However, even though I do not fully buy it I do think I understand the argument. And I do not think it is incoherent.
As I understand the Greenwald-Stiglitz hypothesis–about the Great Depression as applied to agriculture and about today as applied to manufacturing–it goes like this:
- Rapid technological progress in a very large economic sector (agriculture then, manufacturing now) leads to oversupply and steep declines in the sector’s prices. Poorer producers have less income. They come under pressure to cut back their spending. Others–consumers–are now richer because they are paying less for their food (or their manufactures), but their propensity to spend is lower than that of the stressed farmers or ex-manufacturing workers.
- Moreover, the oversupply of agricultural commodities (or manufactured goods) means that only an idiot would invest at their normal pace in those sectors. To the shortfall in consumption spending is added a shortfall in investment spending as well.
- Thus we have systematic pressures pushing spending down below economy-wide income. These aren’t going to go away until the declining sector (agriculture then, manufacturing now) is no longer large enough to be macroeconomically significant.
- Macroeconomic balance requires that the economy generate offsetting pressures pushing spending up. What might they be?
First let’s translate this into a monetarist framework, and then we can examine what’s wrong.
Even the Keynesian model requires a big drop in NGDP (below trend) to get a demand-side recession. So how does the G-S hypothesis do that? The Keynesians would argue that if the central bank held the money supply fixed, these shocks would cause a fall in velocity. That’s not an unreasonable assumption, as DeLong is talking about a situation where desire to save rises relative to desire to invest. That does reduce interest rates. Lower interest rates mean a lower opportunity cost of holding base money, and thus lower velocity. So far so good.
My complaints lie elsewhere. On empirical grounds almost every single step in this argument is wildly implausible. And that’s not hyperbole; I don’t mean one step, I mean every single step:
1. I see no evidence that technological change in the farm sector that pushed farmers toward the city would boost aggregate saving rates or reduce the propensity to invest. This process was going on continually from the late 1800s, until it began slowing in recent decades because there were so few farmer left. Market economies are really good at adapting to these slow and predictable types of creative destruction. Perhaps there was less investment in the farm sector, but there was more investment in the urban sector. And was there really less investment in the farm sector? Farmers were moving to the cities in the 1920s precisely because farming was becoming more mechanized, as machines were replacing workers. So I’m not sure the 100 year trend of farmers moving to the cities depressed real interest rates at all.
2. But let’s suppose I’m wrong. Business cycles aren’t caused by 100 year trends, they are caused by “shocks.” Where is the shock? If each year 2% of farmers move to the city, how does that cause a sudden demand shock? The economy was booming in the 1920s despite the gradual decline in farming. Now you could argue that something else was propping up the economy, like a thriving manufacturing sector, and when the bottom fell out of manufacturing then the economy slumped. But in that case why not blame the collapse of manufacturing?
3. Stiglitz claims things got much worse in farming in the early 1930s, citing evidence that incomes fell between 1/3 and 2/3 (which doesn’t seem very precise data to build a theory around.) But total national income fell by roughly 1/2, right smack dab in the middle of the Stiglitz estimates. So what’s so special about farming?
4. Let’s say everything I said was wrong. Let’s say DeLong is right that the decline in farming during the 1920 gradually led to a saving/investment imbalance, which eventually got so bad it triggered the Great Depression. How would this show up in the data? We would see falling real interest rates. When they got close to zero the real demand for base money would soar, triggering a sharp fall in NGDP (unless offset by lots of money printing.) And something like that did happen in the early 1930s. But the problem is that it didn’t happen in the 1920s. After the 1920-21 deflation, prices were pretty stable for the rest of the 1920s. So nominal rates should give us a rough estimate for real rates. (I’d add that expected inflation rates were usually near zero when the dollar was pegged to gold.) During the 1920s short term nominal interest rates fluctuated in the 3.5% to 6.0% range. Those are strikingly high risk free real rates by modern standards. Even worse for Stiglitz, they were trending upward in the latter part of the 1920s. Thus there’s not a shred of evidence that the migration away from farms during the 1920s had the sort of macro implications that are necessary for the Stiglitz model to be plausible.
I suppose some would try to resurrect the model by pointing to all sorts of “ripple effects.” How problems in agriculture spilled over into other sectors. The problem with this approach is that it proves too much. There has only been one Great Depression in US history. (In real terms the 1870s and 1890s weren’t even close.) If capitalism is so unstable that a problem in one area causes ripples which eventually culminate in a Great Depression, then one might as well argue the Depression was caused by my grandfather sneezing. His sneeze passed a cold to several other people, and voila, via the “butterfly effect” we eventually get the collapse of the world economy and the rise of the Nazis. I happen to believe that any useful model has to be more than “coherent” in a logical sense, it also has to be empirically plausible.
Suppose someone walked up to you in mid-1929 and said a depression was on the way for reasons outlined by Stiglitz. What would you think? What data would support that conclusion? Did the economy seem to be having trouble accommodating farmers gradually moving to the city? No. Was there a savings glut? No. Was the real interest rate trending downward? No. Were there a host if exciting new technological developments that would lead one to be very excited about the future of American manufacturing? Yes. You’d ask Stiglitz why we should believe his model. What pre-1929 facts was it able to explain? As of 1929 I don’t see it explaining anything. Of course we did have a Depression, which is exactly what you’d expect if:
1. The Fed, BOE, and BOF all tightened in late 1929, sharply raising the world gold reserve ratio over the next 12 months.
2. Then falling interest rates and bank failures increased the demand for base money after October 1930.
3. Then international monetary collapse and more bank failures led to more demand for both cash and gold after mid-1931.
4. Then FDR raised nominal wages by 20% overnight in July 1933, aborting a promising recovery in industrial production.
5. Then in 1937 the Fed doubled reserve requirements and sterilized gold, slowing the economy.
6. Then when the economy slowed a dollar panic (fear of devaluation) led to lots of gold hoarding, sharply depressing commodity prices world-wide in late 1937.
That would be a theory with explanatory power. Something Stiglitz’s theory lacks.
Of course I haven’t even discussed the much deeper problems with the Stiglitz worldview. Because he insists on a “real” theory of AD, he has no explanation for movements in NGDP. I’d guess this is where DeLong would part company with Stiglitz. In Delong’s worldview there is a trend rate of inflation high enough to prevent liquidity traps, and hence (unless the Fed crashes the monetary base) high enough to prevent collapses of NGDP. Not in Stiglitz’s world. Although he often uses the language of Keynesianism (aggregate demand, etc) his model is in some ways even more primitive, like the early progressive models that Keynes pushed aside during the 1930s. Recall that Keynes saw the problem as the failure of our monetary system. As Nick Rowe likes to say, the problem isn’t saving, it’s money hoarding.
PS. It seems to me that DeLong mildly scolds Nick Rowe for roughly the same reason that Nick Rowe scolds Bryan Caplan. I agree with Caplan and Nick Rowe. That is Nick Rowe the victim, not Nick Rowe the villain.