Archive for the Category Great Depression


The myth at the heart of internet Austrianism

This post is not about Austrian economics, a field I know relatively little about.  Rather it is a response to dozens of comments I have received by people who claim to represent the Austrian viewpoint.  More specifically, it is a response to the claim that the 1929 crash was caused by a preceding inflationary bubble.  I will show that the 1920s were not inflationary, and hence that there was no bubble that could have caused an economic slump which began in late 1929.

1.  Inflation as price change:  Let’s start with the obvious, the 1920s was a decade of deflation; prices fell.  Indeed the 1927-29 expansion was the only deflationary expansion of the entire 20th century.  That’s right, believe it or not the price level actually declined during the boom at the end of the 1920s.

2.  Inflation as money creation:  At this point commenters start claiming that inflation doesn’t mean rising prices, it means a rising money supply.  I think that is absurd, as that would mean we lack a term for rising prices.  But let’s assume it’s true.  The next question is; which money?  If inflation means more money, then don’t you have to say “base inflation,” or “M2 inflation?”  After all, these quantities often go in dramatically different directions.  Since the internet Austrians seem to blame the Fed, let’s assume they are talking about the sort of money created by the Fed, the monetary base.  In January 1920 the base was $6.909 billion, and in December 1929 it was $6.978 billion.  Thus it was basically flat, and this was during a period where the US population and GDP rose dramatically.  The broader monetary aggregates rose significantly, but the government didn’t even keep data on M1 and M2 until fairly recently.  No one in the 1920s thought the Fed should be targeting aggregates that didn’t even exist.

3.  Housing inflation:  There was no housing bubble in 1929, so there was nothing to burst and cause a depression.

4.  Asset inflation:  There was a stock price boom and crash, but we saw a crash of almost identical magnitude in 1987, and it had zero impact on the economy.  In any case, it would be odd to call rising stock prices “inflation,” because none of these internet Austrian commenters call falling stock prices “deflation.”  Stocks did very poorly during the 1966-82 period, yet I don’t see internet Austrians calling America’s Great Inflation a period of “deflation.”

5.  The price of gold:  Lots of modern internet Austrians focus on soaring gold prices as an indicator of inflation.  If we are going to use gold prices as a proxy, then here are the inflation rates for each year of the 1920s:  0%, 0%, 0%, 0%, 0%, 0%, 0%, 0%, 0%, and 0%.

6.  NGDP:  Ah, now we are talking.  I wish the term ‘inflation’ was used for rising NGDP, not rising prices.  And of course Hayek favored a stable NGDP.  If that’s what they mean by ‘inflation,’ then they can claim a meager victory for the 1920s, but very meager.  NGDP was (according to estimates of Gordon and Balke) $95.98 billion in the first quarter of 1920, and $100.92 billion in the 4th quarter of 1929.  That’s an increase of roughly 5% over 10 years, or about 0.5% a year.  This means NGDP per capita was falling sharply, as the US population rose by more than 15% during the 1920s.  I.e. NGDP per capita did much worse in the 1920s than it has in Japan during an 18 year period where total NGDP actually fell.  In fairness, there were sub-periods of faster NGDP growth, such as the 3% annual growth between the 1926:3 and 1929:3 cyclical peaks.  But that’s still far below average for the US, and thus I have trouble imagining how it could trigger the severe economic slump in late 1929.

And by the way, interest rates were not particularly low during the 1920s, particularly when you consider that it was a period of deflation.  So no one can seriously claim the Fed was following a low interest rate policy.

In my view monetary policy during the 1920s comes closer to the Austrian ideal than any other recent decade.  Then in the early 1930s we had deflation by almost any indicator (prices, NGDP, M1, M2, stock prices, etc) and the economy did poorly.  Too bad the Fed didn’t try to keep NGDP at $100 billion (as Hayek’s policy rule would have called for), instead of letting it fall to less than $50 billion in early 1933.

Austrian monetary economics has some great ideas–most notably NGDP targeting.  I wish internet Austrians would pay more attention to Hayek, and less attention to whomever is telling them that the Depression was triggered by the collapse of an inflationary bubble during the 1920s.  There was no inflationary bubble, by any reasonable definition of the word “inflation.”

PS.  I hope to do much less blogging in December, as I will be quite busy with various other tasks.  Of course if Europe collapses . . .

Is it 1936 already?!?!?

Well that didn’t take long.  I have to admit that when I made this prediction eight days ago I didn’t really expect it to happen so fast:

The great irony of the Depression period is that by 1936 things had gotten so bad that even the French had to devalue.  The French had helped cause the Depression by their obsessive hoarding of gold, and their refusal to help out the weaker countries.  In other words, in monetary terms France was the Germany of the 1930s.  When you see doubts raised about countries like Finland and Austria, you really have to wonder if even the German debt is truly safe.

I still think the policy elite are slightly less pigheaded than in the 1930s, so I doubt things will go that far.  But it would be a lot simpler if they recognized reality right now, instead of dragging out the pain.

First a bit of background.  In the late 1920s and the early 1930s the Bank of France hoarded vast quantities of gold.  This raised the value of gold, which meant deflation (once the US and Britain stopped offsetting the French hoarding after October 1929.)  An international financial crisis ensued, with one country after another leaving the gold standard.  Britain in 1931, the US in 1933, etc.  At first France got off lightly, as their currency had been undervalued on the eve of the Depression.  But by 1936 the deflation in France was so bad that even they had to devalue.  In each case countries didn’t begin recovering until they had left the gold standard.

In the modern world things seem to move much faster than during the long agonizing 1931-36 collapse of the gold standard.  Today German bonds were hit hard:

The debt crisis that began more than two years ago now risks engulfing Germany. The Markit iTraxx SovX Western Europe Index of credit-default swaps on 15 governments rose to an all- time high as Germany failed to find buyers for 35 percent of the bonds offered at an auction.

Germany is of course the France of the 21st century.

It’s now quite possible that the Fed may have to move toward NGDP targeting before they would have liked.  The Fed cannot allow another collapse of NGDP like we saw in 2009.  The cost in terms of banking distress, worsening public finances, international discord and mass unemployment is simply too great to contemplate.  I have no doubt that Ben Bernanke of all people understands this.

Perhaps the Europeans will come together and do something dramatic in the next few days.  But if not, the Fed must be prepared to hold an emergency meeting and do whatever it takes.  To quote David Beckworth:

Also, if a nominal GDP level target is explicit and widely understood it would actually serve to mitigate the effects of financial shocks.  If the public understood the Fed would always close return nominal GDP to its trend path, public expectations would be better anchored and thus be less susceptible to wide swings.  That means velocity (i.e. real money demand) would be more stable.  For these reasons, it is reasonable to conclude that had the Fed been targeting nominal GDP during the 2008-2009 financial crisis, the outcome would have been far milder.  And for the same reasons, the Fed should be targeting nominal GDP now given the looming financial threat coming from the Eurozone crisis.

It’s Bernanke’s moment of truth.

PS.  Also check out Beckworth’s post showing the non-German NGDP in the eurozone.  And people wonder why the eurozone is having a sovereign debt crisis.

HT:  Joe2

Ben Bernanke 1999, Adam Posen 2011

Here’s Ben Bernanke in 1999:

Needed: Rooseveltian Resolve

Franklin D. Roosevelt was elected President of the United States in 1932 with the mandate to get the country out of the Depression. In the end, the most effective actions he took were the same that Japan needs to take””-namely, rehabilitation of the banking system and devaluation of the currency to promote monetary easing. But Roosevelt’s specific policy actions were, I think, less important than his willingness to be aggressive and to experiment””-in short, to do whatever was necessary to get the country moving again. Many of his policies did not work as intended, but in the end FDR deserves great credit for having the courage to abandon failed paradigms and to do what needed to be done.

Japan is not in a Great Depression by any means, but its economy has operated below potential for nearly a decade. Nor is it by any means clear that recovery is imminent. Policy options exist that could greatly reduce these losses. Why isn’t more happening? To this outsider, at least, Japanese monetary policy seems paralyzed, with a paralysis that is largely self-induced. Most striking is the apparent unwillingness of the monetary authorities to experiment, to try anything that isn’t absolutely guaranteed to work. Perhaps it’s time for some Rooseveltian resolve in Japan.  (Italics added.)

Here’s Adam Posen in the NYT:

BOTH the American economy and the global economy are facing a familiar foe: policy defeatism. Throughout modern economic history, whether in Western Europe in the 1920s, in the United States in the 1930s, or in Japan in the 1990s, every major financial crisis has been followed by premature abandonment “” if not reversal “” of the stimulus policies that are necessary for sustained recovery. Sadly, the world appears to be repeating this mistake.

The right thing to do right now is for the Federal Reserve and the European Central Bank to engage in further monetary stimulus. Having lowered short-term interest rates, they should buy (or in the case of the Fed, resume buying) significant quantities of government securities to help push down long-term interest rates and encourage investment.

If anything, it is past time for the Fed and its European counterpart to act. The economic outlook has turned out to be as grim as forecasts based on historical evidence predicted it would be, given the nature of the recession, the cutbacks in government spending and the simultaneity of economic problems across the Western world. Sustained high inflation is not a threat in this environment.   (Italics added.

So we’ve gone from “do whatever was necessary to get the country moving again” to “policy defeatism.”  How did that happen?

HT: Kai, Marcus Nunes

A crisis Paul Krugman was born to cover

The ironies are piling up so fast, and becoming so surreal, that I’m almost at a loss for words.  Fortunately Paul Krugman isn’t, and makes some very good points. After quoting Mario Draghi on the importance of keeping inflation expectations well anchored, Krugman points out that they are failing:

Unbelievable. Right now, the ECB has too much credibility on the inflation front; the spread between German nominal and real interest rates, which is an implicit forecast of the inflation rate, is pointing to disastrously low medium-term inflation:

You’d think at a time like this if the ECB was going to err, they’d want to err on the side of a bit too much stimulus.  Instead they’ll miss their inflation target on the low side.

The events of the last few years have caused me to radically revise my views of the Great Depression.  Not in terms of the causal factors, those have been amply confirmed.  Falling NGDP does create domestic and international financial turmoil—no doubt about that.  But I used to think people were stupid back in the 1930s.  Remember Hawtrey’s famous “Crying fire, fire, in Noah’s flood”?  I used to wonder how people could have failed to see the real problem.  I thought that progress in macroeconomic analysis made similar policy errors unlikely today.  I couldn’t have been more wrong.  We’re just as stupid as they are.

Sometimes I get commenters saying that the Germans are inflation-phobic because of their experience with hyperinflation.  I doubt that’s the reason; when countries make mistakes they tend to repeat them again and again.  I don’t see much fear of inflation in Argentina.  And the Swiss are just as inflation-phobic as Germans, but they never had a hyperinflation.  The lesson that should be taught to German children is that the deflation of 1929-32 caused much more harm than the hyperinflation.  Here’s Krugman:

Dylan Grice of SocGen points out that it was the deflationary policies of 1930-32, not the inflation of 1923, that brought you-know-who to power.

Indeed. When we hear assertions that Germans are deeply hostile to loose money because of their historical memories, I always wonder why those memories are so selective. Why is 1923 seared into collective memory, while the Brüning disaster has apparently gone down the memory hole?

This is important “” and there’s not much time to get the record straight.

That’s right; it was deflation, not hyperinflation, which brought the Nazis to power.  As late as mid-1929 (six years after the hyperinflation) the Nazis had only a trivial share of seats in the Reichstag.  By early 1933 they were in power.

Here’s Krugman’s policy analysis:

There are strong self-fulfilling aspects to this crisis of confidence “” which is why Europe desperately needs the ECB to act as lender of last resort, and short-circuit the vicious circles.

But no, the ECB will defend its credibility. And it will end up as the highly credible defender of the value of a currency that no longer exists.

I’m not sure if the lender of last resort is needed.  It’s possible that a dramatic shift toward monetary stimulus could rescue the euro.  But we’ll never know for sure, as the ECH will definitely not undertake my moderate proposal.  Instead it’s all or nothing.  They will either do nothing, or they’ll start buying up lots of bad debt.  But there’ll be no conventional stimulus.

This reminds me of the US during the Great Depression.  Richard Timberlake pointed out that one of the most damning facts of the interwar period is that when the US left the gold standard in April 1933 it had the largest gold reserves in the world.  Just think about what that means.  Those reserves are there for a reason, and it’s not to prevent the NY Fed building from blowing away in a hurricane.  They are held in case of an emergency.  Why weren’t they used in 1929-33 to massively boost the money supply?  Because they were there for emergencies.  Are you stupid!  I’m sure Fed officials were quite proud of the fact that they maintained those reserves all through the financial hurricane of 1931-33.

Similarly, as Trichet left office he proudly stated that under his leadership the ECB had driven inflation to even lower levels than achieved by the Bundesbank.  The irony of 1933 is that the refusal to do more aggressive monetary stimulus prior to 1933, led to the eventually collapse of the international gold standard, a much more radical move.  And the irony of the ECB circa 2011 is that they’d prefer the collapse of the euro system, or the monetization of potentially worthless debt, to a more moderate program of targeting modestly higher NGDP growth.

Again, I’m not saying my proposal would definitely work, but surely there’s no excuse for undershooting your inflation target at a time like this.  The ECB seems determined to hold on to its credibility just as tightly as the Fed held on to its gold reserves.  And by doing so it may end up losing everything.

PS.  My unusual policy views puts me in the odd position of agreeing with both Krugman and Tyler Cowen.  Too much debt or too much disinflation?  Maybe both guys are right.

PPS.  I’m very grateful for the nice compliment from Tyler, but in all honesty I think both he and Krugman are much better at euro-analysis.  I’m like the hedgehog who knows one big thing—falling NGDP is very dangerous during a debt crisis.  Yes, it’s a rather important thing, but the euro crisis is very complex, and when I read others I am constantly reminded how much of it is beyond my comprehension.  That’s why I’m sticking to the “more NGDP” mantra, it’s the only advice I feel confident about offering.

A suggestion for Mike Kimel

Please take a close look at the data from the Great Depression, before doing more posts claiming I don’t know the facts.

Mike Kimel continues to insist that I don’t know what was going on in 1933, a period I’ve spend 20 years studying.  He insists that FDR’s dollar depreciation program began in October 1933, even though all economic historians agree in began in mid-April 1933, when the exchange rate for the dollar began declining (against gold and against other currencies.)  He insists prices began rising before FDR took office off, which is not true.  He presents a graph that he claims shows prices rising before FDR took office, but his graph shows inflation rates, not the price level.  In fact, the graph actually supports my argument that inflation didn’t turn positive until after FDR took office.  There’s a difference between the rate of inflation and the price level.

When I complained that Keynesian theory wasn’t able to explain the rapid inflation of 1933-34, a period of massive economic “slack,” he responded:

The problem for Sumner is that Keynesian theory is merely an extension of good old fashioned Adam Smith. Prices depend on supply and demand. You can have a good or service go up in price locally even as it goes down everywhere else.

Keynesian theory is just supply and demand?  Then why not call it ‘Smithian Theory.’  In any case, I was discussing the overall price level, not individual prices.  I could go on, but perhaps that’s enough.

PS.  Ironically, his post is entitled “Scott Sumner digs deeper.”