Download The Great Depression

The Great Depression
The United States Experience
1929-1941
What Caused the Great Depression?
• Why was aggregate demand so low? Is there
evidence to support monetary impotence or
evidence of a failure of the economy to self
correct?
• Did the aggregate supply curve shift down and
to the right, permitting the economy to self
correct?
• Were nominal wages rigid and did real wages
fluctuate procyclically or countercyclically?
Data
Year
1929
1930
1931
1932
1933
1934
1935
1936
1937
1938
1939
1940
1941
MS Real MS Real Y Real I
($, b) ($, b, 1929 prices)
26.0 26.0 103.7 14.9
25.2 26.1
94.8 11.4
23.5 26.7
88.7
8.0
20.6 25.5
77.2
4.5
19.4 24.4
76.1
3.9
21.4 26.0
84.3
5.2
25.3 30.4
91.9
6.7
28.8 34.4 103.7
8.9
30.2 35.0 109.2 11.0
29.8 35.3 105.4
9.1
33.4 39.8 114.0 10.9
38.8 45.8 123.7 13.2
45.4 51.1 144.9 15.5
Y/YN
%
102.8
90.8
82.1
69.0
65.7
70.4
74.1
80.8
82.2
76.7
80.1
84.0
95.0
PI
100
96.3
86.3
76.2
74.1
78.3
79.8
80.7
84.2
81.7
80.7
81.9
87.4
UR r
Avg Hourly Avg Real Hr
%
% Earnings ($) Earnings ($)
3.2 3.6
0.563
0.563
8.9 3.3
0.560
0.581
16.3 3.3
0.532
0.605
24.1 3.7
0.485
0.600
25.2 3.3
0.457
0.575
22.0 3.1
0.512
0.623
20.3 2.8
0.524
0.630
17.0 2.7
0.534
0.637
14.3 2.7
0.566
0.656
19.1 2.6
0.576
0.681
17.2 2.4
0.583
0.695
14.6 2.2
0.597
0.705
9.9 2.0
0.655
0.737
Weak Aggregate Demand
• According to the data, the primary initial cause
of the Great Depression was a decrease in
investment spending.
– Real fixed investment fell by 74% from $14.9
billion in 1929 prices in 1929 to $3.9 billion in
1933.
– By 1939, real fixed investment was still 27%
below the 1929 level despite a 53% increase in the
money supply.
Weak Aggregate Demand
• According to the IS/LM interpretation of
events in the 1930s, the IS curve shifted to the
left while the LM curve shifted to the right.
• The failure of investment to recover is
consistent with either a vertical IS curve or a
horizontal LM curve.
• Which is right?
IS/LM Model
r
IS
r
LM1
LM2
LM
LM3
LM4
r4
r3
r2
r1
r1
IS
0
Y1
YN
Vertical IS Curve
Y
0
Y1
YN
Horizontal LM Curve
Y
Vertical IS? Horizontal LM?
• The IS curve is vertical (or nearly vertical)
when a decline in interest rates fails to
stimulate new investment spending.
– From 1934 to 1940, the interest rate declined from
3.1% to 2.2% while investment spending increased
from $5.2 billion to $13.2 billion.
– Apparently, the IS curve was not vertical.
Vertical IS? Horizontal LM?
• The LM curve is horizontal when an increase
in the money supply fails to reduce interest
rates.
– From 1934 to 1940, the real money supply
increased from $26.0 billion to $45.8 billion while
interest rates fell from 3.1% to 2.2%.
– Apparently, the LM curve was not horizontal.
Monetary vs. Non-monetary Factors
• Gordon and Wilcox determined that both
monetary and non-monetary factors contributed
to the depression, but at different times.
– From 1929 to 1931, the drop in the money supply
was not sufficient to cause the collapse of GDP.
– The collapse must be explained by the loss of
wealth in the stock market and the overbuilding
that occurred during the 1920s.
– But after 1931, the contraction was caused mainly
by monetary factors, particularly the failure of the
banking system.
Prices and the Output Ratio
• Does the behavior of output and the price level
support the Keynesian assumption of rigid
nominal wages or the classical interpretation of
a self-correcting economy?
– If the classical story is correct, then decreases in
the price level should cause the economy to return
to full employment.
– If the Keynesian story is correct, then the failure of
nominal wages to fall should hamper the recovery.
Self Correction?
• The story of the Great Depression appears to
lie in shifts of the aggregate demand curve to
the left and then over time to the right.
• There is no evidence of a shift in the aggregate
supply curve to the right as the price level fell.
– Between 1936 and 1940, there was no deflation
despite the fact that Y/YN was at or below 86%.
The Price Level and Y/YN
P
100
75
P
0
P
LAS
1929
1930
1931 1937 1941
1938
1940
1934
1932 1939
1933
Y/YN
50 60 70 80 90 100 110
100
AD1929
AD1941
75
0
AD1933
LAS Y/Y
N
50 60 70 80 90 100 110
Gordon, p. 222
Behavior of Nominal Wage Rates
• Why did the aggregate supply curve fail to
shift?
– A fixed AS curve requires a rigid nominal wage.
• Between 1929 and 1930 when real GDP fell by 9%,
nominal wages did not decline at all.
• Nominal wages fell between 1931 and 1933, but rose
again by 12% in 1934 when unemployment was 22%.
• By 1937, nominal wages equaled those of 1929 despite
an unemployment rate of 14%.
– Nominal wages were not rigid, but they did not fall
continuously after 1933 so were not part of a self
correction mechanism.
Behavior of Real Wage Rates
• The real wage rose after 1933 despite high
levels of unemployment.
• This is attributed to government intervention.
– During 1934 and 1935, the National Industrial
Recovery Act (NIRA) attempted to raise wages
and prices by instituting industry-specific codes
that required employers to raise wage rates.
– The NIRA was declared unconstitutional in 1935,
and was succeeded by the Wagner Act, which
encouraged union membership.
Data
Year
1929
1930
1931
1932
1933
1934
1935
1936
1937
1938
1939
1940
1941
MS Real MS Real Y Real I
($, b) ($, b, 1929 prices)
26.0 26.0 103.7 14.9
25.2 26.1
94.8 11.4
23.5 26.7
88.7
8.0
20.6 25.5
77.2
4.5
19.4 24.4
76.1
3.9
21.4 26.0
84.3
5.2
25.3 30.4
91.9
6.7
28.8 34.4 103.7
8.9
30.2 35.0 109.2 11.0
29.8 35.3 105.4
9.1
33.4 39.8 114.0 10.9
38.8 45.8 123.7 13.2
45.4 51.1 144.9 15.5
Y/YN
%
102.8
90.8
82.1
69.0
65.7
70.4
74.1
80.8
82.2
76.7
80.1
84.0
95.0
PI
100
96.3
86.3
76.2
74.1
78.3
79.8
80.7
84.2
81.7
80.7
81.9
87.4
UR r
Avg Hr Earn Avg Real Hr
%
% Earnings ($) Earnings ($)
3.2 3.6
0.563
0.563
8.9 3.3
0.560
0.581
16.3 3.3
0.532
0.605
24.1 3.7
0.485
0.600
25.2 3.3
0.457
0.575
22.0 3.1
0.512
0.623
20.3 2.8
0.524
0.630
17.0 2.7
0.534
0.637
14.3 2.7
0.566
0.656
19.1 2.6
0.576
0.681
17.2 2.4
0.583
0.695
14.6 2.2
0.597
0.705
9.9 2.0
0.655
0.737