Policy news during 1929 (The 1930 slump, pt. 2 of 4)

As you know, I am taking a break from blogging to work on my book.  If I was still blogging, here would be my views on some of the hot topics in the blogosphere:

1.  A one size fits none monetary policy:  

Are the problems in Europe caused by excessive borrowing, or the fact that a monetary policy appropriate for Germany may be inappropriate for Spain?  Neither.  Monetary policy in the Eurozone is far too tight for all members.  As far as I know they are all seeing drops in NGDP.  That’s the problem, everything else is symptoms.  And there are no liquidity “traps” in Europe; everything the ECB is doing, they are doing intentionally.  They don’t want inflation to be higher, which means, ipso facto, they don’t want NGDP to be higher.

2.  Should we have a 2% inflation target?

No, we shouldn’t be targeting inflation at all.  But if we must we should have either a 0% target, or a 4% target (as Blanchard recently suggested.)  Zero percent is best if the Fed is willing to target the price level, and 4% if they plan on continuing to drive us into deep deflationary recessions every time interest rates get near zero.  Obviously my preference is for sound policy and 0% inflation, or better yet, 3% NGDP growth.  In my view 2% would only make sense if two things happened; we stopped taxing capital (making inflation less of a problem), and we got a sound, forward-looking monetary policy.  Whatever we decide long term, we need a bit more inflation right now.

3.  The exit strategy was implemented on October 8, 2008.

Everyone keeps saying we can prevent monetary policy from having an expansionary impact if we pay interest on reserves.  It’s the Fed’s secret plan, it’s exit strategy.  OK, but can someone remind me why this policy, which we are assured prevents reserves from having an expansionary effect, was implemented in October 2008.  Just asking.  (And don’t say “only a quarter point,” it was close to 1% for about nine weeks.)

4.  Health insurance:  The Goldilocks plan

The right-wing free market types say if we give poor people health insurance, they will spend too much on health care.  OK, so give every poor person the amount needed to buy health insurance, and let them spend it as they choose.  But now those do-gooder paternalists will say “we can’t do that, they’ll spend the money on booze and cigarettes, not check-ups for their kids.”  Here’s my compromise, give them $5000/year, but force them to put it into an HSA.  Have Medicare pick-up catastrophic expenses. When the choice is between fun stuff and healthcare (it is alleged, not my view BTW) the poor will spend too much on fun stuff and not enough on health care.  When it’s between health care and rebating money to taxpayers, it is assumed that the poor (perhaps under pressure from medical providers) will overconsume.  So why not HSAs, with any unspent money rolled over for retirement?  There’s two equally boring goals, health care and retirement.  No more battles between the id and superego.  Both health care and retirement pensions appeal to the same boring part of the brain.  So the poor will be able to make “rational” decisions along their indifference curves.  In fact have everyone pay a 10% payroll tax into an HSA, and top off the amount from government funds for anyone who makes less than $50,000.  Then get rid of health insurance companies.  Please.

Here’s the second part of my essay on the slump of 1930.  It describes policy news during 1929.

4.c Monetary Policy during 1928-29

In the previous section I argued that the post-October 1929 rise in the world gold reserve ratio provides an explanation for the onset of the Depression that is broadly consistent with the gold market approach to aggregate demand.  However this increase seems to have begun after the stock market crash of October 1929; and well after the cyclical peak in output was reached in August 1929.  How then could it have triggered the Depression?  To answer this question we first need to take a closer look at the events leading up to the 1929 crash.

After the Fed switched to a tight money policy in mid-1928 the gold outflow from the U.S. reversed and the gold reserve ratio began to increase.  In the absence of offsetting actions elsewhere, this increase was sizable enough to push the world toward deflation.  Was this policy reversal then a “root cause” of the subsequent depression, or were the financial markets correct in essentially shrugging off the Fed’s tightening?  One place to begin is with the stock market reaction to Fed policy announcements during the late 1920s.

On June 4th, 1928, the New York Times (NYT, p. 4) reported “Credit Curb Hinted by Reserve Board”.  The market actually rose slightly on June 5th, but then over the following week the Dow plunged 7 percent.  Policy news ought to be incorporated into securities prices almost immediately, and thus it is unclear whether the Fed announcement had any impact on the markets.  The June 13th NYT attributed the previous week’s stock plunge to “Disappointment . . . at the turn of politics in Kansas City, with the evident elimination of President Coolidge and the substitution of Hoover as a candidate” and also to “Determination of the Federal Reserve . . . to liquidate broker’s loans”.  This was the first of many stock market crashes that the press would at least partially attributed to Herbert Hoover.[1]

On July 10th the Fed raised the discount rate by one half percent, and the next day the market saw “its widest break since the war”, with the Dow falling 3.0 percent.  Once again, it is not clear that we can attribute the crash to tight money.  The July 12th NYT (p. 1) also indicated that the market actually opened “rather firm” and that the price break didn’t occur until late in the session.  This is not to deny that Fed tightening might have had some impact on securities prices””one can find many instances of rumors about tight money coinciding with sharp stock price declines during late 1928 and early 1929.  But these declines were merely brief interludes in a powerful bull market, with the Dow nearly doubling between June 1928 and September 1929.  There is no evidence that investors thought that the Fed tightening in mid-1928 was likely to trigger a major depression.  To understand why both the stock market, and the economy, performed so well during 1928-29 we need to examine the pivotal role played by the Bank of England during this period.

The June 2nd, 1928, NYT (p. 21) predicted “another large movement of gold from here to London.”  Only a few days later, however, that perception began to change rapidly as interest rates rose in the U.S. on rumors of Fed tightening.  By June 8th the NYT was suggesting (p. 32) that high money rates in New York might lead to a reversal in gold flows back toward the U.S.  Britain would go on to lose 22.8 percent of its gold reserve during the period from June 1928 to October 1929.  This is the price the Bank of England paid for delaying the onset of the Depression by one year with a highly expansionary monetary policy.

The famous bull market of 1928-29 was punctuated by a series of sharp price breaks followed by rapid recoveries.  For instance, between December 5th and 8th, 1928, the Dow plunged 11.5 percent over worries about a discount rate increase.  Then, between February 5th and 8th stocks plunged another 6.4 percent, and a February 8 NYT headline reported “RESERVE BOARD WARNING SENDS STOCKS TUMBLING; LONDON RAISES BANK RATE”.  The article attributed the market decline to both a Fed warning that “drastic action might be taken unless the funds going into speculative channels were curtailed” and “the advance of the discount rate of the Bank of England from 4 1/2 per cent to 5 1/2 per cent.”   The next day the NYT (p. 24) suggested (wrongly) that “The prospect of further gold shipments from London to New York has definitely been disposed of by the advance of the discount rate of the Bank of England”.  The correction seemed to have ended on February 11th, when the Dow rose by nearly 3 percent.  On the following day a front page NYT story attributed the rally to the fact that the Fed had failed to raise rates as had been anticipated.  But just a few days later the market again fell sharply on renewed warnings of monetary tightening by the Fed.

[1] Five days earlier the NYT (p. 38) had predicted that Wall Street would be disappointed if Coolidge wasn’t drafted at the Republican convention.

In some respects, the world monetary situation in the late 1920s was similar to that of the late 1990s.  There was great optimism about the prospects for the U.S. economy.  Unfortunately, the sort of monetary policy that allowed for strong, non-inflationary growth in the U.S., tended to exert deflationary pressure on many weaker nations whose currencies were tied to the dollar.[1]  By March 1929, there were growing complaints that the Fed’s anti-speculation policy was hurting the European economies, particularly Britain.  There was even concern that the Fed’s policy might eventually force Britain off the gold standard.[2]  Stocks again broke sharply during late March on “Fear of a drastic advance in the rediscount rates by the Federal Reserve”.[3]  As with the previous setbacks, stocks resumed their upward march once it became apparent that the Fed’s threats were not slowing the economy.  The final two weeks of May saw the last mini-crash, once again attributed primarily to fear of a discount rate increase.[4]

During the summer of 1929 concern over the monetary situation eased as the peak in the seasonal demand for credit passed and the Fed failed to boost the discount rate.  The NYT even predicted (wrongly) that increased gold flows to the U.S. would eventually force the Fed to expand credit.[5]  On August 9th the summer bull market in stocks was temporarily derailed by the Fed’s decision (the previous evening) to boost its discount rate from 5% to 6%, as the Dow fell 4.0 percent in a slump the NYT called the “Most Severe Since 1911″.  And this time stocks plunged right from the opening bell.

[1] In the late 1920s it was European powers such as Britain that were under pressure from a strong dollar, in the late 1990s it was been developing nations such as Argentina.

[2] See the NYT, March 25, p. 42.

[3] NYT, 3/26/29, p.1.

[4] See the NYT 5/23/29, p. 38 and 5/28/29, p.1.

[5]In fact, the Fed responded to the gold inflow with a contractionary policy during 1930.  (See the NYT, 6/30/29, p. N7.)

In retrospect, the Fed’s decision to raise rates may have been a mistake.  Only a few days earlier the NYThad reported that the Bank of England had seen its gold holdings fall £8,000,000 below the minimum level recommended by the CunliffeCommittee.  They speculated that the Bank of England might be forced to raise its discount rate, an action that was seen as likely to depress the British economy anddisturb financial markets throughout the world.  Ironically, the day before the Fed’s discount rate increase had sent U.S. stock prices tumbling, Wall Street had rallied on relief that the Bank of England had refrained from an increase in its discount rate.[1]

Despite what we now know about its ultimate effects, it is hard to be too critical of the Fed’s action given that the markets seem to have made the same miscalculation.  After dropping to 337.99 on August 9th, the Dow soared to its pre-war peak of 381.17 on September 3rd.  The sharp price break on August 9th suggests that Wall Street was concerned about the discount rate increase, but the subsequent rally also suggests that it wasn’t seen as likely to trigger a severe slump.  U.S/British policy coordination had been effective during the 1920s, and this may have lulled investors into believing that central bankers would again be able to cooperate enough to handle the monetary difficulties that might lie ahead.

Although the cyclical peak in output occurred in August 1929, it probably makes more sense to view October 1929 as the actual beginning of the Great Depression.  Industrial production did decline slightly in August and September 1929 but this sort of modest drop in monthly output was not unusual, similar declines had occurred during May, June and September 1925, a year when no recession occurred. The NYT weekly business index suggests that output only began falling rapidly during the final week of October.  And it wasn’t until November and December that we observe sharp declines in the monthly industrial production index. In addition, the fact that stock prices rose rapidly during the late summer of 1929 suggests that it is very unlikely that investors anticipated even a mild recession until at least late September.[2]  Almost all of the stock market crash occurred between late September and early November 1929.  It is during this period that one would expect the market to have gradually become aware of any adverse shocks that might have triggered the Depression.

[1] NYT 8/9/29, p. 23.

[2] These perceptions changed rapidly after mid-September.  The September 21st NYT (p.38) predicted a strong economy during the fall and winter.  By October 17th, they noted (p. 38) that stocks had been following a business slowdown since mid-September.  And by November 11th 1929, the NYT (p. 35) suggested that many were now forecasting a severe recession in the U.S.

In retrospect, the September 26th decision by the Bank of England to boost its bank rate from 5.5 percent to 6.5 percent appears to have been the decisive step which led to a reversal in Britain’s gold outflow, and thus helped trigger the dramatic increase in the world gold reserve ratio.  But the market response to this action was not quite what one might have expected.  To see why, we need to first consider exactly what type of information is conveyed by a change in central bank lending rates.

Although all indicators of monetary policy, including the money supply, exchange rates, and even the world gold reserve ratio, are susceptible to the identification problem, nominal interest rates are especially problematic.  While an unanticipated increase in the central bank’s target interest rate can be viewed as being contractionary, on the day it is announced, over longer periods of time the nominal interest rate is an especially unreliable indicator of the stance of monetary policy.  Whether a given discount rate will have an expansionary or contractionary impact depends on a complex set of economic factors including expectations of inflation and real economic growth.[1]

Recent monetary theory[2]has revived the Wickselliannotion that monetary authorities implement policy by moving their target rate above or below the ‘natural rate of interest.’  Because investors do not directly observe the natural rate, they have difficulty judging the current stance of monetary policy.  Often it is only in retrospect (after discount rates changes have impacted other variables such as the gold reserve ratio), that investors are able to see whether a particularpolicy action has altered a country’s monetary policy.  In addition, markets often seem undisturbed by discount rate increases that are consistent with a given central bank’s underlying operating procedures, but react very adversely to gold flows and/or other economic shocks which are expected to lead to undesirable changes in monetary policy.  We will see this dynamic at work in the British policy changes of September 1929, and again in the Fed policy actions of October 1931.

As late as September 19th, the Dow had declined only slightly from its previous peak.  A 2.1 percent stock price break on the 20th was attributed to fears of an imminent decision by the Bank of England to raise its discount rate.[3]

[1]This point has been emphasized by monetarists such as Friedman and Schwartz, and Meltzer (2003.)  Also see Hawtrey (1947, p. 120.)

[2]See Woodford (2003.)

[3] NYT, 9/21/29, p. 25.

Just four days later there were reports of “Unprecedented withdrawal of gold from the Bank of England”, and another 1.8 percent decline in the market was linked to expectations that the Bank would raise the discount rate on the 26th as a way of averting a financial crisis.[1]  The actual increase was somewhat anticlimactic, and there was no adverse impact on U.S. stock prices.  But the next day stocks fell by another 3.1 percent, a decline attributed to concerns that the discount rate increase would fail to provide the needed boost to sterling.

Unfortunately, there is no “smoking gun” linking monetary policy to the October stock market crash.  One possibility is that during the month of October the market gradually became aware of the fact that discount rates in the U.S and Britain were set at levels that would soon lead to a dramatic increase in the world gold reserve ratio.   For instance, as late as October 19th the NYT(p. 26) was continuing to report that “experts” doubted that gold flows from the U.S. to Britain were likely to resume before yearend andthat the Bank of England would be forced to take further steps to attract gold.  In fact, although Britain’s contractionary monetary policy appeared to lack credibility, the bank rate increase to 6.5 percent would prove to be so effective that a reduction in the bank rate occurred a mere twelve days after the NYTprediction.  What changed, of course, was the economic environment.  The U.S. stock market crash so reduced the demand for credit that existing discount rates throughout the world, and even somewhat lower rates, now represented highly contractionary policies capable of dramatically increasing the world gold reserve ratio.  As output began to fall sharply in late 1929 and into 1930, the natural rate of interest fell even further, and discount rate reductions in the U.S. and elsewhere were not large enough to prevent a sharp rise in the world gold reserve ratio.[2]

By October 28th the NYT (p. 34) was reporting that London expected to receive gold imports from the United States and South America, and on November 1st the NYT (p. 24) predicted that “We have already seen the end of the crumbling-away of the Bank of England’s gold reserve.”  This shift in British policy need not have a major impact if other countries had simultaneously shifted to a more expansionary policy.  In practice, “other countries” meant primarily the U.S. and France, which between them held over one-half of the world’s monetary gold stock.  However because of the French Monetary Law, investors had little reason to believe that France would reduce its demand for gold.  Prior to October 1929, France had been receiving much of its gold from England.  After England tightened its monetary policy the French had to go elsewhere for gold.  On October 29, the NYT (p. 52) reported that France had just received its first shipment of gold from the United States since the Armistice.

[1] NYT, 9/25/29, p. 1.

[2]Glasner(1989, p. 123) also suggests that excessive demand for monetary gold by the major central banks contributed to the Depression, andblames the October crash on investor disappointment that the Fed  didn’t reverse course in late 1929.  This is similar to my own view, although because Glasnerdoes not look at world gold reserve ratios, he is unable to provide an explanation for the timing of the crash.  He credits Earl Thompson with the basic idea.

At the time of the crash the U.S. monetary gold stock was well in excess of legal requirements and thus the Fed could have easily accommodated the Bank of England, as it had during 1927.  Had it done so, the world gold reserve ratio would have only increased by 3 or 4 percent, and the economy would have held up much better during 1930.  On October 31 the Federal Reserve Bank of New York, in coordination with the Bank of England, did cut its discount rate to reassure the markets.  The same day the Dow rose by 5.8 percent.  Statements by Fed officials, however, gave the market little reason to believe that any significant accommodation was forthcoming.  The Fed was particularly anxious to avoid a repeat of its expansionary policy during 1927, which was perceived as resulting in a large gold outflow and excessive stock market speculation.

4.d  Other Contributing Factors in the 1929 Crash

In addition to the highly uncertain monetary situation, there were several political developments that may have played a supporting role in the stock market crash.  On the evening of October 25, 1929, Attorney General William Mitchell gave a speech advocating much more aggressive enforcement of antitrust laws.  Bittlingmayer(1996) showed that throughout the early 1900s, both the stock market and the overall economy reacted adversely to aggressive enforcement of antitrust laws, and tended to do well when enforcement was lax (as under President Coolidge.)  Although stocks did not fall on October 26th, Bittlingmayer (p. 399) suggested that the speech’s “contents or fundamental message could have reached Wall Street a day or two earlier, in the middle of the week-long October 1929 stock market decline that started on October 23.”

Concern over the worsening political situation in Europe, andespecially Germany, may have also played a modest role in the crash.  Although in retrospect the interwaryears are often seen as a period of almost unending political crises, in the late 1920s there was a brief window of optimism about the prospects for both continued prosperity (the so-called “New Era”), and international cooperation.  At the time, even the conservative business press tended to view developments such as the League of Nations, the World Court, and the Kellogg-Briand Pact (which outlawed war) as effective devices for reducing hostilities.  There was also a perception that progress was being made at the London Naval Disarmament Conference, at the Hague Conference on war reparations, and in the talks aimed at creating the Bank of International Settlements (BIS).

On the economic front, the Young Plan (which rescheduled war debts and reparations), and the BIS were viewed as being particularly important.  Supporters of the BIS argued that the bank could play an important role in coordinating monetary policy among the major central banks.  The Economist(7/6/30, p. 6) suggested that the BIS might be able to “stabilize the value of gold” and also noted that Wall Street was hopeful that the U.S. government would support the BIS.  After the BIS began operating in 1930, it did try to encourage central bank policy coordination.  In order for the BIS to play an important role, however, it was seen as essential that there be cooperation on the question of reparations and war debts, especially between Germany and France.  Because German Foreign Minister Stresemann and French Premier Briand were highly respected internationalists who had played a key role in the rapproachment between France and Germany during the late 1920s, there was optimism that a solution could be reached.

Stocks stabilized during the first half of October, with the only sharp price break occurring on October 3rd.  Early on the morning of the October 3rd there occurred an event which can be seen in retrospect as signaling the end of the cooperative spirit of the late 1920s, and the beginning of the much more contentious 1930s.  The Economistcalled the death of German Foreign Minister Stresemann a “calamity . . . overhanging Europe for months, years” and the NYT termed it a “political catastrophe”.[1]  Carr reported that “Almost at the same moment a panic occurred on the New York Stock Exchange.” [2]  Carr probably exaggerated the importance of this event on U.S. stock prices, Stresemann’s death occurred before the market even opened.  In retrospect, however, it seems just as clear that such a market reaction would have been appropriate.  The ominous fears of the Economist concerning the impact of Stresemann’s death seem mild when compared with subsequent events.  Events in Germany began deteriorating almost immediately and by mid-1931 turmoil in Germany had become the single most important influence on the U.S. stock market.

The most severe phase of the 1929 crash began on October 16th, when the Dow fell by 3.2 percent.  Coincidentally, this was the same day that the German nationalists began a petition drive to stop the Young Plan.  If the nationalists could register at least 10 percent of the electorate within two weeks, then a plebiscite would have to have been held on the proposal.  Even if this were to occur, it was considered highly unlikely that the effort would be ultimately successful since rejection of the Young Plan would require 50 percent of all eligible voters.  Nevertheless, the petition drive was viewed as an irritant to the delicate negotiations underway at the time.  In commenting on the petition drive, the October 26th Economist (p. 752) lamented the passing of Dr. Stresemann whom they regarded as having been a key factor in restraining nationalist sentiment.

[1] See the Economist (10/5/29, p. 610) and the NYT (10/3/29, p. 1).

[2] See Carr (1947, p. 129). The NYTdid attribute the weak opening of the Berlin bourseto Stresemann’s death, and also suggested that it may have depressed French stock prices.  But the London market was mixed on the 3rd and it seems unlikely that this event could, by itself, have pushed the Dow lower by 4.3 percent.

The same issue of the Economist(p. 766) described the collapse of the Briand government, which occurred on the evening of October 22, as a “bolt from the blue” andsuggested that it had occurred at the worst possible moment because of “the delicate situation withthe German plebiscite the Saar Conference and the evacuation.”  The NYT noted that there was concern that the collapse could undermine German support for the Young Plan, and thus delay its adoption.  On October 23rd the Dow dropped 6.3 percent, although the financial press could not find any reason for the decline.[1]

In late October it appeared unlikely that the German petition would be successful, and thus it is unlikely to have been a significant contributor to the October crash.  An October 29th NYTheadline prematurely called the “Anti-Young Plan Vote a Nationalist Rout”, andthen a six days later had to backtrack with a report that the nationalists had surprised everyone by collecting the 4 million signatures necessary to force a referendum on the Young Plan.  At the same time, the Briand government in France was replaced by a more hawkish regime headed by Tardieu.  The weak opening on the German Boerse on Monday, November 4th, was attributed to both the German referendum, and to the gains made by reactionaries in France.  And the U.S. market, which had been widely expected to open higher, instead plunged by 5.8 percent.

If European political troubles contributed in any way to the October crash, the most likely mechanism would have involved a change in expectations regarding international monetary cooperation.  An October 29 NYT headline stated that “Europe is disturbed by American Action on Occupation Debt.”  The reports that the U.S. would take a unilateral approach to German war debts created concern that “German nationalists can make further use of [the] American action as showing that Washington thinks little of the Young Plan or the International Bank.”  And an October 28th NYT headline noted that the “Young Plan [is] endangered by deadlock over BIS.”

[1]  The Oct 30th NYT declared that uncertainty regarding the political situation in France had depressed stock prices in Paris.

Although these European disturbances occurred at roughly the same time as the October crash, there is little evidence linking specific news stories with important stock market movements.  In addition, these events received less coverage in the U.S. press during late October than did the fight over the Smoot-Hawley tariff bill.  A number of economists[1]have suggested that the Smoot-Hawley tariff contributed to the Great Depression, and Wanniski (1978) even argued that it triggered the October stock market crash.  The tariff may have had an impact, but probably not for the reasons suggested in previous accounts.  Indeed the mechanism by which Smoot-Hawley impacted the market appears to have changed over time, and thus it will be useful to separate the impact of the tariff fight of 1929, from the impact of its enactment in 1930.

Wanniski argued that the tariff began affecting the market in December 1928 when word got out that the Republicans planned hearings on a bill that would include more than the agricultural protection promised in Hoover’s presidential campaign.  He also noted that stocks dropped sharply on March 25 and the morning or March 26, 1929, on news that pressure was building for tariff protection on many industrial goods.  Wanniski missed several other news stories that support his interpretation.  The March 5th NYT (p. 40) observed that stocks fell sharply “during yesterday’s inauguration”, but could find no explanation.  The only significant economic news contained in the speech, however, was Hoover’s announcement that he planned to call a special session of Congress for tariff legislation.  And the May 8th NYT (p. 30) reported that the proposed tariff increases reported out of the House Ways and Means Committee on the previous day “go far beyond what the President had led the country to expect.”  The CFC called the proposals “a great shock to the community.”  The Dow dropped 1.3 percent on May 7th.

The first big tariff fight occurred in the U.S. Senate during late October and early November of 1929.  One of the key votes cited by Wanniski was a procedural vote on the afternoon of October 23rd over the issue of the tariff rate on calcium carbide.  A split on this issue within the coalition of Democrats and progressive Republicans that had opposed higher industrial tariffs was treated as a major news story in the October 24th NYT.  The Dow fell 6.3 percent on October 23rd, with most of the decline occurring in the last hour of trading, following the Senate vote.

[1]  See Meltzer (1976), Gordon and Wilcox (1981), and Saint-Etienne (1984.)

Despite the preceding evidence, there is a serious problem with Wanniski’s account of how Smoot-Hawley contributed to the October 1929 stock market crash.  After the October 23rd vote, the anti-tariff coalition grew progressively stronger, just as the crash entered its most severe phase.  The November 1st NYT (p. 1) reported “Republicans Admit Coalition Control.”  By November 10th, the protectionist Republicans had been completely routed and there were predictions that the coalition might force reductions in tariffs on manufactured goods.  Contemporaneous observers also believed the news favored the low tariff bloc.  Bankers Trust director Fred Kent argued that a contributing factor in the crash was the success of the coalition in blocking the tariff.[1]  Even if one does not accept Kent’s analysis of the market reaction, it is hard to reconcile Wanniski’s view with the widespread contemporaneous interpretation that in the weeks following October 23rd the protectionist wing of the Republican Party had suffered a major setback.

There is another way that the tariff dispute could have affected the markets.  The tariff fight was unquestionably the major news story during the October crash (after the crash itself) and NYT headlines indicated that the Senate battle had created a serious split in the Republican Party.  An October 26th NYTheadline reported that Kahn had been appointed chair of the Republican election committee as a slap at Republican members of the anti-tariff coalition.  Only days later, however, an angry reaction from the anti-tariff Republicans forced Kahn to decline the position.  An October 30th NYT headline stated that an outraged Joseph Grundy (the principal lobbyist for eastern manufacturers) had suggested that small (i.e. agricultural) states should be denied equal representation in the Senate.

In November the situation grew even worse for the Republicans.  The November 1st NYT reported “It is a long time since such utter confusion prevailed in Congress as was revealed today.”  On November 10th the NYT reported that even Smoot’s total capitulation to the coalition, which included an offer to let the coalition write its own bill, had been rejected.  And on the next day the NYT headline read “Republican Revolt Seen, Following Senate Split and Chaos in Leadership . . . Call Party Disorganized.”  The same issue (p. 1) argued that the public was upset with the apparent inability of the Republicans to govern and (correctly) predicted major Democratic gains in the next Congress.   This view was reinforced by recent Democratic gains in certain state and local contests.  It was the sort of crisis that could have brought down a parliamentary government.

Roger Babson called the Senate’s actions on the tariff the “most important” factor in the crash.[2]

[1] NYT, 11/12/29, p. 3.

[2] See the CFC(11/23/29, p. 3257). Babson was respected on Wall Street because of his September 1929 forecast of a stock market crash.  Interestingly, although in November he blamed the crash on the tariff fight, his earlier forecast was based on the Fed’s “tight money” policy.  He may simply have been lucky, however, as many of his other predictions were much less accurate.

By explicitly blaming both sides of the tariff issue, Babsonsuggested that the problem had more to do withthe spectacle of government ineptitude than with the specifics of the legislation.[1]  In general, however, observers were much less likely to connect the October crash to the tariff bill than would be the case during the June 1930 market plunge.

The attractiveness of the ‘political paralysis’ explanation is enhanced by the fact that these events would not necessarily have had a deflationary impact on the economy.  Although there was a significant decrease in commodity prices during late October and early November 1929 (see figure 4.1), the drop was certainly too small to account for the severity of the crash.  And the fact that the crash was more severe in the United States than in Europe also points to the likelihood that there were some specific American factors involved.

Additional support for the hypothesis that political turmoil contributed to the October crash comes from its dramatic denouement.  The November 12th and 13th issues of the NYT reported that there was no explanation for the continual slide in the stock market.  The next issue, however, was very different in tone.  The income tax cut announced by the Hoover Administration on the evening of the 13th was treated as the major news story.  Equal importance was given to the promise of cooperation from House and Senate leaders.  The news led to widespread speculation that the market had hit bottom and would rally on the following day (the 14th.)

The following day the NYT was even more optimistic.  The 9.4 percent increase in the Dow was one of its sharpest gains ever.  Front page articles were entitled “Congress to Rush Tax Cut,” “Leaders are Enthusiastic,” and “Officials Confident Will Suffer No Severe Depression Now.”  The financial page (p. 38) noted “There has not been a day in many weeks in which such an aggregation of good news descended on Wall Street.”  One of those pieces of “good news”, the final approval for the BIS, was not entirely unexpected.  Nevertheless, the NYTargued that the French signature was “significant” because it showed that “the Tardieu Cabinet is as conciliatory as its predecessor.”  The Fed also contributed to the government’s effort by cutting the discount rate.

While the plethora of good news makes it difficult to attribute market gains to any one factor, the tax cut was treated as the major news story of the day.  And although its effect on the market was undoubtedly partly due to an anticipation of its expansionary impact, the NYT (p. 26) also suggested a political interpretation; “What will make an unquestionably good impression [to Wall Street] in the Treasury’s present move is the promptness with which Congressmen dismissed political differences in their ready assent to the government’s proposal.”

[1]  A comparable example might be the adverse stock market reaction to the disarray in the Republican Party during the summer of 1990 after President Bush abandoned his no new taxes pledge.


4.e  What do We Know About the 1929 Stock Market Crash?

           At the beginning of this chapter I suggested that in order to understand the October crash, one needed to explain why it would have been sensible for investors to be highly optimistic in September 1929, and somewhat pessimistic in November 1929.  Is there an explanation for such a dramatic change in sentiment? We know that between 1922 and 1929 the U.S experienced strong economic growth accompanied by stable prices, as well as budget and trade surpluses.  Government was widely viewed as being competent and pro-business.  Of course the international situation was never really completely satisfactory during the interwar years, but 1929 saw distinct signs of progress.  In September 1929 there really were good reasons to anticipate a “New Era”.

If we were to list some of the underlying causes of not just the downturn in late 1929, but also the Depression itself, the list might include the simultaneous adoption of tight money in the major economies, international political discord and lack of policy coordination, ineffectual leadership from President Hoover, and widespread banking panics.  It is rather striking that three of these four problems suddenly appeared on the horizon in October and early November 1929.  Nevertheless, it is unlikely that a ‘Great Depression’ was anticipated by investors in the months after the October crash.  The Dow fluctuated between 200 and 260 during the first six months after the crash, levels comparable to those of highly prosperous 1928, or for that matter, the early 1950s.  By contrast, during the summer of 1932 the Dow would fall into the low 40s.  In order to explain the crash it is only necessary to show how investors moved from the giddy optimism of mid-1929 to a much more circumspect mood during the last three months of the year.

The decision by the Bank of England to raise interest rates in September 1929 may have triggered a dramatic tightening in world monetary policy, but we only know this in retrospect.  Contemporaneous observers find it difficult to ascertain even the current stance of monetary policy.  And what matters to most to investors is not so much what a central bank or a group of central banks is doing at a point in time, but rather the policy they are expected to adopt over an extended period of time.  This makes it almost impossible to establish a clear link between monetary policy and the 1929 crash.

If moves toward a tighter monetary policy did contribute to the crash, one might also have expected a decline in commodity prices.  A significant decline did occur in October, however a major stock market crash might reduce commodity prices even in the absence of tight money, and so this correlation doesn’t really provide independent confirmation that tight money triggered the stock market crash.  All we can actually say is that if markets did begin to perceive a worldwide move toward higher gold reserve ratios after October 1929, then that perception was accurate.

A tightening of monetary policy that leads to a decline in equity prices anda slowdown in the economy is also likely to reduce the natural rate of interest.  Unless central bankers understand this and reduce the discount rate sufficiently, policy will become steadily more contractionary over time.  And this doesn’t even account for the deflationary effects of banking panics.  At the most fundamental level, the “New Era” optimism was predicated on confidence in government policy, especially monetary policy.  If markets had expected the macroeconomic environment of the 1920s to continue into the 1930s, that belief was presumably predicated on the assumption that Fed policy would continue on the path set by Governor Strong.[1] The instability of domestic monetary policy would be even worse in the absence of international policy coordination.  In particular, if the world’s central banks began competing for the limited supply of monetary gold then it would become even more difficult for any individual central bank to stabilize domestic prices.  France was accumulating gold throughout the late 1920s and early 1930s.  Once investors became convinced that Britain and the U.S had raised interest rates enough so that their gold reserve ratios would also started increasing, it is likely that expectations turned sharply bearish, and this could explain why prices and output began falling rapidly.

When viewed in isolation, the political events of late 1929 don’t seem all that significant.  But the fact that the turning point in monetary policy occurred in the midst of a tumultuous period in both domestic and international political affairs would have naturally led to doubts about whether a “New Era” had actually arrived.  Investors may have begun to (correctly) perceive that governments would not be up to the task of effectively responding to the weaknesses of the international monetary system.  Further support for this view comes from the fact that several of the subsequent “crashes” during the early 1930s were clearly linked to bearish economic or political news, especially to news stories that first appeared in the October 1929.  The first such example is the June 1930 stock market crash.

[1]The is some dispute as to whether the Fed’s underlying policy regime policy actually changed after the death of Governor Strong.  Meltzer (2003) argues that it did not.  Yet several prominent contemporaneous observers, including Irving Fisher and R.G Hawtrey, argued that Strong’s death left the System without leadership, and that this contributed to the Fed’s passivity during the early 1930s.  While either interpretation is plausible, Strong’s activist policy bent and forceful personality were certainly needed in the early 1930s



35 Responses to “Policy news during 1929 (The 1930 slump, pt. 2 of 4)”

  1. Gravatar of StatsGuy StatsGuy
    16. February 2010 at 20:58


    “But now those do-gooder paternalists will say “we can’t do that, they’ll spend the money on booze and cigarettes, not check-ups for their kids.”

    Please count me among those “do gooder paternalists” who enjoys being talked down to by wise and worldly economists.

    Yes, I do favor forced health care spending rather than general purpose transfers (which economics tells us is always superior) because lack of health care has negative externalities (crowded hospitals, disease reservoirs, etc.), and because even if I believe someone should spend their own money how they please, I don’t trust everyone to spend grant money to take care of their kids (witness the prevalence of child abuse, criminal neglect, deadbeat dads, etc). So if society foots the bill, society gets some say.

    HSAs are not some compromise between those idealistic, misguided liberal do-gooders and those savvy practical economists. They are a compromise between those savvy do-gooders and the idealistic economists who seem to think that every parent really would use that money in the best interests of their children.

    Some day, I would like the economics field to rebuild their rational optimizing actor models to account for the fact that 26% of the US population suffers from mental illness in any given year (NIH numbers), 1 in 14 Americans (across all age categories, but even higher in target populations) has a serious substance dependence problem, 1 in 58 children suffers severe neglect or abuse. And I strongly suspect these numbers are ALL higher among the subpopulation of Americans that is most likely to receive aid. Maybe, as part of the PhD program at top tier universities, we should require Econ grad students to spend 3 months as a social worker intern working with the hardest cases.

  2. Gravatar of Richard A. Richard A.
    16. February 2010 at 22:40

    FRED has been posting information on haw much interest the Fed has been paying on reserves (under reserves).

    Interest Rate Paid on Excess Reserve Balances (Institutions with 1-Week Maintenance Period)

  3. Gravatar of Lorenzo from Oz Lorenzo from Oz
    17. February 2010 at 02:17

    Stats guy: what are the distribution of those figures among politicians and public servants? After all, if limits to human rationality are evenly distributed, then they do not actually increase the reasons for government action, since they will have the same rationality problems.

    I am reminded of Buchanan’s comment when it was pointed out that Americans donate about 10% of their income to charities of various varieties. He responded he was happy to analyse the other 90% of their behaviour.

    I am also a little leary of “getting a say because it costs society” arguments where they are based on government spending on the first place, because you then get an expanding circle of ever increasing central control.

  4. Gravatar of mbk mbk
    17. February 2010 at 04:18


    “I am also a little leary of “getting a say because it costs society” arguments where they are based on government spending on the first place, because you then get an expanding circle of ever increasing central control”

    As a footnote, if memory serves this is the logic behind the famous Hayek quote “Socialism is slavery” (Belloc apparently said it first): What starts out as unconditional generous aid by “society”, or to be precise, government, soon turns into conditional aid, then into forced consumption, with its corresponding mirror image, forced production, i.e., slavery.

  5. Gravatar of ssumner ssumner
    17. February 2010 at 07:22

    Statsguy, It seems you didn’t read my post very carefully. I didn’t propose the policy consistent with complete rationality, but rather a quasi-paternalistic policy. I intended the remark about do-gooders as a joke.

    Thanks Richard.

    Lorenzo, Good point.

  6. Gravatar of Dan Carroll Dan Carroll
    17. February 2010 at 07:51

    Your work on the Depression is very interesting, as is the theory that the increase in the world’s gold reserve ratio was a/the triggering mechanism of the Depression. I am not an expert on the Depression, but instead a ‘student’.

    My question is this: You seem to rely very heavily on a rational expectations model for the stock market (in previous posts you have mentioned the EMH). I don’t intend to reinvite a philosophical debate, but perhaps considering alternative mechanisms would enhance your discussion. For instance, there seems to be an implicit assumption that the stock market has, in aggregate, unlimited liquidity with which to implement these expectations. Yet, the market of 1929 was highly leveraged, and stocks – even without direct margin – are inherently leveraged bets on real assets. If there is a liquidity shock to the economy, wouldn’t a crash more likely follow it, not precede it, especially if that shock was not well understood in advance?

    btw, I agree with your heath care solution – as HSA’s combined with catastrophic insurance and subsidies for the poor are a useful compromise between highly inefficient and costly government control (but needed due to the disconnect or adverse correlation between health and income) and a much more efficient consumer -driven choice.

  7. Gravatar of StatsGuy StatsGuy
    17. February 2010 at 08:37


    “I am also a little leary of “getting a say because it costs society” arguments where they are based on government spending on the first place, because you then get an expanding circle of ever increasing central control.”

    That’s fine – but you are making an argument against intervention at all. I’m arguing that IF govt does use transfers, dedicated funds are better than unpurposed funds (in contrast to the reco of microecon) – not merely that they are a politically expedient compromise that is economically inferior, but still better than the even worse solution of creating a government agency.

    Or are you arguing society would be better off if we just gave everyone 5k to spend rather than 5k for HSA (with remainder going to forced savings)?


    I understand it was in good humor, but I bristle at the constant poking. In practice, I think the definition of “do-gooder” applies equally well to hopelessly naive economists who have no appreciation for the real world as it does to ‘liberal’ activists.

    do-goodâ‹…er”‚”‚/ˈduˈgÊŠdÉ™r, -ËŒgÊŠd-/ Show Spelled Pronunciation [doo-good-er, -good-] Show IPA

    -noun a well-intentioned but naive and often ineffectual social or political reformer.

    While you aren’t hopelessly naive, it seems the terms of debate are structured to cast pragmatic reformers as hopelessly naive and academic economists as savvy and worldly.

  8. Gravatar of Robert Simmons Robert Simmons
    17. February 2010 at 09:32

    “Are the problems in Europe caused by excessive borrowing, or the fact that a monetary policy appropriate for Germany may be inappropriate for Spain? Neither. Monetary policy in the Eurozone is far too tight for all members.”
    Can’t it be all three? With the excessive borrowing, the issue of tight monetary policy is exacerbated. The correct policy for Germany is tigher than the correct policy for Spain (and Greece, etc.). Current policy is too tight even for Germany.

  9. Gravatar of Premature tightening – Economics – Premature tightening - Economics -
    17. February 2010 at 10:22

    […] customers". Still, this is something to keep an eye on.And speaking of the Great Depression, here's more interesting stuff from Scott Sumner's book-in-progress, including a blow-by-blow […]

  10. Gravatar of azmyth azmyth
    17. February 2010 at 13:05

    “And don’t say “only a quarter point,” it was close to 1% for about nine weeks.” (I agree with the spirit of this statement)

    It is an all-too-common fallicy to analyze human actions without reference to the opportunity costs they face. The opportunity cost to holding reserves is giving up holding short term bonds. A bank holding reserves does not want to make a loan, they want a safe store of value. If you look at the returns on T bills, they are actually lower than the return on reserves. I was surprised by that. Not only are reserves better because they can be directly spent/lent out and you don’t have to wait for them to mature, they also earn a higher interest rate! No wonder everyone was switching to them.


    StatsGuy, the mental illness thing is a red herring. Most of those are anxiety disorders, mild depression and other things that have absolutely no impact on whether or not someone can manage their own health care expenditure. The severely mentally handicapped get their health care taken care of by others anyway. The real disadvantage of HSAs compared to Federally managed care is that HSAs don’t let politicians hand out government money to corporations who contribute to their campaigns. I would guess that HSAs do just as good of a job addressing the externalities as directed expenditure.

  11. Gravatar of jj jj
    17. February 2010 at 13:36

    re: 3
    I can remind you, Scott: fed politics! As you say, central bankers are conservative. Only in the time of direst need were they willing to make a (completely impotent) change. I see it as a step in the right direction: true there were two equal and opposite forces (base increase vs reserves increase), but at least the idea of paying interest on reserves is a reality now. Maybe our grandkid’s central banker will take the next step of using the reserves rate to increase the monetary base.

    re: 4
    These forced savings plans always get under my skin. It’s like the person proposing them is saying, “I am willing to give up some of my own liberty, in order that I may take away some of your liberty.”

    That said… HSA’s are an improvement on what we have now, so I’d gladly move in that direction.

  12. Gravatar of Premature tightening « Credit, Collections, and Finance Premature tightening « Credit, Collections, and Finance
    17. February 2010 at 14:53

    […] speaking of the Great Depression, here’s more interesting stuff from Scott Sumner’s book-in-progress, including a blow-by-blow […]

  13. Gravatar of Bill Stepp Bill Stepp
    17. February 2010 at 15:14

    Here is the proper monetary policy for a free society:

    { }.

    Political class dismissed.

  14. Gravatar of Assorted Links « It Don't Mean Much, These Seats are Cheap. Assorted Links « It Don't Mean Much, These Seats are Cheap.
    17. February 2010 at 15:14

    […] Scott Sumner on the News in 1929. […]

  15. Gravatar of Lorenzo from Oz Lorenzo from Oz
    18. February 2010 at 02:02

    Statsguy: It is not as simple as saying “no intervention”; it is more that if you are getting effects you do not like, it is time to revisit the intervention not simply take it for granted and then add another layer.

    Health is genuinely difficult and, as a mere Downunder denizen, I rapidly get lost with all the US-specific health policy jargon. I am impressed by the evidence of third party payment encouraging rising costs (a nice conjoining of theory and empirics). I also realise that the US’s current situation is very much “I wouldn’t start from here”. Megan McArdle’s commentary makes sense to me, such as:
    But I do not have a settled position.

  16. Gravatar of Scott Sumner Scott Sumner
    18. February 2010 at 07:09

    Dan , You asked;

    “For instance, there seems to be an implicit assumption that the stock market has, in aggregate, unlimited liquidity with which to implement these expectations. Yet, the market of 1929 was highly leveraged, and stocks – even without direct margin – are inherently leveraged bets on real assets. If there is a liquidity shock to the economy, wouldn’t a crash more likely follow it, not precede it, especially if that shock was not well understood in advance?”

    Actually, I don’t assume unlimited liquidity, I agree that markets aren’t perfectly efficient. Rather I think the EMH is a useful assumption when thinking about the relationship between policy shocks and asset prices. For example:

    1. I don’t claim that the actual fall in stock prices was optimal, given the news received by the market, just that a sharp fall was too be expected from all the bad policy news.

    2. I don’t claim that stock market crashes could not impact AD, just that the evidence from 1987 suggests the impact is quite small.

    Regarding your second question, markets tend to be very forward looking, they often sniff out problems before they show up in the government statistics. In August 2007 markets saw severe problems with our financial system, at a time the Fed was still clueless. I believe that between late September and late October the markets sensed that the stance of monetary policy adopted by all the major central banks was too contractionary, and was about to sharply raise the gold ratio. Yes, the gold ratio didn’t start rising until November, but I think they sensed that discount rates had been set at a level, which combined with a slowing economy and less demand for credit, would reduce the world monetary base and raise the gold ratio. I can’t know any of this, unfortunately, but it is my best guess.

    Statsguy, Well I certainly wasn’t thinking of you, I had no idea what your views were on paternalism. I know liberals who are strongly opposed to the idea of forcing people to buy health insurance, for instance, and I know conservatives who think pot should be illegal, so I wasn’t equating paternalist with liberal.

    You said;

    “While you aren’t hopelessly naive, it seems the terms of debate are structured to cast pragmatic reformers as hopelessly naive and academic economists as savvy and worldly.”

    I apologize if I gave this impression. I don’t think academic economists are any more savvy and worldly than pragmatic reformers. Each side has their strengths and weaknesses, but pragmatic types often have better policy ideas, as they know real world problem of implementing textbook ideas.

    I am glad that I am not hopelessly naive. So there is still a ray of hope that I can get over my naivete? 🙂

    Robert Simmons, Yes, it could be all three. The one size fits all problem was there even before the crisis. Actually, Germany used to complain about the opposite problem, when Spain had the higher inflation rate, and Germany was near deflation. And yes, Greece borrowed too much. But I think 90% of the problem is tight money, and 10% is those other problems.

    azmyth, Good points.

    jj, Yes, I agree they always wanted to do this, but are you defending the Fed? They picked a bad time.

    I agree about forced saving, but I prefer forced saving to forced taxes, plus not having to deal with insurance companies. I see it as a baby step toward less government. Once people start saving and taking care of their own needs, the public will become more libertarian, not feeling the emotional need to rely on the government for all sorts of things. And we will become a nation of investors, which might also make us more pro-free market. And as you say, it can’t be worse than what we have now.

    Bill, That will be a tough sell.

    Lorenzo, Those are good points.

  17. Gravatar of Dan Carroll Dan Carroll
    18. February 2010 at 08:00


    I’m not sure you really understood my question … In any event, you appeared to address a different question than the one I asked. A liquidity shock would force a sell-off of assets, specifically cause a stock market crash regardless of expectations. I agree that markets do sniff out problems before the government and before they show up in statistics. However, in the case of a major crash (~50% drop), I would expect that is indicative of a structural shift and not indicative of expectations. Having lived through 2008 first hand, and having studied major crashes in the past (there have been 14 of them since 1871), all but one of them were followed by sharp rebounds to roughly 70-80% of the previous peak within the year. Even the one (1929-33) did have a significant rally before the bottom dropped out. Again, this indicates a structural shift that is temporary in nature. In 2008, it appeared to me that the structural shift was a liquidity crisis – forced selling overwhelming available buying liquidity, feeding on itself to create a panic.

  18. Gravatar of jj jj
    18. February 2010 at 08:59

    I’m not defending all of the fed – just guessing at how their decision-making process might actually work. I’m defending Bernanke (or somebody else on the fed) by suggesting that paying interest on reserves was the largest possible *politically feasible* step towards a better monetary policy.

  19. Gravatar of mbk mbk
    18. February 2010 at 09:16


    I live in Singapore. So I follow your various comments on the Singapore system with interest. As with all things the devil is in the details. At closer look the Singapore health and pension savings system is sometimes quite different in practice from the way I see it presented here or in other blogs.

    For instance I do not have the impression that the forced health savings system makes people less likely to ask for government help. Quite the contrary, savings can really only cover the “known unknowns” of typical pay-as-you-go ailments. The less frequent, more severe ailments people get later in life, or accidents, can’t really be covered by having everyone prepare and save for them. So the Singapore health savings system is supplemented by insurance and government subsidies (in hospitals up to 80% for public multi-bed non-a/c wards. If you want individualized care in 1-2 bed rooms with a/c, you can get that too in public hospitals but you pay much more). Generic doctors fees and drugs are kept cheap out of pocket to begin with. Whenever people can’t pay their health care bills because their savings / insurance / generic gov. subsidies were not enough, a direct subsidy system with financial means testing kicks in.

    At the end of the day, health care in Singapore is quite heavily subsidised in some parts. At the same time, the standard catastrophic insurance supplementing the savings system does not cover certain things that one might naively assume covered, say, as I’ve been told, outpatient chemotherapy, something which can reach thousands per month for treatment. Should your savings account run dry you just have to pay this from your private pockets, if you can. Of course you can get private insurance for that eventuality, but then, you can get that in the US too. Standard insurance also won’t cover you for pregnancy and delivery, dental, eyes, AIDS, prevention, and any disease declared an epidemic (SARS for instance was technically not covered by medical insurance, only government negotiated goodwill and the low number of total cases made insurance companies pay for it in the end).

    Since drugs are such a large part of health care cost, witness the hoopla in the US over recent Medicare entitlement expansions, the non coverage of drugs and various other items may well be the key reason government health care can be kept so cheap here. But government subsidies are an integral part of health care here, in fact, as the ministry of health puts it on their own website, its primary element. (http://www.moh.gov.sg/mohcorp/hcfinancing.aspx?id=104)

  20. Gravatar of cucaracha cucaracha
    18. February 2010 at 14:40


    The Fed has just raised the discount rate.

    Any comments ?

  21. Gravatar of Ramanan Ramanan
    19. February 2010 at 00:11


    I have left you a note at Nick Rowe’s blog.


  22. Gravatar of OGT OGT
    19. February 2010 at 05:41

    Ok, I have to see your comments on this, book or no. I know you believe in ‘revealed tightness’ by looking at NGDP growth, the markets are certainly taking this move as tightening.


    Plus, Romney was at CPAC calling for a stronger dollar yesterday. I can only guess that’s a dog whistle for gooooolld.

  23. Gravatar of Scott Sumner Scott Sumner
    19. February 2010 at 08:16

    Dan, Perhaps I don’t understand what you mean by ‘liquidity crisis.’ Does that mean tight money? Or tight credit? In my view the stock crashes of 1929 and 2008 would not have occurred if NGDP growth expectations had remained at 5%. Even if liquidity was a problem short term, equity prices are based on long term expectations.

    I also don’t like the term “panic,” as it implies irrationality. There was nothing irrational about the stock crashes of 1929 and 2008. Stocks should have crashed given the monetary policies adopted by the Fed in those two years.

    What does structural shift mean? What structural elements of the economy changed?

    jj, Well have to agree to disagree. I think the payment of interest on reserves was one of the most disastrous decisions in American history.

    mbk, I know you live in Singapore, but I’m not willing to accept your arguments without figures. You said:

    “At the end of the day, health care in Singapore is quite heavily subsidised in some parts.”

    I read that Singapore’s government only spends about 1.2% of GDP on health care subsidies, vs. 7% in the US. Is that wrong? I’m glad things like eyes and dental are not covered, why should they be? Our dental insurance in this country is a complete farce, paying the first $2000 in my case, and nothing thereafter. That is exactly the opposite of what insurance is supposed to be. Why not have people pay out of pocket? As you know, Singaporeans save a lot, they are forced to.

    And having a family is not some unforeseen disaster that must be insured against, it’s a life choice. People should save money to pay for pregnancies. Again, if people are poor that’s another story, my comments refer to the middle class, which is the majority in Singapore.

    I do understand that the government pays for those too poor to afford to save, and did note that in earlier posts. I also noted that Singapore had catastrophic insurance, and was aware that people with more money could buy better hospital rooms, which is appropriate. It is also appropriate that people can buy extra health insurance if they want to. They only thing that makes me like the Singapore system less is the price controls and government ownership of hospitals.

    cucaracha, So Bernanke is following the Fed in October 1931–two years into the Great Depression was viewed as a good time to raise the discount rate. Now we have just had 24 months of job loss, just like in October 1931. See my new post for comment.

    Ramanan, Can you summarize their view of the price level. Why are nominal prices nearly 100 times higher in Japan than in the US?

    OGT, If Romney was calling for a stronger dollar then he is no different than Herbert Hoover.

  24. Gravatar of Ramanan Ramanan
    19. February 2010 at 09:51

    Hi Scott,

    I do not know. I think I know their models bang on, though. Any place I can look at price levels of Japan vs the US ? Are you talking of PPP levels. Or historic changes ? Can you please specify ? I thought inflation is low in Japan.

  25. Gravatar of JP Koning JP Koning
    19. February 2010 at 10:06

    You have a number of underlying assumptions in this piece.

    Mood and perceptions are important to your analysis. You used NYT headlines as a proxy for mood, assuming this sufficient. I’m not sure how rigorous this method is since the NYT is only one source of market opinion, and there were any number of US papers describing mood at around the time (including the Wall Street Journal) and they probably had had a different take on things.

    Secondly, focusing on the NYT is US-centric. The 1929 crash was a worldwide phenomenon. Why focus on US proxies for mood and not French, British, and German proxies? What were the London papers saying?

    Even if you did expand your sources for mood, I would question the underlying assumption behind this practice. Basically, you are assuming that news media can accurately capture something as circumstantial as mood. I’m not so sure that financial journalists are capable of capturing the true complexity of these issues; their simplistic explanations may hide truth rather than explain it.

  26. Gravatar of jj jj
    19. February 2010 at 13:09

    scott, I think we do agree, only you’re wishfully thinking of a counter-factual where the monetary base expanded without the neutralization through paying interest on reserves. That was never going to happen anyways (and now looks like it never will — witness yesterday’s rate increase!!!), so why not view the interest-on-reserves as another degree of freedom that has positive potential for the future.

    Although, I’m beginning to doubt that Bernanke is truly constrained by the rest of the board. This recession has gone on long enough that surely he could have made some headway in convincing his fellow members, if he was trying.

  27. Gravatar of Doc Merlin Doc Merlin
    19. February 2010 at 14:17

    @Bill Stepp


    @Robert Simmons:
    “Can’t it be all three? With the excessive borrowing, the issue of tight monetary policy is exacerbated. The correct policy for Germany is tigher than the correct policy for Spain (and Greece, etc.). Current policy is too tight even for Germany”

    Tight and loose is relative to acted on expectations of rates. Excessive borrowing/savings ratio is a sign of expected low rates, if the central bank raises rates unexpectedly this will be seen as too “tight” if they lower rates unexpectedly it will be “too loose.”
    I can’t remember who it was (maybe Rothbardt) made an argument that the only way to ensure that rates are never too tight was to keep always lowering them unexpectedly, and never raising them. Obviously this is a bad idea because it causes inflationary problems.

  28. Gravatar of mbk mbk
    19. February 2010 at 18:13


    My points were mostly in reply to your assertion along the lines of “if people are forced to save [rather than rely on insurance] they will rely less on subsidies” quoting Singapore’s health system. Now Singapore’s health system happens to work very well, and comparatively cheaply so, but it is your above point that I meant to discuss, the behavioral change you implied. E.g., I’d have to look up total % of GDP for health subsidy figures but from the standpoint of the individual, typically, middle class, at least some subsidies apply at the source (say hospital). (There are quite a few private hospitals too btw, not all is public).

    As for the total cost to the government, there is the implied question “if Singapore’s system is cheaper than others, then why is this so” and here I quoted some relevant factors, e.g., that selected items are not covered the same as they might be somewhere else, say in the US (drugs) and that thusly, one can not directly compare the costs of the various health care systems using % of GDP precisely because the coverage may be significantly different. The no-free-lunch principle applies.

  29. Gravatar of Scott Sumner Scott Sumner
    20. February 2010 at 05:54

    Ramanan, The price of a Big Mac, is 400 in Japan. It is 4 in the US. Don’t tell me they us a different currency, I know that is the answer. I want someone who doesn’t believe money determines the price level to tell me why prices are 100 times higher in Japan. And don’t rely on PPP, I claim prices in Japan would be 100 times higher even if it was completely closed off to trade.

    I know this sounds silly, but the point is that although Keynesian models claim to explain inflation, what they really need to explain is the price level, and they can’t do that without the QTM or some other monetarist model.

    JP Koning, I looked at a number of papers, and I am confident that the NYT fairly accurately portrayed the mood on Wall Street. Of course many other factors, other than mood, enter into my analysis. Nevertheless, I find it interesting that people at the time saw many factors as being important, that I also believe were important.

    On the other hand, I agree that these newspapers reports, by themselves, prove nothing.

    In some of the later chapters I occasionally discuss what British, French and German papers were saying. But the NYT was a fairly good international paper, even back then. They did a pretty good job of discussing foreign affairs. I read almost every single NYT between mid-1928 and 1939. That takes a long time. I also spent hundreds of hours reading other old papers. I can only do so much. And I don’t read French or German, and must rely on translations.

    I totally agree that the true complexity is often not captured by the newspapers. My gold model of the Depression is generally not discussed in the papers, as they never put it all together in the way I did. So I agree with you there.

    jj, Good point about Bernanke, but I am keeping an open mind.

    One more degree of freedom, or one more tool to screw up when they can’t even handle their current responsibilities?

    mbk, Whether something is covered or not doesn’t directly affect the health care to GDP ratio. Even including what people spend out of pocket, Singapore spends far less than we do, even far less than the Europeans do. So I think the comparison is fair.

    I wasn’t trying to dispute your facts, I agree it wasn’t as simple as I suggested. But what I was arguing is that your points didn’t change these broad conclusions:

    1. People are forced to save for their own health care
    2. Thus the government only needs to spend 1.2% of GDP in subsidies
    3. Since they pay out of pocket, they are more careful shoppers, and total health expenditure is only about 4% to 5% of GDP, vs. 16% in the US.

    I think those three statements are still true, despite the valid issues you raise.

  30. Gravatar of Ramanan Ramanan
    20. February 2010 at 14:37


    There is an inherent assumption here. You are assuming that the Yen exchange rate was 1 at some point in the past. Now, not only has a lot of things happened in the world, I am not even sure if this question makes sense. Let us “create” for the sake of argument. I can decide the exchange rate to be anything on day 1. In the sense it can be 54.67 or any such number like that. The correct question is “why has the Japanese Yen moved from around 300+ to the value right now. The question is not about the value 100 itself.

  31. Gravatar of ssumner ssumner
    21. February 2010 at 07:47

    Ramandan, No I am not assuming the rate was ever 1. I am not interested in explaining inflation. Maybe Japan always had lower inflation. I am interested in explaining the price level, or NGDP. Why is US NGDP $14 trillion, rather than $14 billion, or $14 quadrillion? I say PKs can’t explain that.

  32. Gravatar of Ramanan Ramanan
    21. February 2010 at 09:18


    You are being harsh on them. I mean no theory can explain “human” related factors completely. Every model has an input. There are endogenous variables and there are exogenous variables. They have formulae which give the GDP which depends on these endogenous and exogenous variables!

    I honestly believe that the way the Stock-Flow consistent modelers describe an economy is the correct one and hence advertised their work in Nick’s blog. I can just ask you to look at their work, especially their text and decide.


  33. Gravatar of ssumner ssumner
    22. February 2010 at 07:23

    Ramanan, I appreciate the suggestion, but you need to understand that I get book suggestions almost everyday, and don’t have time to read them all. My first priority is to finish my book. After that I hope to haver time to read more PKs, Austrians, etc.

  34. Gravatar of Ramanan Ramanan
    22. February 2010 at 09:25

    Sure Scott … Ooops Austrians … seem religious – what do you think ? What book are you writing ?

  35. Gravatar of ssumner ssumner
    23. February 2010 at 06:05

    Ramanan, Austrians are no more religious than PKs. I don’t agree with either view, but both are serious theories.

    The book will be on the Depression. I just posted chapter 4 in 4 parts, and will soon post 5 and 6. The total book will be 14 chapters. As you can see from the 4 parts of chapter 4, it is a big project and I need to wrap it up soon.

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