The best explanation of our current crisis (and it’s from 1933!)
JimP sent me this really neat video. It’s the best explanation of the crash of 2008 that I have yet seen on video. This shlocky, crude piece of pro-FDR propaganda from 1933 shows a more sophisticated understanding of the current crisis than what you get from 99% of contemporary economists. As you watch, note the following similarities:
1. The rise in the value of the dollar (1929-33 and late 2008) caused the price level to fall, and NGDP to fall even faster as output also declined.
2. A policy of mild inflation will reverse this process. NGDP, output, and employment will rise, and debts will be easier to repay as dollar incomes start rising again.
They knew that in 1933, why have we forgotten? BTW, don’t tell me things are different now because we have a severe financial crisis. They had one in early 1933 as well. But at least they understood that their crisis was caused by falling nominal incomes, and not vice versa.
Today all we hear economists talk about is the symptoms of falling NGDP, not the causes.
Update 6/19/09, I just noticed that Tim Cavanaugh at Reason had the same video. Tim seemed slightly less impressed than I was.
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14. June 2009 at 12:21
Krugman tells us all economists have forgotten the lessons of the past. How true. Including himself.
This is the Roosevelt of optimism and joy. Could we ever use a taste of that now.
14. June 2009 at 14:15
Very interesting video!!!
So, who was the first economist to understand the importance of nominal aggregate demand as the driver of the business cycle? It feels to me that this is the key insight. The video puts inflation first. But in a way, inflation (like deflation) are by-products of either spending money or expectations of money being spent. The really first thing is printing money. And the second thing is spending money. And the third thing is inflation.
Jeremy
15. June 2009 at 02:02
Jeremy Goodridge:
Something always worth remembering Jeremy. The Roosevelt administration and the Hoover administation sought to use supply side policies (like price floors) to raise prices and cause inflation.
15. June 2009 at 04:12
JimP, Yes, we have forgotten things we used to know. I guess things have to get really bad before we shed the “Puritan attitude” that says it can’t be as simple as creating a bit of inflation.
Jeremy, I think good economists have always known about the relationship between nominal shocks and real output, although they lacked terms like NGDP. David Hume certainly knew this in 1752. Fisher understood this very well.
Normally you are right about the chain of effects. But in this case the inflation came before the actual printing of money. When FDR devalued the dollar it created expectations of future money printing, and this created current inflation.
Bill, You are right that Hoover and especially FDR had really bad supply-side policies, which I hope to address in my next post—as Krugman just endorsed those bad policies.
15. June 2009 at 06:55
Scott
With all of the current worry about inflation from the right I think people might think Bernanke is being successful in creating “a bit of inflation” – so what is the issue?
The issue is that Bernanke and Obama (and I don’t think Bernanke can do this without the explicit support of Obama)need to have “a bit of inflation” as a policy AIM. That video had the aim of inflation – they were proud of it. And so should we be. As you say – a stated price level target and an end to paying interest on reserves. The aim of recovery. Optimism as a policy goal. Will that happen?
Unfortunately both Bernanke and Krugman seem to agree – no it won’t. We are in for a “decade of stagnation” – so Krguman tells us. And they are targeting THAT forecast.
15. June 2009 at 09:22
argh. i’m always the devil’s advocate with you – debtor nation vs creditor? that would be an important difference. it may be wrong to worry about that, but i’m just saying that i can see how some might think that in the non-normal world of finance a country can go from deflation quickly into too-high-inflation and then you can jack up interest rates i guess, but there’s only one REAL way to find out. But the likelihood of a phaseshift from deflation into highinflation depends on whether the models are linear or complex. However i completely agree that inflation is the only thing that the gov’t CAN do to “fix” the crisis.
i’m not saying that they SHOULD however. And maybe we should focus on that for once. not cause of hypeinflation. i think it’s the fed’s job to keep the system ALIVE and they’ve done a reasonable job at that. I know of one captain that could have done it better 🙂 Reinflation can wait. good idea of course. NGDP is even better, but i’d like to buy my first home (and not at 2:1 comparable rent). I don’t care whether we get there cause of a real estate crash, 15% unemployment , AD curves shifting into 3 dimensions, or American Dream Premium getting converted into American Nightmare Discount. You can’t force a fool to hold on to his money, even if you’re the Fed. Keep the system afloat and let the free market work IT’S redistribution magic. I know quite a few people that didn’t jump on the bandwagon just because of that.
16. June 2009 at 09:11
JimP, I share a similar concern, but let me state it slightly differently. The Fed announced QE in March. There was a nice stock bump on the news, so I said “better than nothing.” But expectations remained far too low, so much more was needed. Markets price in the entire expected impact into current asset prices. Then stocks rose much more over the next few months. Many people saw that as the effect of QE, I saw it as luck. The QE was priced in right away. The luck was that the developing world, especially China, looks set for a pretty good recovery. That will help the US somewhat, slightly move us away from liquidity trap conditions. But we can’t rely on continued luck. As you imply, we need to create our own luck, not rely on random shocks that might go our way. So while I give Bernanke a tiny bit of credit for the QE program, it did bump stocks up a few percent on the announcement, that’s all I’ll give him. I will only give the Fed credit for changes that result from them targeting expectations, or targeting optimism as you might say.
Alex, I agree the Fed can’t micromanage the economy. Just have NGDP grow at 5% but let the winners and losers sort themselves out. Remember that the real estate bubble starting crashing well before NGDP. So NGDP targeting does not prop up loser investments. Relative shifts still occur.