Reflation and The Great Recovery: Concepts in the Air

KeynesianFiscal

Stimulus

Monetary Ease

Self-correcting

Mechanism

Inflation Expectations

Dynamic General

Equilibrium

Negative Real Interest Rate

Utility Maximization

Inter- temporal

Substitution

MultipleEquilibria

Liquidity Trap(ZLB)

Animal Spirits

New Deal Distortions

Real Wage

Gold Standard Mindset

Reflation and The Great Recovery: Contributors to Debate

JohnCassidy:

Fiscal Fallacy

Evan KoenigPaul Krugman:

It’s Baaack…Trapped Again

Temin:Regime Change

MinskyRapping

Akerlof & ShillerInherent Instability

Cole&OhanianEggertsson

Duel’n’ DSGE

ChristinaRomer:

Money Matters

RomerEggertssonKrugman

Expectations Rule

Cole & OhanianCodd’l’n Interests

EichengreenTemin

BernankeBreak’n’ Fetters

• Speculation led to too much capital (or wrong capital) investment: “malinvestment”

• Liquidate improper uses of capital and reallocate to other business sectors.

• “The Depression could have been good medicine for the economy”

• Let those who are going to fail… fail.• Hold tight and let the economy fix itself!• Recall Mellon’s mantra:

Liquidate labor, liquidate stocks, liquidate the farmers, liquidatereal estate. It will purge the rottenness out of the system. Highcosts of living and high living will come down. People will workharder, live a more moral life. Values will be adjusted, andenterprising people will pick up the wrecks from less competentpeople.

Brad de Long: Liquidationist Argument

1/2/1

929

4/3/1

929

7/3/1

929

10/2/1

929

1/1/1

930

4/2/1

930

7/2/1

930

10/1/1

930

12/31/1

930

4/1/1

931

7/1/1

931

9/30/1

931

12/30/1

931

3/30/1

932

6/29/1

932

9/28/1

932

12/28/1

932

3/29/1

933

6/28/1

933

9/27/1

933

12/27/1

933

3/28/1

934

6/27/1

934

9/26/1

934

12/26/1

934

3/27/1

935

6/26/1

935

9/25/1

935

12/25/1

935

3/25/1

936

6/24/1

936

9/23/1

936

12/23/1

936

3/24/1

937

6/23/1

937

9/22/1

937

12/22/1

937

3/23/1

938

6/22/1

938

9/21/1

938

12/21/1

938

3/22/1

9390.00

20.00

40.00

60.00

80.00

100.00

120.00

140.00

50.00

60.00

70.00

80.00

90.00

100.00

110.00

120.00

djia, left scale $/pound, right scale producer price index, right scale mfg employment, right scale

Producer Price Index

Onset of the Depression: Persistent Deflation…Persistent Job Loss

$/pound

DJIA

Manufacturing Employment

1/2/1

929

3/27/1

929

6/19/1

929

9/11/1

929

12/4/1

929

2/26/1

930

5/21/1

930

8/13/1

930

11/5/1

930

1/28/1

931

4/22/1

931

7/15/1

931

10/7/1

931

12/30/1

931

3/23/1

932

6/15/1

932

9/7/1

932

11/30/1

932

2/22/1

933

5/17/1

933

8/9/1

933

11/1/1

933

1/24/1

934

4/18/1

934

7/11/1

934

10/3/1

934

12/26/1

934

3/20/1

935

6/12/1

935

9/4/1

935

11/27/1

935

2/19/1

936

5/13/1

936

8/5/1

936

10/28/1

936

1/20/1

937

4/14/1

937

7/7/1

937

9/29/1

937

12/22/1

937

3/16/1

938

6/8/1

938

8/31/1

938

11/23/1

938

2/15/1

939

5/10/1

9390.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80

real m1 balances (ppi deflator) demand deposit to currency ratio real m2 balances (ppi deflator)

Ratio of Demand Deposits To Currency

Real Money Holdings

Onset of the Depression:Bank Runs

Deflationary Expectations

FDR Inaugural Address… the only thing we have to fear is fear itself—nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance…This Nation is asking for action, and action now.

Franklin Delano RooseveltPresident, 1933 – 1945

A “New Deal”—A New Regime •1932

•Reconstruction Finance Corp, Glass-Steagall (T-bonds back cash)•March/April 1933

•Loosened Fetters•Emergency Banking Act/Gold to Treasury

•CCC and Reforestation Relief Act•May 1933

•AAA/Thomas Amendment (President & gold price/BoG & reserve requirement), TVA, Federal Securities Act

•June 1933•NIRA, Glass-Steagall FDIC

•October-November 1933•Commodity Credit Corp, Civil Works Administration

•January 1934•Gold Reserve Act : $ Devaluation: $20.67 $35/oz.

•June 1934•SEC, FSLIC

•1935•WPA, REA, Wagner Act NLRB•Schechter Poultry – NRA

1/2/1

929

4/3/1

929

7/3/1

929

10/2/1

929

1/1/1

930

4/2/1

930

7/2/1

930

10/1/1

930

12/31/1

930

4/1/1

931

7/1/1

931

9/30/1

931

12/30/1

931

3/30/1

932

6/29/1

932

9/28/1

932

12/28/1

932

3/29/1

933

6/28/1

933

9/27/1

933

12/27/1

933

3/28/1

934

6/27/1

934

9/26/1

934

12/26/1

934

3/27/1

935

6/26/1

935

9/25/1

935

12/25/1

935

3/25/1

936

6/24/1

936

9/23/1

936

12/23/1

936

3/24/1

937

6/23/1

937

9/22/1

937

12/22/1

937

3/23/1

938

6/22/1

938

9/21/1

938

12/21/1

938

3/22/1

9390.00

20.00

40.00

60.00

80.00

100.00

120.00

140.00

50.00

60.00

70.00

80.00

90.00

100.00

110.00

120.00

djia, left scale $/pound, right scale producer price index, right scale mfg employment, right scale

New Deal Reflation

DJIA

Manufacturing Employment

$/pound

Producer Price Index

1/2/1

929

3/27/1

929

6/19/1

929

9/11/1

929

12/4/1

929

2/26/1

930

5/21/1

930

8/13/1

930

11/5/1

930

1/28/1

931

4/22/1

931

7/15/1

931

10/7/1

931

12/30/1

931

3/23/1

932

6/15/1

932

9/7/1

932

11/30/1

932

2/22/1

933

5/17/1

933

8/9/1

933

11/1/1

933

1/24/1

934

4/18/1

934

7/11/1

934

10/3/1

934

12/26/1

934

3/20/1

935

6/12/1

935

9/4/1

935

11/27/1

935

2/19/1

936

5/13/1

936

8/5/1

936

10/28/1

936

1/20/1

937

4/14/1

937

7/7/1

937

9/29/1

937

12/22/1

937

3/16/1

938

6/8/1

938

8/31/1

938

11/23/1

938

2/15/1

939

5/10/1

9390.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80

real m1 balances (ppi deflator) demand deposit to currency ratio real m2 balances (ppi deflator)

Ratio of Demand Deposits To Currency

Real Money Holdings

New Deal Reflation

1929

1930

1931

1932

1933

1934

1935

1936

1937

1938

1939

0

1

2

3

4

5

6

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

Full Employment Demand Shift Federal Expend as % of Real GDP

Federal Budget Stimulus

Full Employment Demand Shift(Brown)

Federal Spending(% of GDP)

1929

1930

1931

1932

1933

1934

1935

1936

1937

1938

1939

0

1

2

3

4

5

6

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

Full Employment Demand Shift Federal Expend as % of Real GDP

Federal Budget Stimulus: “Mistake of 1937”

Full Employment Demand Shift(Brown)

Federal Spending(% of GDP)

1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939

-15

-10

-5

0

5

10

15

20

full employment demand shift july-to-july m1 growth (%)

Fiscal and Monetary Stimulus…And Retrenchment

Romer: Money not Spending

1/2/1

929

4/3/1

929

7/3/1

929

10/2/1

929

1/1/1

930

4/2/1

930

7/2/1

930

10/1/1

930

12/31/1

930

4/1/1

931

7/1/1

931

9/30/1

931

12/30/1

931

3/30/1

932

6/29/1

932

9/28/1

932

12/28/1

932

3/29/1

933

6/28/1

933

9/27/1

933

12/27/1

933

3/28/1

934

6/27/1

934

9/26/1

934

12/26/1

934

3/27/1

935

6/26/1

935

9/25/1

935

12/25/1

935

3/25/1

936

6/24/1

936

9/23/1

936

12/23/1

936

3/24/1

937

6/23/1

937

9/22/1

937

12/22/1

937

3/23/1

938

6/22/1

938

9/21/1

938

12/21/1

938

3/22/1

9390.00

20.00

40.00

60.00

80.00

100.00

120.00

140.00

50.00

60.00

70.00

80.00

90.00

100.00

110.00

120.00

djia, left scale $/pound, right scale producer price index, right scale mfg employment, right scale

DJIA

Manufacturing Employment

Producer Price Index

$/pound

Stimulus and Retrenchment: Recession in Depression

1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 19390.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

18.00%

20.00%

40.00%

45.00%

50.00%

55.00%

60.00%

65.00%

70.00%

75.00%

80.00%

85.00%

investment federal govt state & local exports imports consumption, rt axis

The Great Depression: An Overview(Percents to Real GDP)

The End of One Big Deflation

Peter Temin and Barrie A. Wigmore

Introduction• US recovery from the Great Depression in the second

quarter of 1933—Roovelt’s Inauguration– Sargent’s (1983) regime change paradigm

Recall Sargent

• “the key to a costless stabilization was the establishment of a new policy regime”

• “immediate effects were through rapidly revised expectations”

• “changing expectations were the key to stabilization”

Introduction• US recovery from the Great Depression in the second

quarter of 1933—Roovelt’s Inauguration– Sargent’s (1983) regime change paradigm

• Dollar devaluation was key to recovery...signaled change in policy regime and reversed expectations of deflation– Dispute Friedman and Schwartz who claim “the reopening of the

banks was followed by a rapid spurt in personal income and industrial production”• Temin & Wigmore: National Industrial Recovery act anticipated

higher costs and prices which led to a rise in the money supply– Romer, however, maintains that money growth mattered

Before FDR• Hoover supported gold standard—devaluation was not an option• People expected continued contraction & deflation

– The government’s monetary and fiscal policies warranted such expectations

– Hoover focused on efforts to bolster credit markets rather than the economy directly

– Hoover’s Reconstruction Finance CorporationRelief of financial institutions to promote investment

• Recovery required a change in the policy regime--taking actionFDR• That action was devaluation...taken soon after inauguration– Signaled the abandonment of the gold standard expansionary effects on American industry

• Stock market as index of expectations– Stock prices rose because of expected inflation“change in expectations, therefore, stimulated business investment and expenditures on consumer durables, not consumption”• Rise in the demand for automobiles encouraged a rise in auto

production, steel production, and industrial production

• Grain and cotton prices rose as the value of the dollar fell farmers had higher incomes

• If Hoover had done what FDR did, the economy would have recovered earlier