Brad DeLong finds “coherence” in the Greenwald-Stiglitz Depression model

The following isn’t Brad DeLong’s entire summary of Greenwald-Stiglitz, but it gets at the central assumption:

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:

  1. 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.
  2. 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.
  3. 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.
  4. 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.

:)


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29 Responses to “Brad DeLong finds “coherence” in the Greenwald-Stiglitz Depression model”

  1. Gravatar of DeLong defends Stiglitz « Thought du Jour DeLong defends Stiglitz « Thought du Jour
    17. December 2011 at 08:07

    [...] Scott Sumner has much more here. Oh dear! This does not look good for Joe [...]

  2. Gravatar of Morgan Warstler Morgan Warstler
    17. December 2011 at 08:17

    Shweet! More of this please…

  3. Gravatar of Martin Martin
    17. December 2011 at 08:23

    I wonder what the response would have been if the same or similar theory came from Prescott. I think the response would have “the stupidest man alive” in the title at the very least, just for suggesting that it could be due to a productivity shock. Krugman then probably would have piled on with something about “the dark ages of macro”.

    Then again perhaps I am being uncharitable, because I think that the difference in response is due to ideological affinity with Stiglitz.

  4. Gravatar of Kevin Donoghue Kevin Donoghue
    17. December 2011 at 08:56

    You’d ask Stiglitz why we should believe his model.

    This is the right question. If I understand him correctly, what he needs to show is that signs of financial distress first appeared in the agricultural sector and the waves spread out from there. I’ve no idea whether that’s true or not. Greenwald and Stiglitz have published a lot of papers together and maybe they have assembled the evidence. Then again, maybe not.

  5. Gravatar of W. Peden W. Peden
    17. December 2011 at 10:02

    Great post.

    Martin,

    I agree. I think we are naturally inclined to be more intellectually charitable towards those with whom we agree on other issues; after all, we already consider them to be right about some things!

    Kevin Donaghue,

    Good point. It would be interesting to see if Stiglitz didn’t provide such empirical information either because (a) he isn’t thinking so soundly or (b) he looked but didn’t find it.

  6. Gravatar of Morgan Warstler Morgan Warstler
    17. December 2011 at 10:18

    Scott, I’m savoring the win:

    http://www.tnr.com/article/the-vital-center/98655/obama-2012-income-inequality-gallup

    I think we should offer up VIDEO apologies as part of the bet, renouncing our previous positions.

  7. Gravatar of Kevin Donoghue Kevin Donoghue
    17. December 2011 at 10:25

    W. Peden,

    (a) and (b) are both possible, but I wouldn’t rule out (c) Greenwald and Stiglitz have another paper in the pipeline giving details, or even (d) they’ve already published it and he’s just trying to get more people to look at it. Who among us has read all of Stiglitz’s work? The man writes papers faster than I can read them.

  8. Gravatar of John Papola John Papola
    17. December 2011 at 11:17

    This theory really sounds like pure bedlam. But it comports quite nicely with the President called ATM machines a “structural problem” for employment. Bizarro.

  9. Gravatar of StatsGuy StatsGuy
    17. December 2011 at 12:09

    I don’t think the Greenwald/Stiglitz story works in the absence of a parallel monetary story, however it can support the monetary story (as can many other stories).

    The fundamental problem with the pure monetary story is that it exists without causality to explain the initial triggers.

    Your chain begins with: “The Fed, BOE, and BOF all tightened in late 1929, sharply raising the world gold reserve ratio over the next 12 months.”

    But it doesn’t have a “why” in there. Presumably, the Fed, BOE, and BOF didn’t just do this for no reason (unless you believe they woke up one day and just made a dumb mistake). Likewise, the Fed did not tighten in summer 2008 for no reason. Something happened…

    I’m consistently bewildered that you treat the Fed as if it were in some way a truly independent institution, whereas most political economists treat organizations(and even politicians) as a function of their institutional environment and incentive structure.

    Since Star Wars seems to be one of the few ‘sci fi’ flicks you consider worthy of quoting:

    Scott Skywalker: “Your overconfidence in Keynes is your weakness.”

    Darth Krugman: “Your faith in your fellow monetarists is yours.”

  10. Gravatar of John Papola John Papola
    17. December 2011 at 12:29

    Oh… and Nick Rowe’s response to Bryan and Joe is every bit as bizarre (or at least bizarrely framed) to me as Joe’s theory.

    Bryan Caplan and Joseph Stiglitz are making the same mistake. They are forgetting that income = output. And in a demand-constrained economy, output is determined by output demanded. And output demanded depends on output (=income). The only way to increase output in a demand-constrained economy is to do something that changes that relationship between output demanded and output, so that more output is demanded for any given level of output. That’s what monetary and/or fiscal policy are supposed to do. All that micro stuff, messing around with relative prices like the price of food (Stiglitz) or labour (Caplan) won’t do anything unless, as a by-product, it happens to change the relationship between output demanded and output.

    Who demands “output”?!? Where’s the “output” store? What’s the price of “output”? How does that price form? Is there bidding for “output”. This macro talk of real production makes no sense to me at all. I know it’s shorthand, but it’s indicative of that over-aggregated keynesian method that acts as if there is a thing called “output” that is real and can thought of as responding in micro-like ways. I think that’s wrong.

    Now, this is all probably just an inverted way of talking about money. That nominal income is determined by monetary equilibrium. If there is a net increase the demand for money (decrease in “output demanded”?) then nominal income will fall because nominal prices are falling.

    Very well. Make sure that the demand for money is met with increasing supply so that nominal spending doesn’t fall… you know… like Hayek and Scott suggest.

    But that really says nothing directly about output. NGDP can stay stable even as output shrinks (and thus prices rise). What I find most strange about Keynesianism in comparison to monetarist/hayekian macro is that it conflates the supply and demand for money, which is a real microeconomic market activity, with a fiction called “aggregate supply” and “aggregate demand”. There is money. It can literally be demanded or supplied. There is no “aggregate supply” that can be “aggregated demanded”. These are ex-post summaries. Accounting.

    Yes increasing demand for money decreases nominal demand for certain goods which will then tally up to be a fall in the total summary of demand. What I’m getting at is that so-called “fiscal policy” is nonsense and a product of this false linguistic inversion of the supply and demand for money. They are not really the inverse. One is a real thing and one is not. Increases in the demand for money won’t be changed by the government digging ditches unless the ditch diggers they hire are the actual demanders and getting hired to dig will meet that demand.

    Put another way, you could have all kinds of ditch digging going on all while a completely different group of people are pilling cash in their basement vaults and the two could never interact. Talk of various “propensities” to save or spend doesn’t seem to change any of that either.

    It’s time to decouple these two ideas. An increase in the demand for money does not mean there is a “general glut”.

    I hope Nick will follow up and write about Say’s law and where he thinks it’s right and wrong. Again, I’m not even saying that what he’s alluding to is wrong above, provided its just a linguistic inversion of monetary equilibrium / NGDP.

    Does any of this make sense, Scott? Am I missing something?

  11. Gravatar of John Papola John Papola
    17. December 2011 at 12:38

    One other note. In his first response, Nick writes:

    Sure, an improvement in productivity may cause deficient demand, but it does this by increasing Aggregate Supply, not by reducing Aggregate Demand. And the appropriate response by the monetary authorities would be to loosen monetary policy to increase AD by the same amount that AS has increased, in order to prevent deflation.

    This seems wrong to me. Why is he called productivity norm deflation “deficient demand”. What’s this mean? “Deficient” compared to what? Has Nick read “Less Than Zero”? Maybe he should.

  12. Gravatar of Steve Steve
    17. December 2011 at 12:50

    Well, Stiglitz flunks MICRO as well:

    “Finally, our decaying infrastructure, from roads and railroads to levees and power plants, is a prime target for profitable investment.”

    Hmmm, we already repaved all the roads due to ARRA.
    The railroads are investing heavily on their own already. (Think Burlington Northern and Berkshire Hathaway)
    Power prices have been falling for years, due to falling demand, increased efficiency, and a glut of natural gas.
    Maybe levees are the solution? That sounds like the inverse of digging holes and filling them in. Employ the country building dirt mounds and then tearing them down?

  13. Gravatar of Steve Steve
    17. December 2011 at 13:11

    Stiglitz writes: “Without investment in basic research, what will fuel the next spurt of innovation?”

    Stiglitz writes: “the widespread decline in agricultural prices and incomes, caused by what is ordinarily a “good thing”—greater productivity.”

    How does one reconcile these two statements?

  14. Gravatar of david david
    17. December 2011 at 14:40

    Perhaps I am misreading someone here, but Delong is saying that the model is coherent, not that it is empirically correct. And Rowe is saying that it is incoherent.

    You concede that the analysis is coherent – “so far so good” – so why are you disagreeing with Delong and agreeing with Rowe?

  15. Gravatar of W. Peden W. Peden
    17. December 2011 at 15:34

    John Papola,

    I think that one of the defining features of Keynesian economics is a lack of interest in the nominal. Where does inflation come into the picture in a Y = C + G etc. painting? Also, in the UK at least (and I suspect elsewhere) there has long been a tendency of Keynesians to be interested in IS and in real GDP, and to delegate inflation to the monetary policy wonks (post-1990 ish in the UK) or the political scientists (pre-1990 when fighting inflation was about incomes policies and distributional “justice”).

    I found myself nodding vigorously while reading your comment.

  16. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    17. December 2011 at 16:09

    Deirdre McCloskey once, back in the 1990s, tweaked several economists (notably including Brad DeLong) on the now defunct EH Net discussion forum, with, ‘As far as I can tell some like the theory because…they like the theory.’

    So history seems to be repeating itself.

    Also, Richard Fischer just gave a speech that seems to support Scott’s argument that monetary authorities can ‘undo’ fiscal stimulus;

    http://www.dallasfed.org/news/speeches/fisher/2011/fs111216.cfm

    ‘Our nation’s economy is at risk. The Federal Reserve has done everything it can to reduce unemployment without forsaking our sacred commitment to maintaining price stability, or crossing over the monetary river Styx into full-blown debt monetization. I personally don’t care which party is in the White House or controls Congress. All I know is that the “honorable” members of Congress and presidents past, Republicans and Democrats alike, have conspired over time, however unwittingly, to drive fiscal policy into the ditch. They purchased their elections and reelections with popular programs so poorly funded that they now threaten the economic well-being of our children and our children’s children. Instead of passing the torch on to the successor generation of Americans, they have simply passed them the bill. This is the opposite of honorable.’

  17. Gravatar of ssumner ssumner
    17. December 2011 at 17:13

    Martin, THIS is the dark ages of macro, far more than anything Prescott has done.

    Kevin, Farm banks failed in small towns all through the 1920s. It had no impact on the macroeconomy.

    Morgan, Don’t count your eggs before . . .

    John Papola, Yes, and were you the one that pointed out that Obama met with Stiglitz?

    Statsguy, You said;

    “But it doesn’t have a “why” in there. Presumably, the Fed, BOE, and BOF didn’t just do this for no reason”

    Surely you must know by now that that’s wrong. I’ve published papers explaining exactly why each of the three central banks behaved as they did. So have others–there’s no big mystery.

    John Papola, You might want to read the back and forth between Nick and I in his comment section.

    Steve, All excellent points.

    I have no problem with DeLong, it’s Stiglitz who lacks a coherent model. What drives NGDP in Stiglitz’s model?

    Patrick, Thanks, that was not my all time favorite speech, to put it mildly.

  18. Gravatar of anon anon
    17. December 2011 at 19:12

    I found these comments by Brad DeLong quite interesting:

    So then why does Nick have such an adverse reaction to Stiglitz?

    I think it is because Stiglitz is at bottom a Wicksellian and Rowe is a Fisherian. A Wicksellian is a believer that the key equation in macro is the flow-of-funds equation S = I + (G-T), savings S equals planned investment I plus government borrowing (G-T), and that the money market exists to feed the flow-of-funds an interest rate that has a (limited) influence on planned investment I. A Fisherian is a believer that the key equation in macro is the money market’s quantity theory equation PY = MV(i), and that the flow-of-funds exists to feed the quantity theory an interest rate that has a (limited) influence on velocity V.

    Thus they have a hard time communicating. From the Fisherian viewpoint, the Wicksellians are talking nonsense because they spend their time on things that have a minor impact on velocity while ignoring the obvious shortage of money. From the Wicksellian viewpoint, the Fisherians are talking nonsense by ignoring the obvious fact that movements in money induce offsetting effects in velocity unless they somehow alter the savings-investment balance.

    Honestly, the flow-of-funds approach seems quite confusing; it seems to mix real with monetary factors and to put too much emphasis on hard-to-analyze interest rate changes.

    OTOH, the only stated critique of the Fisherian approach is that short-term bonds may become a perfect substitute for money due to a liquidity trap. But what if we regard the aggregate of money and short-term bonds as the equivalent for “M” in the equation of exchange, at least as long as the liquidity trap is binding? Could this be a proper foundation for the flow-of-funds approach?

  19. Gravatar of DeLong Smackdown Watch: Structural Change and Macroeconomic Vulnerability in the 1920s and Today Edition | FavStocks DeLong Smackdown Watch: Structural Change and Macroeconomic Vulnerability in the 1920s and Today Edition | FavStocks
    18. December 2011 at 00:20

    [...] Sumner protests that I am giving an overly generous reading to Stiglitz in Vanity [...]

  20. Gravatar of John John
    18. December 2011 at 01:54

    For an Austrian, one of the funnier parts of Stiglitz’s analysis is that the consumer have/had a lower propensity to spend than farmers. This idea seems to imply that if the government could just print up money and tax savings in any way possible then hand newly printed money and the money of the frugal over into the hands of drunken sailors (or the government whose fiscal recklessness puts drunken sailors to shame) then our economy would boom.

    Economic output is not determined by pure consumption. How much people decide to spend or save determines what type of production people get and over time an economy that focuses more on present consumption will actually have lower levels of output. An economy that tends to have higher rates of savings will see output geared towards capital goods. Production processes will lengthen which leads to greater output per unit of input over time. An economy that saves less will focus more on providing for present consumption and will produce less over time.

    The basic production possibilities frontier illustrates this and it always amazes me that high level economists miss this basic point. Savings is the basis of growth and that is something that the liberal economists just can’t seem to grasp.

  21. Gravatar of John John
    18. December 2011 at 01:58

    I also want to point out that the government does not invest money. There is no profit and loss feedback and therefore no way to tell if they have spent the money wisely or not. Most government investments are really politicians using other people’s money to buy votes. The work by public choice theorists has nicely shown that the infrastructure programs during the New Deal and the ARRA went to politically important areas and was not meant to benefit the economy at large.

  22. Gravatar of W. Peden W. Peden
    18. December 2011 at 06:17

    John,

    I think there are some kinds of government expenditure that constitute a form of investment e.g. building roads and then collecting the tolls/fuel taxes from their use; student loans; educating children to extract higher taxes when they grow up; buying and selling shares of private companies; training the unemployed to turn them from claimants to contributors.

    However, it’s notable that this kind of expenditure makes up a small proportion of the kinds of expenditure that are called “investment” and a tiny proportion of total government expenditure. As you say, the government’s expenditure decisions are driven by political profits (public choice theory) rather than benefiting the economy for its own sake.

  23. Gravatar of ssumner ssumner
    18. December 2011 at 07:50

    anon, I don’t think that correctly characterizes Nick’s view (it certainly doesn’t characterize mine.)

    The Wicksell approach doesn’t explain the level of NGDP, that’s why I don’t like it. (I’m not saying that’s true of Wicksell himself, I don’t know enough to comment, but it’s a flaw in the model DeLong presents.)

    John, I agree with your comments about consumption and saving and growth. More savings means faster growth. That’s why Nick and I emphasize money hoarding, not saving, as being the problem. Saving should be encouraged.

  24. Gravatar of JLD JLD
    18. December 2011 at 13:49

    Your so swift attack on Stiglitz explains to me why we are where we are. With a friend like you, who needs an enemy?

    It doesn’t seem to me that one can dispute where Stiglitz starts–our economy has not worked well for sometime. He thesis–the United States has under-invested in infrastructure, technology, and education for decades–seems, to me, undisputed, albeit you avoid that issue entirely.

    You also appear to agree when he writes, “Two conclusions can be drawn from this brief history. The first is that the economy will not bounce back on its own, at least not in a time frame that matters to ordinary people. Yes, all those foreclosed homes will eventually find someone to live in them, or be torn down. Prices will at some point stabilize and even start to rise. Americans will also adjust to a lower standard of living—not just living within their means but living beneath their means as they struggle to pay off a mountain of debt. But the damage will be enormous. America’s conception of itself as a land of opportunity is already badly eroded. Unemployed young people are alienated. It will be harder and harder to get some large proportion of them onto a productive track. They will be scarred for life by what is happening today. Drive through the industrial river valleys of the Midwest or the small towns of the Plains or the factory hubs of the South, and you will see a picture of irreversible decay.”

    Now, while you attack him, I see nothing in your writing that is any better of an idea about how to go foward.

    You seem to think this is some contest between academics of no real moment. BS. To the contrary, it is bad, really really bad for millions and millions of Americans.

  25. Gravatar of Matt Waters Matt Waters
    18. December 2011 at 15:05

    Scott,

    For the first time, I fully read through your posts from Feb. 2010 on the causes of the 1929 crash (the first two parts of your series). I read after you referenced that you posted before about why, exactly, America, Britain and France decided to tighten money all at once.

    I’ve tried looking at the crash from many angles and this is the most plausible way I find of looking at it.

    1. The Dow did nearly double from 1928 to its peak in 1929. People keep looking for news to explain the crash, but equally we should look for news to explain such an anti-crash. A 80% increase in equity when interest rates are around 5% is just as extraordinary as a large drop in equity. Perhaps there is a more EMH-friendly explanation, but I find this to be a classic bubble.

    2. As with the housing bubble in four states in the 00′s, the stock market bubble was driven by high leverage and the resulting crash was driven by forced selloffs. I know that you’ve hated the term “bubble” because any regular stochastic downturn could be called a bubble in retrospect. However, when the stochastic downturn is seemingly happening for no reason at all, then it’s fair to say that there hasn’t been any real news concerning the fundamental asset valuations. The downturn merely happened at some chaotic breaking point where the money of speculators leaves the market due to forced selloffs and bankruptcies/foreclosures.

    3. All that said, just because a stock market bubble happened doesn’t mean a stock market bubble “caused” the Depression. More and more, I’ve come to the conclusion that the 1929 stock market crash had little to do with the resulting Depression, just as the 1987 and 2000-01 crashed did not lead to depressions. Like those crashes, the 1929 crash merely brought stocks back to their 1928 levels, exactly what you would expect with a regular old market correction like 1987.

    Now I said “little to do with the Depression,” not nothing to do with the Depression. Industrial output did start its decline in late October 1929 probably due to the 1929 crash. One would expect a stock market crash to increase the preference for savings vs. investment and thus decline the Wicksellian natural rate. The lower natural rate, in turn, would start hurting output.

    But, at least according to stock prices, the Depression really started in mid-1930 as the markets processed multiple demand and supply shocks that, unlike the news-absent 1929 crash, actually changed the fundamental asset valuations past the crash itself. That was when the market went far below even mid-20′s levels and the only convincing cause is extremely tight monetary policy.

    And in any case, Stiglitz’ theory is complete nonsense. The fringe left and fringe right meet on monetary policy because monetary reasons do not have a moralistic cause. It’s not banks or speculation or subprime borrowers or the government. It’s just a handful of serious people who decide monetary policy and that’s it.

  26. Gravatar of Lorenzo from Oz Lorenzo from Oz
    18. December 2011 at 16:48

    The “technological shift causes massive unemployment surges” theory (in all its versions, including PSST) is such a deeply silly theory I am bemused by why anyone would buy into such parochial crap.

    I say parochial, because explaining the recent surge in US unemployment by sudden shifts in skill demands provides no basis for explaining why unemployment rates in the OECD vary so much Or why the postwar period (rapid technological change) was a period of low unemployment? Australia is a first world economy, really it is, and somehow our employment has experienced no such collapse, no such sudden skills redundancy.

    After all, getting back to Stiglitz and Greenwald, if food is getting cheaper, should that not spur demand in the rest of the economy? Is that not why rising productivity has gone with rising labour force participation and living standards? The 1920s were, after all, the sole decade in which secondary industry/manufacturing was the biggest employer in the US (before that, it was primary industry, after that, it was tertiary industry/services). It would be truly remarkable if technological shifts in farming could cause the biggest income collapse in US history some years AFTER primary industry had stopped being the biggest employer.

    Coherence is also a limited virtue.

  27. Gravatar of e e
    18. December 2011 at 17:31

    I had heard the old argument about increases in productivity causing unemployment. I am not a fan, obviously but given the severity of the great depression Stiglitz is basically saying that because we became more efficient at making things, we ended up making 30% fewer things. It’s kind of breathtaking.

  28. Gravatar of ssumner ssumner
    19. December 2011 at 14:10

    JlD, You said;

    “Your so swift attack on Stiglitz explains to me why we are where we are. With a friend like you, who needs an enemy?”

    I’m not your friend, I’m a blogger. It’s my job to attack. As you know Stiglitz attacks his fellow economists as ferociously as anyone.

    You said;

    “Now, while you attack him, I see nothing in your writing that is any better of an idea about how to go foward.”

    Do you know ANYTHING about me?

    Matt, You said;

    “Industrial output did start its decline in late October 1929 probably due to the 1929 crash. One would expect a stock market crash to increase the preference for savings vs. investment and thus decline the Wicksellian natural rate. The lower natural rate, in turn, would start hurting output.”

    Close, but not quite. The drop in industrial production (caused by tight money) occurred before the stock crash, and helped cause it. A lower Wicksellian rate only depresses the economy if it makes money tighter. In this case it did, in 1987 the Fed didn’t let it do that.

    The 1927-29 expansion was extremely healthy, because it was deflationary. That’s one reason stocks rose so much. It should have been able to last indefinitely, but alas, the Fed blew it.

    There’s no solid evidence that stocks were too high in 1929. Someone who bought and held for 70 or 80 years did well.

    Lorenzo and e, I agree.

  29. Gravatar of In search of a theory of deep downturns | She's a Savvy Investor In search of a theory of deep downturns | She's a Savvy Investor
    1. January 2012 at 07:59

    [...] of economic history, but following on an exchange between Brad Delong and Scott Sumner (here, then here, then here) I’d like to add a few more [...]

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