Tuesday, November 25, 2008

Depression economics

Not only do we know what caused the Great Depression, it seems like we don't really what ended the Great Depression:

MR: The traditional story is that President Franklin D. Roosevelt rescued capitalism by resorting to extensive government intervention; the truth is that Roosevelt changed course from year to year, trying a mix of policies, some good and some bad. ... In short, expansionary monetary policy and wartime orders from Europe, not the well-known policies of the New Deal, did the most to make the American economy climb out of the Depression.

Again MR: Bernanke notes that there were "remarkably strong" productivity gains throughout much of the 1930s, even though there was no capital deepening. This is a central puzzle which any account of the New Deal, or New Deal recovery, must incorporate. ... Rick Szostak's work suggests that the New Deal saw lots of labor-saving, process innovations, which meant both high productivity gains and pressure on labor markets at the same time. In my view most of these gains were simply the result of working through the implications of the earlier fundamental breakthroughs of the preceding twenty years. ... Whatever is the case (and we genuinely don't know), these productivity gains are central to the story of New Deal recovery. Roosevelt may deserve credit for some of them, or for allowing them to proceed, but don't assume that the New Deal caused such gains just because you see them in the gross data.

Arnold Kling via MR: The New Deal is a mythical event in history. Just as we revere the constitution as the basis for our government and we revere Abraham Lincoln for ending slavery and preserving the union, we are supposed to revere the New Deal as somehow providing the basis for our modern prosperity. Yet the policies of the New Deal are quite a mixed bag, to say the least. Most were discarded by 1950. The survivors include agricultural policies that were almost certainly wrong then and are almost certainly wrong now. Most of the financial regulations, such as interest rate ceilings on bank deposits, proved unworkable by the 1970s. Social Security, and its offspring Medicare, are going to be the next great financial crisis in this country.

Again, MR: Christina Romer writes:
This paper examines the role of aggregate demand stimulus in ending the Great Depression. A simple calculation indicates that nearly all of the observed recovery of the U.S. economy prior to 1942 was due to monetary expansion. Huge gold inflows in the mid- and late-1930s swelled the U.S. money stock and appear to have stimulated the economy by lowering real interest rates and encouraging investment spending and purchases of durable goods. The finding that monetary developments were crucial to the recovery implies that self-correction played little role in the growth of real output between 1933 and 1942.

Did the World War Help End the Great Depression? Joseph Cullen and Price Fishback write:
We examine whether local economies that were the centers of federal spending on military mobilization experienced more rapid growth in consumer economic activity than other areas. We have combined information from a wide variety of sources into a data set that allows us to estimate a reduced-form relationship between retail sales per capita growth (1939-1948, 1939-1954, 1939-1958) and federal war spending per capita from 1940 through 1945. The results show that the World War II spending had virtually no effect on the growth rates in consumption that we examined. This contrasts with Fishback, Horrace, and Kantor's (2005) findings of about half a dollar increase in retail sales associated with a dollar of New Deal public works and relief spending. Several factors contributed to this relative lack of impact. World War II spending often required a conversion of plants designed for civilian good production into military factories and back again over the 9 year period. Substantially higher federal tax rates that were paid by the majority of households imposed much stronger fiscal drags on the benefits of the spending. Finally, less of the military spending was earmarked for wages and use of locally produced inputs, which reduced the direct stimulus to the local economy. ... My [Tyler Cowen] understanding has long been that wartime orders from Europe, by 1940, provided the decisive turning point for the American economy. So if WWII did end America's Great Depression, it was not through the traditional mechanism of massive domestic fiscal stimulus.

Some notes by Jim Hamilton on how the New Deal may have prolonged the Depression:
Cole and Ohanian noted that many in the Roosevelt Administration believed that the severity of the Depression was due to excessive business competition that led to wages and prices that were too low. I actually agree, in a perverse sense, with part of that diagnosis-- I see the rapid deflation of 1929-33 as quite destabilizing. But I'm inclined to believe that the way to fix that would have been through a monetary and fiscal expansion rather than trying to lift nominal wages and prices back up by sheer government fiat. ... The purpose of the NIRA and NLRA was to promote labor and trade practice provisions so as to limit the extent of competition between firms and competition between workers. Among the NIRA codes that Cole and Ohanian highlight include minimum prices below which firms were not allowed to sell their products, restrictions on productive capacity and the amount that could be produced, and limitations on the workweek. Cole and Ohanian concluded on the basis of model simulations that these kinds of New Deal policies might have accounted for 60% of the persistence in the output gap. ... I openly confess to believing that government policies that were explicitly designed to limit manufacturing, agricultural, and mining output may indeed have had the effect of limiting manufacturing, agricultural, and mining output.

Finally, via Mark Thoma, the views on fiscal policy and Christina Romer:
Citing Free Exchange: Mr Cowen is seeking to use Ms Romer's findings as evidence that little expansionary action should be taken beyond easy money, but I'm not sure the paper reflects that conclusion. For one thing, it is the extraordinary monetary actions that made the difference during the 1930s—the abandonment of the gold standard coupled with massive capital inflow from Europe. But as importantly, Ms Romer doesn't say that fiscal policy couldn't have worked, just that it didn't. The reason it didn't, as many commentators have pointed out in recent weeks, is that president Roosevelt didn't do a particularly good job of employing it. He was stubbornly resistant to deficit spending, and he threatened to undo the progress made to 1937 with a misguided attempt to balance the budget, throwing the country back into recession.

And quoting, Edge of the West:
She’s very clear throughout that deliberate policy choices were key, and she thinks the deliberate policy choice of FDR to devalue in 1933/34 was most key.
But there’s nothing particularly prejudicial there against fiscal policy. Nor an argument about the superiority of monetary policy. But an empirical case that owing to planning and luck, monetary policy worked in the 1930s. And just now we haven’t stabilized the banks quite as the New Deal did in 1933.

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