Download The Great Depression of the 1930s

The Great Depression of the1930s:
Lessons for Policy Today
Nicholas Crafts
Economic History Seminar
Bank of Spain
October 6, 2016
The Great Depression of the 1930s
• Deflation, slump and crises
• Collapse of gold standard
• Life at the ZLB
• Strong recoveries
The Great Depression in the
Advanced Countries
Real GDP
Price Level
Unemployment Trade
(%)
Volume
1929
100.0
100.0
7.2
100.0
1930
95.2
90.8
14.1
94.8
1931
89.2
79.9
22.8
89.5
1932
83.3
73.1
31.4
76.5
1933
84.3
71.7
29.8
78.4
1934
89.0
75.3
23.9
79.6
1935
94.0
77.6
21.9
81.8
1936
100.6
81.4
18.0
85.7
1937
105.3
91.5
14.3
97.4
1938
105.4
90.4
16.5
87.0
Myths (1)
• The Wall Street Crash caused the
American Great Depression
• There was a great depression in the UK in
the 1930s
• Rearmament rescued the UK from
depression
Myths (2)
• Roosevelt’s New Deal was a massive
fiscal stimulus
• The Glass-Steagall Act was evidencebased policy
• The United States was mired in secular
stagnation in the 1930s
The USA in the 1930s
Real GDP
GDP Deflator
Unemployment
Stock Market
(%)
Prices
1929
100.0
100.0
2.9
100.0
1930
91.4
96.4
8.9
69.4
1931
85.6
86.3
15.6
35.8
1932
74.4
76.2
22.9
30.8
1933
73.4
74.2
20.9
46.2
1934
81.3
78.4
16.2
45.8
1935
88.6
79.9
14.4
63.1
1936
100.0
80.7
10.0
79.8
1937
105.3
84.1
9.2
50.5
1938
101.6
81.7
12.5
61.7
Impact of Wall Street Crash on
Real Economy
• Probably an exogenous component in stock price
declines which might have been but wasn’t neutralized
by Fed policy response (cf. 1987, 2000)
• Transmission mechanism might be via wealth effects,
uncertainty effects, balance-sheet effects
• Wealth effect on consumption quite small (Temin, 1976)
• Uncertainty channel deserves much closer scrutiny
(Baker et al., 2015)
The Banking Crisis in USA
• 1/3 American banks failed
• Bank failures not random but reflected ex-ante
balance-sheet weakness (Calomiris & Mason, 2003a)
and weak regulation (Mitchener, 2007)
• Bank failures led to credit crunch that greatly
exacerbated the effects of monetary contraction
on output (Bernanke, 1983)
• Banks had to re-establish low default risk
through reduced lending and dividends; adverse
impact on supply of credit (Calomiris & Wilson, 2004)
Understanding the Role of Financial
Crisis in the Downturn
Bernanke (1983)
• Key aspect is loss of financial intermediation services;
it’s a severe credit crunch that affects real economy
through supply of loans
• Bernanke’s regression demonstrates that adding bank
failures helps account for the output decline that money
supply per se does not seem to explain
• It’s a black box that needs evidence on bank behaviour
to be more persuasive but suggests that effective LOLR
might have made a big difference
Banking Crisis and Investment
(Calomiris & Wilson, 2004)
• Regression analysis of behaviour of New York banks
• Bank lending in early 1930s constrained by capital
losses, high (adverse selection) costs of issuing equity
and need for liquid assets
• Deposit default risk reduced by shrinking loans and
holding more reserves; high risk penalized by
withdrawals
• Increased costs of equity rather than reduced quasirents from loans promote big reductions in lending –
adverse impact is on supply of loans
An Effective LOLR Was Missed:
Evidence from Mississippi
(Richardson & Troost, 2009)
• Northern (southern) ½ of state in St Louis (Atlanta) Fed
district
• St Louis (Atlanta) was passive (active) in 1930/1
• ‘Quasi-experiment’ shows that aggressive Fed LOLR
policies could have big impact; providing liquidity
reduced bank failures which averted reduction of credit
supply and decline of economic activity
• % banks suspending (failing): 39.2% vs. 14.2% (18.6%
vs. 7.1% in the period of policy difference, otherwise
similar
Investment Banking and Failure Risks
(White, 1986)
• Much higher survival rate for banks with security
affiliates suggests that they offered diversification and
economies of scope advantages
• Having a security affiliate did not reduce capital
adequacy or weaken liquidity
• Return relative to risk looks much better for banks with a
security affiliate; imposing separation of investment and
commercial banking potentially has efficiency costs
• Glass-Steagall Act not evidence-based policy
New Deal and Recovery
• Alphabet soup of New Deal initiatives well
known
• New Deal did not, however, raise aggregate
demand by much (Fishback, 2010)
• Did have adverse labour-market implications
(Bordo et al., 2000;Cole & Ohanian, 2004)
• But was perhaps central to changing
inflationary expectations and escaping the
liquidity trap (Eggertsson, 2008); mentions of inflation
spike in April-May 1933 (Jalil and Rua, 2015)
Fiscal Stimulus
• New Deal was not a big fiscal stimulus –
perhaps about 2.5%GDP (Peppers, 1973)
• In the mid 1930s, fiscal-policy stimulus didn’t fail,
it wasn’t really tried; however, size of fiscal
multiplier not clear
• Roosevelt was definitely not a convinced
Keynesian and by 1937 was seeking to balance
the budget even though D/Y below 0.5
How Big Was the Fiscal Multiplier?
• Not clear: wide range of estimates many of them using
very dubious methods
• Might expect it to vary over time; prima facie, reasons to
think it could have been large in some years (ZLB, U)
• Recent estimates include Gordon & Krenn (2010) at 1.8
but Ramey & Zuchairy (2014) only 0.8
• NB: the key issue is how far output increases reflect
expect future government spending (Ramey, 2011) so
need a strategy to exploit ‘fiscal news’
The End of One Big Deflation
(Temin & Wigmore, 1990)
• Need to explain lower turning point at a time when
money supply not rising
• Expectations of future monetary policy are influenced by
regime change in April 1933 when USA leaves gold; this
was the big signal that the Hoover regime was over
and markets responded very positively
• Policy changes allows real interest rates to be reduced
even though nominal rates are at lower bound
• Classic solution to liquidity trap is credibly to commit to
inflation (Svensson, 2003); this is what the New Deal does
(Eggertsson, 2008)
Inflationary Expectations: the
Narrative Record (Jalil & Rua, 2016)
• Use daily newspapers to count mentions of ‘inflation’;
big spike in April-May 1933 after USA leaves gold
standard and after Thomas Amendment
• Event-study analysis shows that inflationary news
shocks raise stock prices and lower dollar
• Adding a regime-shift dummy (April-July 1933) to
Bernanke (1983) regression suggests industrial output
growth raised by 7 percentage points per month
• NB: Fed no longer independent
Secular Stagnation
• Hansen (1939) famously thought this was the
key problem facing the United States
• Low trend growth prospects (adverse
demography, slow technological progress)
implied low investment demand and would lead
to prolonged (Keynesian) unemployment
• Hansen (1951) thought this could be solved by
deficit-financed government expenditure
Why Was Alvin Hansen Wrong?
• Regime change stimulated strong
recovery post-1933 (Eggertsson, 2008)
• USA had strong TFP growth from the
1920s through the 1960s (Field, 2011)
• Unemployment tends to U* in long-run and
the positive shock of WWII offset
hysteresis effects (Mathy, 2015)
A Revised View of U.S.TFP
Growth Over Time (Bakker et al. (2015)
• Estimates of TFP growth for the PDE through
the 20th century on a consistent basis
• TFP growth in the 1930s is lower than in 19481973; contrary to Field (2003) the1930s is not
the ‘most technologically progressive decade’
• Nevertheless, TFP growth in the 1930s was very
strong and broadly based – quite different from
the ‘productivity puzzle’ of today
TFP Growth in the U. S. Private Domestic
Economy, 1899-2007 (% per year)
1899-1909
0.92
1909-1919
0.68
1919-1929
1.68
1929-1941
1.87
1948-1960
2.00
1960-1973
2.23
1973-1989
0.48
1989-2000
0.98
2000-2007
1.45
Source: Bakker et al. (2015)
Whence Came TFP Growth
before WWII?
• Key feature of the 1930s is very broadly-based
TFP growth; Gordon’s key clusters perform
strongly but do not dominate
• Taken together, the ‘great inventions’ outdo ICT
but the strength of other sectors is remarkable to
modern eyes
• Rapid TFP growth pre-dates the 1930s;
Gordon’s emphasis on positive Great
Depression and WW2 shocks is misplaced
TFP Growth and TFP Contribution to Labor
Productivity Growth in PDE (% per year)
Bakker et al. (2015)
1919-29
1929-41
TFP Growth Contribution
Rate
TFP Growth Contribution
Rate
PDE
1.68
1.68
1.87
1.87
Manufacturing
4.5
1.25
2.3
0.67
Non-Manufacturing
0.6
0.43
1.7
1.20
‘One Big Wave’ Sectors
2.6
0.60
3.1
0.74
Electricals
2.6
0.07
4.9
0.15
Wholesale & Retail Trade
0.9
0.12
3.4
0.46
Early 20th-Century National
Innovation System
• Traditional accounts rightly stress college and highschool education (Acemoglu, 1998; Goldin & Katz, 2008)
• Second key aspect which deserves more attention is
prowess at ‘creative destruction’
• Micro evidence show firms with market power innovating
strongly to maintain rents (Nicholas, 2003)
• Macro evidence using DEA techniques shows lagging
British and German manufacturing productivity
performance with a persistent inefficiency handicap
(Timmer et al., 2016; Woltjer, 2013)
The UK in the 1930s
Real GDP
GDP Deflator
Unemployment
Stock Market
(%)
Prices
1929
100.0
100.0
8.0
100.0
1930
99.9
99.6
12.3
80.5
1931
94.4
97.2
16.4
62.8
1932
95.1
93.7
17.0
60.2
1933
96.0
92.5
15.4
74.3
1934
102.8
91.7
12.9
90.3
1935
106.6
92.6
12.0
100.0
1936
109.9
93.1
10.2
115.9
1937
114.7
96.6
8.5
108.0
1938
118.2
99.3
10.1
88.5
The UK Downturn
• Relatively short and mild (not a depression)
• Fits the international pattern: early devaluation,
no banking crisis
• Unemployment is the reason that the 1930s are
seen as ‘traumatic’
• Strong growth after 1933 but cyclical recovery
driven by fiscal and monetary stimulus rather
than trend improvement
Unemployment Rates for Insured Workers (%)
1924
1929
1932
1937
London
9.0
5.6
13.5
6.4
South East
7.5
5.6
14.3
6.7
South West
9.1
8.1
17.1
7.8
Midlands
9.0
9.3
20.1
7.3
North West
12.9
13.3
25.8
14.0
North East
10.9
13.7
28.5
11.1
8.6
19.3
36.5
23.3
Scotland
12.4
12.1
27.7
16.0
UK
10.3
10.4
22.1
10.8
Wales
Source: Garside (1990)
Devaluation in the 1930s
• In absence of coordinated monetary expansion,
very good for early recovery; staying on the
gold standard made things much worse
• Regain control of interest rate, change
inflationary expectations, remove need for
money wages to fall, increase international
competitiveness, improve fiscal arithmetic
• This policy space allows regime change
Dates of Changes in Gold Standard Policies and
Economic Recovery (Bernanke & James, 1991: Maddison, 2003)
Return to 1929
Income Level
Devaluation
Belgium
1939
03/1935
Denmark
*
09/1931
France
1939
09/1936
Germany
1935
*
Italy
1938
10/1936
Netherlands
1949
09/1936
Norway
1932
09/1931
Sweden
1934
09/1931
Switzerland
1946
09/1936
United Kingdom
1934
09/1931
United States
1940
04/1933
The 1930s UK Recovery: 1st Phase
• Started during fiscal consolidation which
reduced structural deficit by 4%GDP between
1930 and 1934
• Strong growth 1933-35 based on monetary
stimulus which offset negative impact of fiscal
policy
• Exit from gold standard plus cheap money;
housing investment led the recovery
• NB: no banking crisis
The ‘Cheap Money’ Policy
• Was a coherent framework arrived at by mid-1932 at
ZLB with HMT not B of E in charge
• Aim to raise the price level and to underpin this by
holding exchange rate at $3.40 then FFr. 88
• Short term interest rates kept at lower bound and real
interest rates fell
• Credible because it was clearly in HMT’s interests as a
route to recovery that did not open Pandora’s Box and
improved fiscal arithmetic
The ‘Managed Economy’
Strategy of the 1930s
• Post-1932 dirty floating, cartels, tariffs
understandable as damage limitation and as a
way to restore profitability and raise prices
• This implied a major reduction in competition
which lasted well into the post-war period (cf.
Eggertsson, 2012)
• The reduction in competition reduced
productivity growth both before and after WWII
(Crafts, 2012)
The 1930s UK Recovery: 2nd Phase
• From 1935 onwards, rearmament central; large
exogenous fiscal shock with short-term interest
rates held constant
• This was a de facto Keynesian policy
• Probably raised real GDP by about 3-4% in 1938
but fiscal multiplier only 0.5-0.8 (Crafts & Mills,
2013)
• Explanation for ‘low’ multiplier may be high D/Y
Revisiting the Interwar Multiplier
Crafts and Mills (2013) (2015)
• Model-dependent results from macro literature
suggest ‘let the data speak’
• Used time-series analysis of new quarterly data
from Mitchell et al. (2012) applying the ‘defense
news’ approach developed by Ramey (2009,
2011) and adopted by Barro & Redlick (2011)
• Tested a variety of alternative specifications but
fiscal multiplier always < 1
Fiscal Sustainability: Δd = 0
• Δd = -b + d(i – π – ΔY/Y)
so required primary budget surplus is
b = d(i - π – ΔY/Y)
• Required primary budget surplus rises with
higher debt to GDP ratio and higher real interest
rate but falls with faster growth rate
• If the real interest rate is smaller than the real
growth rate, then fiscal sustainability is
consistent with a primary budget deficit
Reducing d in Interwar UK
• Proved extremely difficult despite prevailing balanced
budget orthodoxy; b averaged 6.2% but d in 1938 same
as in 1921
• (r – g) is a massive headwind pre-1932
• ‘Displacement effect’ of WWI used to finance welfare
state not sinking fund (cf. 19th Century)
• Price deflation in the context of returning to gold a
major handicap in the 1920s; leaving the gold standard
transformed the fiscal arithmetic
Fiscal Sustainability Data, UK 1921-1929
b
i
π
g
d
b*
1921
5.10
4.41 -10.52
-4.71
1.472
28.92
1922
7.38
4.45 -16.05
4.11
1.668
27.34
1923
8.92
4.52
-8.01
3.40
1.763
16.10
1924
7.60
4.58
-1.39
5.10
1.726
1.50
1925
6.46
4.59
0.27
2.89
1.633
2.34
1926
6.10
4.85
-1.41
-4.59
1.717
18.63
1927
6.89
4.57
-2.36
8.22
1.635
-2.11
1928
7.53
4.75
-1.12
1.17
1.613
7.58
1929
7.00
4.85
-0.34
3.43
1.584
2.79
Fiscal Sustainability Data, 1930-1938
b
i
π
g
d
b*
1925-9 average
6.80
4.72
-0.99
2.22
1.636
5.85
1930
6.15
4.75
-0.40
-3.72
1.592
14.12
1931
5.41
4.51
-2.40
-2.37
1.698
15.76
1932
7.25
4.49
-3.58
0.65
1.736
12.88
1933
7.42
3.90
-1.40
4.74
1.792
1.00
1934
6.76
3.58
-0.68
4.78
1.731
-0.90
1935
5.68
3.64
0.87
4.26
1.650
-2.46
1936
4.95
3.59
0.55
4.15
1.587
-1.76
1937
3.89
3.67
3.73
3.17
1.472
-4.75
1938
1.56
3.62
2.77
0.42
1.438
0.62
1933-8 average
5.04
3.67
1.67
3.59
1.612
-1.38
1930s’ Fiscal Arithmetic
• Using the standard ex-post fiscal sustainability formula
(Abbas et al., 2011), about 2/3 of the fall in d post 1933
came from budget surpluses
• After exit from the gold standard in an era of limited
capital mobility, the growth/interest rate differential did
the rest (ΔY/Y > r)
• Attraction for HMT (and hence credibility) of cheap
money policy is obvious
• NB: from 1934-1937, b* was negative so rearmament
was compatible with fiscal sustainability
Self-Defeating Austerity
• Means that selected fiscal indicator deteriorates
rather than improves when government
expenditure is cut and/or taxes are raised
• Most often discussed in context of public debt to
GDP ratio (d) and would mean Δd/ΔG < 0
• NB: well-known that path of d is probably not
monotonic under austerity (Boussard et al., 2012)
so need to distinguish short-run and long run
impacts
Deficit-Financed Expenditure
• The debt to GDP ratio (d) will fall if ΔD/ΔY <
D/Y
• This will require that
(1 - τμ)/μ < d or equivalently that μ > 1/(d + τ)
• However, any increase in Y is temporary but any
increase in D is permanent
1930s: Getting the Fiscal Story Right
• Frequently suggested we should not repeat
1930s’ mistakes
• Procyclical fiscal policy attacked by Keynes
• Rearmament seen as major boost to recovery
and indictment of earlier fiscal policy
• d fell as rearmament surged after 1935
• So was austerity ‘self-defeating’ in the 1930s?
Self-Defeating Austerity in the
1930s? (Crafts & Mills, 2015)
Assuming τ = 0.44, d = 1.7, μ = 0.5 – 0.8
• μ > 1/τ definitely was not met, cf. Keynes
(1933)
• μ > 1/(d + τ) may have been met,
depending on lags
• Low μ makes it much less likely
Lessons
• Preventing collapse of banking system is
paramount
• Regime change is the key to recovery in a
‘depressed economy’; easier with ‘subservient
central bank
• Avoiding price deflation is imperative
• Fiscal multiplier is not always big at ZLB
• Major crisis does not necessarily imply long-run
secular stagnation