Thursday, February 11, 2010


How Far the Mighty Have Fallen

[UPDATE below.]

You know how I said Scott Sumner had revived my faith in economic bloggers? Well now I feel like the blond-haired kid on the beach who introduced Daniel-son to the other Cobra Kai's. How's this for you:
I believe the Great Depression had two primary causes. One cause was deflationary monetary policies during 1929-33, and 1937-38. The other cause was five nominal wage shocks during 1933, 1934, 1936-37, 1938 and 1939. These 5 shocks were caused by New Deal programs, and slowed the recovery. This is why the Great Depression lasted 12 years, ending about the time of Pearl Harbor. I don’t know what ended the Great Depression, and don’t really discuss it in my manuscript, but I suspect it had something to do with the German invasion of France, which led to a military mobilization in the US and elsewhere. This may have directly raised AD, and indirectly increased expected NGDP growth by raising the expected inflation rate. Wars are usually inflationary.
OK let's just put aside the claim that the German invasion of France ended the Great Depression. How could Scott have failed to include, among the causes of the Great Depression:

(1) Herbert Hoover's insistence on rigid wages immediately after the stock market crash, and

(2) The outrageous tax hikes passed in 1932? E.g. people who made $10,000 in 1931 faced a marginal tax rate of 6%, and in 1932 the rate had jumped to 10%. That's rather a big jump, wouldn't you say? The top bracket jumped from 25% to 63% in one year. Note I'm not saying a 63% increase, I'm saying the rate itself more than doubled in one year. And it wasn't like 1932 was a good year to begin with.

UPDATE: Well I guess I'll have to cut Scott some slack, because in the very next paragraph he addressed all of my concerns. He doesn't deal with the fact that the deflation (whether in money or CPI) was steeper in 1920-1921 than it was in any 12-month period after 1929, but OK fair enough. Come to think of it, maybe Daniel-son is all right, once you overlook him spraying water on the guys in the bathroom stall at the Halloween party.

Prof. Murphy,

Regarding the difference between the 1920-21 episode and the Great Depression I asked a Keynesian blogger the same question you would ask Simner.

I was told that the difference was that in 1920-21 the interest rates were high and had space to fall, while in the Great Depression interest rates had nowhere to fall.

I think I see one fallacy with such kind of arguments. They imply that the Fed Funds rate is representative of all the interest rates in the economy. Is there other reasons why this liquidity trap logic is wrong?
Ooops, I meant Sumner
Well, off the top of my head that seems a bit weird. The reason they had "room to cut" after 1921 is that they jacked *up* the rates during the 1920-1921 depression, whereas they pushed them down to (then) record lows following the 1929 crash.

This is in conjunction with massive spending and tax cuts (and deficit slashing) in the 1920-1921 episode, contrasted with massive spending and tax hikes (with deficit surging) in the early 1930s.

So whether you're a monetarist or a Keynesian, the 1920s should have been awful, and the 1930s should have been fine after a soft landing in the start of the decade.

History of course played out just the opposite.
Slight nitpick:
"-san" is the usual way of spelling it. I work for a Japanese owned company, and still laugh to myself when I get addressed as Daniel-san.
Daniel, I am embarrassed. When I read your comment I thought, "No kidding, that's why I spelled it that way in my post." Oops. I blame the pseudo-all-nighter that was in progress when I wrote the post.
Thanks for your explanation, Prof. Murphy! It really makes sense.
have any of the monetarists/keynesiasns had a serious go at 'explaining' the depression of 20-21? I'd be interested in reading it.
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