Archive for the Category Great Depression


The Great Depression

My book on the Great Depression is officially being released on December 1st.  At that time I plan to do a few posts discussing the book.  But since some have already received copies, I thought it might help to provide a quick overview for what is a fairly complicated hypothesis.  The book is certainly not “easy reading”, and I’m hoping the following two charts will make it easier to follow the thread of the argument.  (In other words, unlike Garett Jones I didn’t take Bryan Caplan’s advice.)

Here is a flow chart in the first chapter:

Screen Shot 2015-11-19 at 10.25.13 AMThe final chapter (13) includes a more detailed model, intended for serious scholars. In that chapter I also have a more detailed flow chart, which explains how all the pieces fit together:

Screen Shot 2015-11-19 at 10.26.39 AMIf you get confused while reading the book, consult these flow charts.  They explain how each piece of the puzzle fits together.  When I wrote the book (it was done by about 2005) I had no idea that more than 50 people would ever read it, so I wrote it at a level aimed at specialists.  Now it seems that many more people than I expected will read the book. Obviously I’m pleased by the interest, but quite honestly if you only have time to read one economics book this year, make it Garett Jones’s Hive Mind, not my book.

We all know how it developed.

Matt Yglesias has a post describing how Hjalmar Schacht cleaned up after not one but two monetary policy disasters:

I was reading recently in Hjalmar Schacht’s biography Confessions of the Old Wizard (thanks to Brad DeLong for getting me a copy) and part of what’s so incredible about it are that Schacht’s two great achievements””the Weimar-era whipping of hyperinflation and the Nazi-era whipping of deflation””were both so easy. The both involved, in essence, simply deciding that the central bank actually wanted to solve the problem.

.   .   .

The institutional and psychological problem here turns out to be really severe. If the Federal Reserve Open Market Committee were to take strong action at its next meeting and put the United States on a path to rapid catch-up growth, all that would do is serve to vindicate the position of the Fed’s critics that it’s been screwing up for years now. Rather than looking like geniuses for solving the problem, they would look like idiots for having let it fester so long. By contrast, if you were to appoint an entirely new team then their reputational incentives would point in the direction of fixing the problem as soon as possible.

This reminded me 1936-37, when the Fed made the mistake of doubling reserve requirements.  Late in the year the economy slumped badly, and it was clear that the decision had been a mistake.  At the November FOMC meeting they discussed the possibility of reversing the decision:

“We all know how it developed. There was a feeling last spring that things were going pretty fast … we had about six months of incipient boom conditions with rapid rise of prices, price and wage spirals and forward buying and you will recall that last spring there were dangers of a run-away situation which would bring the recovery prematurely to a close. We all felt, as a result of that, that some recession was desirable … We have had continued ease of money all through the depression. We have never had a recovery like that. It follows from that that we can’t count upon a policy of monetary ease as a major corrective. …  In response to an inquiry by Mr. Davis as to how the increase in reserve requirements has been in the picture, Mr. Williams stated that it was not the cause but rather the occasion for the change. … It is a coincidence in time. … If action is taken now it will be rationalized that, in the event of recovery, the action was what was needed and the System was the cause of the downturn. It makes a bad record and confused thinking. I am convinced that the thing is primarily non-monetary and I would like to see it through on that ground. There is no good reason now for a major depression and that being the case there is a good chance of a non-monetary program working out and I would rather not muddy the record with action that might be misinterpreted. (FOMC Meeting, November 29, 1937. Transcript of notes taken on the statement by Mr. Williams.)”

This is one of the most chilling statements I have ever read.  The opening sentence is the sort of thing juvenile delinquents say to each other when their prank has gone horribly awry, and they are nervously working on a joint alibi.  An incredible effort at denial runs all through the piece.  First he admits that they raised reserve requirements because “some recession was desirable.”  Then he claims it was just a “coincidence in time” that the downturn followed the reserve requirement increase, even though the express purpose of the increase was to cause a “recession.”  Then he claims that if they reverse their decision it will look like the previous decision had caused the recession.  Then he said that a depression can’t be happening, because there is no good reason for a depression.  Well it was happening, unemployment rose to almost 20% in 1938.  In the end, they decided to stick with the high reserve requirements throughout the rest of 1937.  Reading that quotation one can almost see the perspiration on Mr. Williams’ forehead.

In a recent comment section a Fed employee named Claudia Sahm took me to task for some intemperate remarks I made about the Fed.  I think her criticism was valid.  I should not throw around terms like “criminally negligent.”  I don’t doubt that the vast majority of Fed employees are well-meaning.  Maybe all of them are.  But Matt’s piece reminds me that human psychology is very complex.  We often don’t know why we do things.  Why am I blogging?  Is it the valiant crusade I’d like to believe I’m engaged in, or am I just fooling myself?   (As Robin Hanson would presumably argue.)  Suppose Ben Bernanke had been at Princeton for the past 5 years.  Now suddenly the Fed chairman is “promoted” to Secretary of the Treasury, and replaced with Bernanke.  (As G. William Miller was replaced mid-term with Volcker.)  What would happen next?  My guess is that Bernanke would immediately set out implementing some of the bold policies that he recommended the Japanese adopt back in 2003.

In 2008 the Fed did what the consensus of economists thought they should be doing.  If we could go back in time to the meeting right after Lehman failed, most economists would now say the Fed should slash interest rates sharply (they actually left them unchanged.)  If John Taylor is appointed Fed chairman in 2014, and if aggregate demand is still quite depressed, I very much doubt he’d adopt the tightening of monetary policy that many on the right are now calling for.

Update: Speaking of Robin Hanson, his new post relates to his very issue.  And I also enjoyed this recent post:

For example, to impose punishments bigger than lifetime exile, beat them a bit first.

Some worry about variation in how much people dislike exile. But there is also variation in how much people dislike fines, prison, torture, and public humiliation. The best way to reduce punishment variation is probably to bundle together many kinds of punishment. Maybe fine them some, beat them a little, humiliate them a bit, and then exile them for a while.

In 2006 the US spent $69 billion on corrections, and 2.3 million adults were incarcerated at year-end 2009. A state prisoner cost an average of $24,000 per year in 2005 (source). Why waste all that money?!

Not so much the ideas, but the way they are expressed.  Only an economist can write like that!

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.


No Mr. Stiglitz, Ben Bernanke does not agree with you

Joe Stiglitz has a new article, where he continues to develop his rather unconventional view of business cycles.  Is his theory a real theory or a demand side theory?  I can’t quite tell, maybe one of my commenters can help me out.

Of course the most important stylized fact of the Great Depression was the horrific collapse in industrial production between 1929 and 1933.  And what caused this collapse?  Apparently productivity improvements in the farm sector.  Productivity gains that were also occurring in the booming 1920s.

And how does Stiglitz know this?

At the beginning of the Depression, more than a fifth of all Americans worked on farms. Between 1929 and 1932, these people saw their incomes cut by somewhere between one-third and two-thirds, compounding problems that farmers had faced for years. Agriculture had been a victim of its own success. In 1900, it took a large portion of the U.S. population to produce enough food for the country as a whole. Then came a revolution in agriculture that would gain pace throughout the century””better seeds, better fertilizer, better farming practices, along with widespread mechanization. Today, 2 percent of Americans produce more food than we can consume.

Interesting, but this has been going on for 120 years.  So why was the economy booming in 1929, and flat on its back in 1932?  And why doesn’t Stiglitz discuss what happened to the incomes for the other 80%, the people not in farming?  It turns out that their incomes also fell “between one-third and two-thirds,” indeed nearly 50% by the fourth quarter of 1932.   So nothing particularly interesting was going on in farming, and yet this somehow explains the far greater collapse in output in manufacturing, mining, and construction.  There may be a model there, but I don’t see it.

What about the conventional explanation, that it was an adverse demand shock?  The view that errors of omission or commission by the Fed explain the 50% fall in NGDP:

Many have argued that the Depression was caused primarily by excessive tightening of the money supply on the part of the Federal Reserve Board. Ben Bernanke, a scholar of the Depression, has stated publicly that this was the lesson he took away, and the reason he opened the monetary spigots. He opened them very wide. Beginning in 2008, the balance sheet of the Fed doubled and then rose to three times its earlier level. Today it is $2.8 trillion. While the Fed, by doing this, may have succeeded in saving the banks, it didn’t succeed in saving the economy. Reality has not only discredited the Fed but also raised questions about one of the conventional interpretations of the origins of the Depression. The argument has been made that the Fed caused the Depression by tightening money, and if only the Fed back then had increased the money supply””in other words, had done what the Fed has done today””a full-blown Depression would likely have been averted. In economics, it’s difficult to test hypotheses with controlled experiments of the kind the hard sciences can conduct. But the inability of the monetary expansion to counteract this current recession should forever lay to rest the idea that monetary policy was the prime culprit in the 1930s.

.   .   .

Monetary policy is not going to help us out of this mess. Ben Bernanke has, belatedly, admitted as much.

Readers of Vanity Fair are being led to believe that Bernanke went into this downturn thinking that monetary stimulus was the answer to depressions, and then had a sort of epiphany that monetary stimulus doesn’t work.  Is this really true?  Has Bernanke suddenly become an adherent to the view that the Fed is out of ammunition?  Or that they have ammo, but that nominal growth can’t solve real problems (as RBC adherents believe.)  I’ll pay $100 to the first person who can convince me that Bernanke believes monetary policy can’t boost AD, or that he believes AD can’t boost output.  (I should offer $10,000, but proportional to wealth my offer is just as generous as Mitt Romney’s.)

Stiglitz is a distinguished Nobel Prize winner.  But he didn’t win for business cycle theory.  I doubt even his fellow progressive Paul Krugman could make heads or tails out of Stiglitz’s essay.  That doesn’t make Stiglitz wrong (I’m also a contrarian.)  But if you are going to make that sort of argument, you need more evidence than farm incomes falling during the Great Depression.

Paul Krugman likes to show a graph indicating that each country began recovering from the Depression right after it adopted expansionary monetary policies (i.e. currency devaluation.)  If Stiglitz has an explanation for that, I’d love to hear it.

Back in the 1930s many people thought the Great Depression was caused by too much output.  This led FDR to adopt programs aimed at reducing output (such as the AAA and the NIRA.)  They “worked.”  Today economists tend to scoff at such ideas, as falling output is essentially the definition of a depression.  But not Stiglitz:

Throughout the 1930s, in spite of the massive drop in farm income, there was little overall out-migration. Meanwhile, the farmers continued to produce, sometimes working even harder to make up for lower prices. Individually, that made sense; collectively, it didn’t, as any increased output kept forcing prices down.

HT:  Gregory Barr, Larry

Update: I see Ryan Avent is equally puzzled by Stiglitz’s model.  And so is Nick Rowe.  Will Krugman give Stiglitz the Fama/Lucas/Cochrane treatment?

Moralizing about money, moralizing about cultures

I’ve been trying to do a sort of Clintonesque triangulation, where I accept a good bit of both sides of the euro-debate, but not all.  In other words, the current crisis is caused by both dysfunctional socio-economic systems in the European periphery, and by a dysfunctional ECB.  I suppose to some that sounds like a cop out, but I have very good reasons for taking this position.

Let’s start with the conservative position on Europe, which was very ably defended by Tyler Cowen in this post.

Ryan Avent tweeted:

Dear @tylercowen, Germany and the periphery ARE morally equivalent.

How might a response go?  Not an argument that German citizens are morally superior to other Europeans; that would be false and indeed repugnant.  I mean the kind of “system-wide” moral judgments that progressives offer up when they judge the institutions of Denmark to be superior to the institutions of Mexico, of course without ever judging the residing individuals per se.  Let’s play at intellectual Turing test“” with no commitment to endorsing these views “” and draw up a short list of, dare I so label them, (ostensible) German moral superiorities:

Read the whole thing.  The post is very impressive, so much so that I’d easily lose an Oxford debate with Tyler.  So why do I say; “Yes but . . . ?”

Because of the interwar period of world history.  Start with America’s very uneven performance between 1921 and1933.  What lessons can we draw?  I’d argue that the US circa 1921-29 was close to a conservative paradise, at least as conservatism was defined back then (obviously modern conservatives don’t agree with the racial and gender discrimination of that era.)  The economy seemed to have almost no “imbalances,” whatever they are.  Fast growth led by huge productivity gains, low unemployment, no inflation, no trade of budget deficits, relatively free markets.  And then it all collapsed during 1929-33, as tight money caused NGDP to fall in half.  Inevitably some commenters will mention the bad supply-side policies adopted by Hoover (taxes, tariffs, and wage jawboning) but they were far too minor to create the mother of all depressions, and indeed should have led to wage and price inflation, not deflation.  Instead, money was the main culprit.  But the conservatives of the era could not accept that, so in 1932 they mumbled about workers in the late 1920s living beyond their means, feeling entitled to own cars, radios, and iceboxes.  Given what we know about the mass consumer economy after WWII, how likely an explanation is that?

No, the Great Contraction wasn’t a moral problem.  The left is wrong in saying it was caused by income inequality, and the right is wrong to portray it as the hangover after an orgy of excess during the 1920s.  It was a technical problem, plain and simple.  Too little money.

Europe is both, a technical (tight money) problem and a set of structural problems.

Now let’s consider the second half of the problem, the structural weaknesses in the Mediterranean countries.  When I did a study of neoliberal policies and cultural valuesof all 32 developed countries back in 2007, I was shocked to find that the “best” cultural values were in Denmark and the “worst” cultural values were in Greece.  Why was I shocked?  Because Greece was doing quite well in 2007.  It had grown rapidly, and its income level was only modestly lower than Germany.  Indeed Germany’s income per capita (PPP) was $33,820, lying somewhere between Greece ($32,520) and Iceland ($34,060.)  How times have changed!  Don’t laugh, but I viewed the success of Greece as a weak point in my argument.  So I’m certainly not going to contest Tyler’s cultural argument.  But I am going to discuss how it might be misunderstood, and tweak it slightly.

I predict that most readers will have difficulty processing Tyler Cowen’s disclaimer that he is not making invidious comparisons between people, but rather merely describing “cultures,” which have a sort of life of their own.  So I’d like to put some meat on the bones of this idea, so that people don’t just assume Tyler is trying to be PC.

1.  Some cultural differences do apply to individuals.  If I claim the American culture is more gluttonous than the Japanese culture, then I also mean American people are individually more gluttonous than Japanese people.  It is an invidious comparison, at least if you consider gluttony a bad thing.  (I have no opinion on the subject.)

2.  However, cultural characteristics that relate to the organization of society are not as embedded in individuals as it might seem.  It almost makes more sense to view culture as something “in the air.”  That’s why Greeks and Sicilians do very well in America, and easily blend in to our culture.  That’s why Israel is quite different from what one would predict if the only Jewish people you had met were those living in America.

3.  When discussing the superiority of a given culture, you always need to identify the context.  Superior at what?  Producing wealth?  Producing equality?  Producing peace?  Producing strongly knit families and communities?  Producing great art or great science?  Producing un-neurotic people?  Producing joie de vivre?  Being fun places to visit?

4.  And even if you mean “good at producing successful economies,” it’s still not an easy call.  People often see the cultures of Germany, Japan, Korea, and China as being well-suited for economic success.  Yet all four countries were economic basket cases in 1945.  If an asteroid had destroyed Earth in 1945 the last word on culture would be that Germany had one of the worst societies on earth.  Admittedly, pulling out the Nazi example is usually the last refuge of a losing argument.  But suppose an asteroid has destroyed Earth as recently as 2002.  The last word on Germany would have been that its culture is too “rigid” to adapt well to the post-manufacturing world, and that Catholic upstarts like Ireland and Spain were much more dynamic.  There is no last word on culture. All judgments are contextual, and provisional

5.  Despite all these provisos, my hunch is that culture is fairly important, and Tyler’s judgments are reasonable.  If you don’t agree, consider the following example:  Both Afghanistan and North Korea are extremely poor.  Which country do you think is more likely to be rich in 2061, fifty years from today?  Of course we’ve been wrong before; as recently as the 1950s the small East Asian countries were widely expected to do poorly in the coming decades.  We might be wrong again.  But right now Korean cultural values seem to be quite useful for the purpose of generating fast RGDP growth.

Bottom line.  Europe needs BOTH more NGDP and structural reforms (which may require cultural change.)  But not bailouts.

It’s possible that tight money might speed economic reforms, just as economic sanctions on Cuba might speed political reforms.  But history suggests that tight money usually leads to bad supply-side policies, and trade sanctions usually fail, as political reform is highly correlated with economic growth.  When in doubt, always place your bets with “doing the right thing.”  Don’t do bad policies in one area in the hope that they’ll generate good policies in another area.  Do good policies in the hope they’ll generate other good policies.  That way if you are wrong about spillover effects, at least you have the good policies in one area.

PS.  I would quibble with Tyler’s point 9:

9. One clear warning sign of trouble is when you see “trade imbalances” put at the center of the argument, as if “being very productive” and “not being productive enough” were somehow the same kind of disease.

By all means keep “trade imbalances” out of all arguments.  Not because they tell us something interesting about productivity, rather because they tell us nothing interesting about anything.

PS.  Although I quote Tyler Cowen, this post is not really a rebuttal.  I have no idea what he thinks of the views expressed here.  Oddly, I find myself agreeing with much of what Tyler says, but also with much of Ryan Avent says in opposition.  Are they talking past each other, or am I just a muddled-headed easily impressionable person?