July-August is peak of business cycle. Recession begins
            Summer 1929
     i)     October 1929 U.S. Stock market crash: wealth effect—lowers
            consumption and investment, credit effect—reduces value of
            collateral and hence lending
     j)     Smoot-Hawley tariff 1929 by U.S. induces retaliatory tariffs by
            other countries, international trade declines
          Understanding the Great Depression:
                Its Evolution by Phases
3.  Aggravating Shocks, 1930-1933
   a) Banking Panics, 1930, 1931, 1933
   b) Failure of the Fed to Pursue Expansionary Policy
   c) Collapse of Gold Standard: Austria, Germany leave the gold
       standard, Britain departs after a run on the pound in September 1931
   d) U.S. begins losing gold, trade deficits and capital flight.
4.  From Rock Bottom to Recovery, 1933-1936
   a) Bank Holiday March 1933
   b) U.S. abandons the Gold Standard March 1933
   c) New Deal Banking and Securities Legislation
   d) Monetary Expansion
   e) Minimal Fiscal Policy
     f)     National Industrial Recovery Act (NIRA)
5.        The 1937-1938 Recession
     a)     The Fed Raises Reserve Requirements
6.    The Recovery, 1939-1941
     a) Monetary Expansion
     b) Fiscal Expansion in preparation for war.
      Four Basic Questions:
        1. Why It Began?
 2. Why So Deep and 3. So Long?
• Friedman and Schwartz (and others), the
  economy is entering a recession in late
  1929
• The economy is beginning to recover in
  1931 like a normal business cycle
• BUT what makes the recession worse?
• What turns the recession into a
  depression?
       The Worsening Depression
• Slight recovery early 1931,then plunge.
• Why?
• Romer (1993) ―The source of the continued
  decline in production in the United States was
  almost surely a series of banking panics.‖
• Friedman and Schwartz (1963) document four
  panics
  –   Fall of 1930
  –   Spring 1931
  –   Fall 1931---Britain abandons the Gold Standard
  –   First Quarter 1933
• 9000 Banks suspend operations. Depositors
  and stockholders lose $2.5 billion = 2.4% of
  GDP…...not the whole story
Why are there
banking panics?
       Why Banking Panics?
• There were no banking panics in Canada.
• Fragmented unit banking system
• Undiversified bank portfolios with high
  regional concentration of loans. Large
  number of bank closures in the agricultural
  states when agricultural prices fall. In
  addition, many hold bonds whose value
  collapsed.
• Many banks become insolvent
• Fear of insolvency feeds the liquidity
  crisespanics.
    Effects of Banking Panics
• Money Supply Declines and there is a massive
  rise in realized real interest rates, over 10%.
• Friedman and Schwartz blame inaction of the
  Fed for this decline---and hence for the
  depression.
  How do Friedman and Schwartz
  explain why the Fed did not act?
• Up to end of 1930
  – What is the Fed concerned
    about?
  – How does it react to banking
    failures?
• Who was Benjamin Strong?
• New York Fed v. Board of
  Governors?
• What could the Fed have
  done 1930-1931?
• What does Congress do?
          Why didn’t the Fed act?
• Beginning in 1931, Friedman and Schwartz argue that Fed
  could have expanded but chose not to.
• In diary of Charles S. Hamlin member of the FR Board, he
  wrote during August 1931 that Open market committee
  voted 11 to 1 against $300 million open market purchase
  of bonds---reduce it to $120 million.
• Governor Mayer of the Board worried about inflation.
• Members of the regional banks did not grasp the extent of
  the crisis.
• Pressure from Congress---open market operations of $1
  billion. Until Congress adjourns.
• After Britain leaves gold in September 1931, gold drain
  starts. Dollars exchanged for gold---Fed’s reserves fall, it
  is afraid that further expansion will lead to greater loss of
  gold----constrained by the gold standard. Reserves falling
  after UK goes off gold in 1931, must retain high interest
  rates.
Understanding the Great Depression:
       Four Basic Questions
    1.   Why it Began?
    2.   Why so Deep?
    3.   Duration?
    4.   Recovery?
  Understanding the Great Depression:
         Four Basic Questions
1. Why it Began?
    Business Cycle Peak 7/8-1929, Federal
    Reserve’s tight policy
2. Why so Deep?
    Banking Panics. Inaction of the Federal
    Reserve
3. Duration?
4. Recovery?
 How is the economy driven into a
severe depression by the declining
          money supply?

    What is the mechanism of
         transmission?

    Several Explanations……
        Romer (1993) basic argument is simple
   • Depression is the result of a series of aggregate demand
     (monetary) shocks that moved economy down an
     upward sloping aggregate supply curve.


Price                          Price
Level                          Level




                      Output                       Output
  Romer (1993) basic argument is simple
• Depression is the result of a series of aggregate
  demand (monetary) shocks that moved
  economy down an upward sloping aggregate
  supply curve.
• Result is two problems: (1) unemployment and
  (2) deflation.
• Unemployment:
  – Key point is the upward sloping supply curve.
    Wages and prices not perfectly flexible in 1920s and
    1930s.
  – Why did they become less flexible? Some studies
    point to turn-of-the-century change in labor contracts,
    World War I or desire of business to keep demand
    strong.
  – Wage and price stickiness means that aggregate
    demand shocks will have real effects.
The Sticky Wage Conundrum---markets don’t seem to clear
  How did deflationary shocks affect the
               economy?
• Conventional 19th century view: fall in wages and
  prices raises stimulate investment, countering
  shock….but not in sticky price world.
• How did the monetary shocks hurt the
  economy?
  – Explanation 1: High real interest rate hypothesis:
    Deflation affects expectations. Deflation generates
    expectations of higher real rate of interest, raising real
    rates and driving down investment
  – Explanation 2: Debt-Deflation hypothesis:
    Unanticipated inflation increased real debt, increasing
    defaults and thus depressing supply of credit
  Rising Real Interest              r = i – p(expected)
  Rates—Did the Fed
      understand?
• Nominal commercial paper
  rate 1927.4 to 1928.4 rises
  from 4.0% to 5.5% and the
  realized real rate from 5.6% to
  9.5%.
• Rational expectations
  estimates by Romer of the
  expected real interest rate are
  shown to rise----implying
  higher anticipated interest
  rates.
• Interest sensitive industries
  begin to slow in 1929: building
  permits and automobile
  registrations.
• Sources of the onset—1929-1930/1931 contrasts
  previous experience
• The decline in consumer spending and fixed investment
  that are the key elements that need to be explained.
Romer (1992)
 The Risk
 Premium
during the
Depression


Rate Romer uses
Debt Deflation
Hypothesis:
Hamilton looks at
the futures
markets for
predictions of
future prices----
errors random
until 1930s when
underestimate
deflation seriously-
---don’t believe
that crisis will
continue
 Klug, Landon-Lane and White looked at the forecasts of
  Railroad Shippers and found huge cumulating errors in
forecasts of carloadings---businessmen keep thinking that
                                       recovery is around the bend.
                          20



                          10



                           0
       percentage error




                          -10



                          -20



                          -30



                          -40



                          -50
                                1928      1930   1932         1934      1936   1938   1940
                                                     Year and Quarter
Bernanke’s Contribution—a Third Factor
• In addition to monetary collapse, there was a
  disruption of intermediation.
• Bernanke (1983): banks play special role for
  firms that cannot issue bonds and stocks. When
  banks fail the information and relationships are
  lost and the cost of credit intermediation rises.
  Costs include screening, monitoring, and
  accounting costs as well as expected losses
  from bad borrowers.
• Major contribution to economic decline 1931 and
  1932.
Banking crises an
important
determinant of
loans as much as
industrial      Panic
production.     begins

Liquidation of loans
after stock market
crash
But then credit
declines little even
though IP falls 25%
until banking
crises.
  Understanding the Great Depression:
         Four Basic Questions
1. Why it Began?
     Business Cycle Peak 7/8-1929, Federal
     Reserve’s tight policy
2. Why so Deep?
     Banking Panics. Inaction of the Federal
     Reserve—prolonged monetary contraction
3. Duration?----Clearly inaction plays a
   role—what else?
4. Recovery?
        What about Fiscal Policy—Deficit
                  Spending?




Price                    Price
Level                    Level




                Output              Output
                Fiscal Policy?—Deficit Spending?
                                                                                      In 2005---it was -2.6%
                                               Federal Deficit as Percentage of GDP

          10


           8


           6


           4


           2
Percent




           0
                1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939
           -2


           -4


           -6


           -8


          -10

                                                   Actual GDP        Full Employment GDP
           Industrial Policy?
• Specific Intervention in industry?
• National Industry Recovery Act (NIRA) of 1933
  created the National Recovery Administration
  (NRA). (Declared unconstitutional May 1935)
• National Labor Relations Act (1935) that
  promoted unions and Fair Labor Standards Act
  (1938) that set minimum wages in certain
  industries and regulates working conditions.
• NRA established guidelines that raised nominal
  wages and prices and encouraged higher levels
  of employment by work-sharing reductions in the
  length of the work week.
                  Industrial Policy
• Weinstein (1980), using
  aggregate monthly data on
  hourly earnings in
  manufacturing, he found that
  the NIRA raised nominal wages
  directly and indirectly by raising
  prices. Econometric estimates
  that average hourly earnings
  would have been 35 cents not
  60 cents.
• Result----higher wages create
  more unemployment and
  increase the duration of the
  depression because of higher
  costs to producers---
  counterproductive
• Shift in the Aggregate Supply
  Curve
     Did the
Duration have
something to
 do with bad
   monetary
     policy?
 After 1929-
1933, had the
 Fed learned
  its lesson?
     Recession of 1937-1938
• Did the Fed learn its lesson?
• Rising excess reserves held by banks—
  Fed worries about inflation potential and
  wants to induce lending.
• Uses new tool of required reserves.
  Required reserve ratio doubled.
• Result? Banks raise their excess reserves
  and huge monetary contraction.
  Understanding the Great Depression:
         Four Basic Questions
1. Why it Began?
     Business Cycle Peak 7/8-1929, Federal Reserve’s
     tight policy
2. Why so Deep?
     Banking Panics. Inaction of the Federal Reserve.
     Prolonged Monetary Contraction
3. Duration?
     Continued Monetary Policy Mistakes, Fiscal Policy
     not tried. Industrial Policy makes things worse.
4. Recovery? Why?
    Recovery, 1934-1937….why?
• Real GDP grows at
  10% p.a. 1934-
  1937.
• But real GDP on
  reaches 1929 peak
  in 1937 and trend
  path in 1942.
• What drove the
  recovery.
• Friedman and
  Schwartz (1963)
  and Romer (1992):
  huge increases in
  the money supply.
                                                                    Real GDP, 1920-1941

           140



           130



           120



           110
1929=100




           100



            90



            80



            70



            60
                 1920 1921   1922   1923 1924   1925   1926 1927   1928   1929 1930   1931 1932   1933   1934 1935   1936   1937 1938   1939   1940 1941
  What
Increase
  d the
 Money
Supply?
How was the money supply increased?
• F.D. Roosevelt takes emergency powers granted by
  Congress in the 100 days.
• FDR allows the dollar to depreciate—sets new value for
  gold in 1934: from $20.36 per ounce to $35 per ounce.
• Huge revaluation of big U.S. gold stocks. Treasury
  issues gold certificates equal in value to increase and
  deposits them with the Fed. As government spends
  them, they enter the monetary base. High powered
  money increased 12% between April 1933 and April
  1934.
• Devaluation also improved the competitiveness of U.S.
  goods—rise in the trade balance.
• Devaluation attracted capital flows from Europe,
  especially with Hitler’s rise to power. High powered
  money rises 40% from April 1934 to April 1937.
• Result: real interest rates fall and recovery of investment
  and consumer durable spending.
What drove
the money
supply?
  Understanding the Great Depression:
         Four Basic Questions
1. Why it Began?
     Business Cycle Peak 7/8-1929, Federal Reserve’s
     tight policy
2. Why so Deep?
     Banking Panics. Inaction of the Federal Reserve
     Prolonged Monetary Contraction.
3. Duration?
     Continued Monetary Policy Mistakes, Fiscal Policy
     not tried. Industrial Policy makes things worse.
4. Recovery?
     Monetary Expansion
 Some Effects of the Great Depression
1. Activist Monetary Policy
2. Activist Fiscal Policy---idea of cyclically
   balanced budget
3. Insurance and Regulation of the Financial
   Sector
4. Agricultural Regulation
5. Growth of Government and shift in Federalism
6. Growth of Unions
7. Genesis of Social Security
8. Smoot-Hawley Tariff of 1929 to the WTO
9. The IMF and World Bank

								
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