Archive for the Category Great Depression

 
 

Matt Yglesias on America’s self-induced paralysis

This is from an excellent Matt Yglesias post entitled “Could A Determined Central Bank Fail To Inflate?”:

He quotes both former Federal Reserve Vice Chair Donald Kohn and former NEC Chairman Larry Summers as expressing skepticism that it would be possible for the Federal Reserve to generate higher inflation expectations under conditions of depressed demand and slack output. It’s difficult for me to know how we would prove this one way or another, but I believe this view is mistaken. What’s more, I think it’s noteworthy that administration officials who say they believe this seem disinclined to follow this line of thought to its logical conclusion.

For starters, a little throat-clearing about the burden of proof. Many of the inflation skeptics have impressive resumes. What they don’t seem to have are empirical examples of central banks determined to raise inflation expectations and failing to do so. We don’t, unfortunately, have a directly parallel case to the current U.S. situation. But on my side I’ll cite as evidence the successful implementations of exchange rate policy by Sweden, Israel, and Switzerland during the current recession. Those, however, are small economy. So I’ll also cite FDR’s gold policy in the 1930s. That, however, was a gold standard. Then there’s QE 2. I would say we have examples of small open economies with determined policymakers doing this successfully. I would say we have an example of a large economy with determined policymakers doing this successfully under different historical conditions. And I would say we have an example of the Federal Reserving acting with only weak determination and achieving weak results. In my view that means our overwhelming presumption ought to be that a determined Federal Reserve system could increase nominal expectations, especially if the president and the treasury secretary supported that goal.

What’s more, it’s important to get a better understanding of why this would help the economy. The Obama administration seems to have thought of higher inflation expectations as useful primarily because they would help with the debt-deleveraging problem. That’s true. But there’s something more profound happening. Higher expected inflation lowers real interest rates and encourages investment. Higher expected inflation, at the margin, spurs consumption among households who aren’t debt-constrained. Most of all, higher expected inflation coordinates expectations so that households and firms expect higher levels of nominal spending and nominal income in the future, which encourages more real economic activity.

Now flip this around. What if I’m wrong. What if Michael Woodford and Paul Krugman and Lars Svensson and Scott Sumner are wrong? What if the academic writing of Christina Romer and Ben Bernanke is wrong? What if there’s something different about the 1930s and Switzerland and Sweden and Israel that means that in the United States you can’t spur higher inflation expectations as long as there’s all this slack in the economy? Well that’d be a pretty wild scenario. I first started to hear about this scenario back in late 2008 from folks who regarded themselves as well outside the mainstream of the economics profession. Their wacky idea was that faced with a deep recession, the government should basically just finance itself by printing money and not bother with the whole taxes thing. The natural counter to that argument was and is that such a policy would be highly inflationary. Personally, I’m old-fashioned, and I think it would be inflationary for the central bank to just print money at random to finance government operations. But by the same token, I have no doubt that a determined central bank can create inflation expectations. So bringing this back around to where we began, I think the Obama team made a huge mistake here and that most of the key players continue to be making the same mistake. Worse, a large fraction of the progressive community keeps making it along with them. But either the Fed could be doing a lot more to fix the economy, or else some really strange fiscal policy ideas need to be adopted.

It’s interesting to compare Matt’s post to the Ryan Avent quotation discussed in the previous post.  It seems to me that there is growing acceptance of this view among thoughtful centrists and progressives.  As much as I’d like to give credit to us market monetarists, there was obviously a sort of historical inevitability to the increased focus on the Fed, especially after fiscal policy seemed to reach a cul de sac.  Still, I think it’s fair to say we’ve at least contributed some talking points, which allow others to make the case much more effectively than we can.

PS.  I don’t mean to suggest that Avent and Yglesias are recent converts to these views–they been discussing monetary stimulus for several years.  Rather that the issue recently seems to have taken on a new urgency, especially given the lackluster employment numbers.

PPS.  This is also an excellent post.

Another misleading argument by Cole and Ohanian

I agree with Cole and Ohanian that the NIRA aborted a promising recovery after July 1933.  I disagree with Paul Krugman on this issue.  And unlike most Keynesians, I don’t think the recovery from the Great Depression under FDR was very impressive.  Much of the recovery was due to productivity growth (until 1941.)

And yet I find myself once again to be very irritated by an argument against the demand-side view put forward by Cole and Ohanian:

The main point of our op-ed, as well as our earlier work, is that most of the increase in per-capita output that occurred after 1933 was due to higher productivity – not higher labor input. The figure [at the link] shows total hours worked per adult for the 1930s. There is little recovery in labor, as hours are about 27 percent down in 1933 relative to 1929, and remain about 21 percent down in 1939. But increasing aggregate demand is supposed to increase output by increasing labor, not by increasing productivity, which is typically considered to be outside the scope of short-run spending/monetary policies.

I originally read this quotation over at MR, and immediately thought; “When has a Keynesian ever argued that there was a robust demand-side recovery from 1933 to 1939?”  I’ve read just about everything ever written on the subject, and I’ve never heard that argument made.  Instead, Keynesians argue that demand stimulus led to a fast recovery during 1933-37, and then tight monetary and fiscal policies caused a severe relapse in 1938.  So why would Cole and Ohanian pick those dates?

As soon as I clicked over to the Stephen Wiliamson post where Tyler found the argument, I immediately knew the answer.  Cole and Ohanian present a graph that strongly supports the AD view of the recovery from the Great Depression.  Hours worked went from being 27% below normal in 1933, to only 17% below normal in 1937, the cyclical peak.  That means an extra 2.5% per year.  Using Okun’s Law, I’d guess that gets you about 5% RGDP growth per year.  Now the actual rates were substantially higher during 1933-37, as productivity also grew briskly.  But the hours worked finding basically follows the predictions of AD models.  Even Keynesians believe the economy was still far from full employment in 1937.

Then hours worked plunged between 1937 and 1939, in response to the sharp fall in AD (as measured by NGDP) during 1938.  Again, this is perfectly consistent with demand-side explanations of the 1930s.  Indeed it’s the standard view.   BTW, I happen to think a massive adverse supply-shock also reduced hours worked and output during 1938, so my position is actually intermediate between C&O and the Keynesians.  Looking at the entire period from 1929 to 1939, the blue line (hours worked) is highly correlated with changes in AD (i.e. NGDP.)

I think aggregate supply mattered a lot in the Great Depression.  But none of the data presented by C&O refutes the argument that demand played a major role in the Depression, indeed it strongly supports that view.

PS.  I’d be interested in whether the C&O data include hours worked on government jobs programs.  Official government unemployment data from that period is highly inaccurate, as they treat millions of WPA/CCC workers as “unemployed.”

PPS.  In case anyone wonders why I view the 1933-37 recovery as disappointing, despite high RGDP growth rates, consider that industrial production grew 57% between March and July 1933, due to dollar devaluation.  Then FDR raised nominal wages by 20% in late July, as part of the NIRA.  Monthly industrial production data fell immediately, and didn’t regain July 1933 levels until after the NIRA was declared unconstitutional in May 1935.  This led to rapid growth in late 1935.  Because of the way annual GDP data averages over entire years, the RGDP growth from 1933-35 looks deceptively steady and impressive.  It wasn’t.

Update:  I just noticed that Matt Yglesias is just as puzzled as I am by their chart.

How could they have been so passive?

I once read all the New York Times from the 1930s (on microfilm.)  You can’t even imagine how frustrating it was.  They knew they had a big problem.  Then knew that deflation had badly hurt the economy (including the capitalists.)  They new that monetary policy could reflate.  And yet . . .

Weeks went by, then months, then years.  Somehow they never connected the dots.

“Monetary policy is already highly stimulative.”

“There’s a danger we’d overshoot toward too much inflation.”

“Maybe the problems are structural.”

“There are green shoots, things are getting worse at a slower pace.  The economy needs to heal itself.”

“Consumer demand is saturated.  Even workingmen can now afford iceboxes and automobiles.  We produced too much stuff in the 1920s.”

And the worst part was the way political news kept slipping into the financial section.  Nazis make ominous gains in the 1932 German elections, Spanish Civil War, etc, etc.  In the 1930s the readers didn’t know what came next—but I did.

Thankfully we can learn from their mistakes.

Hoover reversed the Depression, until hit by bad luck from Europe

Herbert Hoover succeeded in reversing the Depression during early 1931.  During the first 4 months of 1931, industrial production in the US rose slightly, after plunging sharply throughout 1930.  Then bad luck hit.  The German-Austrian agreement of late March poisoned relations with France.  Then the Austrian bank Kreditanstalt failed in May.  Then German banks came under pressure, then the German currency.  Then the British currency.  The crisis kept moving from one country to another.  People sought gold as a safe haven, and the value (or purchasing power) of gold increased.  More deflation set in.  The severe recession of 1930 turned into the Great Contraction.

Here’s Obama yesterday:

At a town hall meeting on his campaign-style tour of the Midwest, President Obama claimed that his economic program “reversed the recession” until recovery was frustrated by events overseas.

Hoover wasn’t able to print gold, but can be blamed for supporting the Fed’s tight money policies.  Obama can’t print dollars, but can be blamed for not moving aggressively to put people at the Fed who understand the need for more dollars.

No more jobs mystery. Period. End of story.

If I hear one more discussion of the mysterious lack of jobs I’ll explode.  The new GDP numbers are the final nail in the coffin.  For years I’ve been saying there is no jobs mystery.  That any deviation from Okun’s Law was minor compared to the scale of the output collapse.  With the new RGDP figures we now know I was right, there isn’t and never was any mystery as to why there are so few jobs.  RGDP is very low.  Period.  End of story.

I also argued that there was no mystery as to the low level of RGDP.  The new GDP reports shows the NGDP collapse, already the worst since 1938, was even worse than we thought.  Show 100 economists in mid-2007 the NGDP path over the next 4 years, and all but the kookiest RBC-types will tell you a severe recession is ahead.  At least 97 out of 100 will make that prediction.  Check out the graph in this Stephen Gordon post.

And then we have none other than Ben Bernanke telling is that the Fed can do more stimulus, he just doesn’t feel it’s necessary.  How do our elite economists react to the following facts?

1.  Unemployment is unambiguously caused by RGDP collapse.

2.  RGDP collapse is almost certainly caused or greatly worsened by the NGDP collapse.

3.  Bernanke says the Fed drives NGDP.

They react by pretending the Fed has no role in the crisis.  The conservatives say it’s structural.   And then we have one famous liberal economist after another issuing calls for more stimulus, which either ignore the Fed entirely (Larry Summers, Robert Shiller) or suggest that the Fed claims it’s out of ammunition (Alan Blinder), which is wrong.

I don’t find it hard to connect the dots between jobs, RGDP, NGDP and the Fed.  I can’t understand why so few other economists see things the way I do.

A subscriber to the publication Consensus Forecasts passed along to me this summary of a survey of economic forecasters they conducted earlier this month:

Percentage of respondents in each country who consider current monetary policy
too tight / about right / too stimulative

US: 4 / 88 / 8
Japan: 15 / 85 / 0
Euro area (German respondents): 0 / 18 / 82
Euro area (French respondents): 9 / 55 / 36
Euro area (Italian respondents): 0 / 100 / 0
UK: 0 / 25 / 75

Unfortunately, there is no link.  Yes, the sample looks rather small (based on the percentages), but it’s consistent with other surveys I’ve seen.  If the public of the developing world actually understood the role of economists in this crisis, we’d all be lynched.  They think we failed to predict it.  But since monetary policy generally reflects the establishment view of the economics profession, it would be more accurate to say we caused the Great Recession.

Check out the always excellent Marcus Nunes on the new NGDP numbers.  This post compares RGDP, NGDP, and jobs in the 1982 and 2009 recessions.  The graphs are quite suggestive.  He also provided the Shiller link.  David Glasner is the go-to-guy on interwar monetary history, at least among us quasi-monetarists.  He has a good post comparing 1932 and 2011.