Another Angry Bear attack
Every few months I get attacked by the Angry Bear blog. Here Mike Kimel questions my interpretation of the 1933-34 inflation, which I attribute to dollar depreciation:
I see a much simpler story.
1.Aggregate demand was very slack when FDR took office.
2.FDR showed up in Washington with a plan to start spending a lot of money and thus boost aggregate demand.
3.The immediate effect was to convince factories they’d be running down their inventories. That boosted producer prices. It had a much smaller effect on consumer prices because everyone knew the gubmint was going to buy a heck of a lot more producer goods than consumer goods. (The government did buy some consumer goods for the various programs, plus there was a spillover effect, but as the graph clearly shows, the action was on the producer side.)
4.After a bit of time, the public realized FDR wasn’t planning just a one-off, but rather a sustained program of purchases of industrial items. That led them to start using some of their idle capacity, which meant not just selling the fixed amount that was in inventory. The rate of price increases thus dropped.
5.GDP increased at the fastest rate in the United States peacetime history since data has been kept. There was a big hiccup, of course, in 1937 when the government cut back on spending for a while.
There are all sorts of the problems with the argument that the inflation of 1933-34 was caused by expectations of fiscal stimulus. First of all, it’s completely at variance with Keynesian theory, which Kimel seems to be trying to defend. Keynesian theory says demand stimulus doesn’t raise prices when there is “slack,” and there has never been more slack in all of American history than in 1933.
But put that problem aside; assume the Keynesian theory did predict inflation. Prices didn’t start rising when FDR came to Washington with spending plans; they started rising when he began depreciating the dollar. Furthermore, the weekly rise in the WPI index was highly correlated with weekly increases in the dollar price of gold (i.e. currency depreciation.) And those changes (in gold prices) were caused by explicit statements and actions by FDR. Not by fiscal stimulus, which would be expected to appreciate the dollar.
In addition, the fiscal stimulus was far too small to produce the more than 20% WPI inflation observed in the 12 months after March 1933. So the fiscal stimulus theory of 1933-34 inflation fails on all counts. Indeed I’m almost certainly that Keynes himself would acknowledge that it was dollar depreciation that boosted prices in 1933 (he favored the policy), despite the fact that it conflicted with his “bottleneck” theory of inflation.
I don’t have time to fully address all his comments, but a few brief points. Kimel says:
So…. his story requires the devaluation of the currency to worsen the trade balance, and rational expectations to cause a one time explosion in industrial prices and a rather smaller recovery in consumer prices. Rational expectations, however, that came an abrupt halt, at roughly the same amount of time one would predict companies might decide that demand will be sustained enough to start producing more rather than just selling off inventory sitting in warehouses. And his story doesn’t explain why growth was so much faster during the New Deal era than any other period of peacetime since the US began keeping data, nor why there was the big hiccup in 1937.
No, my story doesn’t require devaluation to worsen the deficit, but economic theory suggests it can do so via the income effect. Lars Svensson has written on this subject. And my story does explain 1937, but I don’t have time to write a 400 page blog post on the Depression every time I comment on it. I’ve published numerous articles on the topic over the years. The 1937 downturn was caused by a combination of falling prices (due to gold hoarding) and rising nominal wages (due to the post-Wagner Act unionization drives.) I have no idea what the phrase “rational expectations . . . that came to an abrupt halt” means.
The growth in the New Deal period was very uneven. During March to July 1933 industrial production rose 57%. That ended with the NIRA wage shock, and IP was no higher in mid-1935 (when the NIRA was repealed) than in July 1933. If IP had continued rising after July 1933 at the rate of the fast 1921-22 recovery, the Depression would have been essentially over by the end of 1934.
When output falls sharply due to a demand shock, it’s possible to have very fast “catch-up” growth. Since the hole in 1933 was much deeper than at any time in US history, it’s not surprising that the growth rates during the recovery were quite rapid. But as late as mid-1940 the US economy was still deeply depressed. So it’s a glass half full/half empty situation. There were both good and bad aspects of FDR’s policies. Monthly data shows those effects quite clearly.