Econ 210c, Spring 2002, Reading Notes for March 13: The Great Depression I
Christina Romer (1990): "The Great Crash and the Onset of the Great Depression," QJE 105:3 (August), pp. 597-624.
Ben Bernanke (1995), "The Macroeconomics of the Great Depression: A Comparative Approach," JMCB 27:1 (February), pp. 1-28. http://papers.nber.org/papers/W4814.
Charles Calomiris (1993), "Financial Factors in the Great Depression," JEP 7:2 (Spring), pp. 61-85.
Christina Romer (1993), "The Nation in Depression," JEP 7:2 (Spring), pp. 19-39.
Peter Temin (1993), "Transmission of the Great Depression," JEP 7:2 (Spring), pp. 87-102.
Brief notes on the six papers for this week...
Eugene White, "The Stock Market Boom and the Crash of 1929" tries to take a balanced look at the question of whether the stock market boom of the 1920s was a "bubble." White concludes that it probably was: irrational exuberance rather than a sober calculation of expected present discounted values. But does the fact that there was a stock market bubble play a role in causing the Great Depression? What could be the causal connections between bubbles on the one hand and big depressions on the other?
Christina Romer, "The Great Crash and the Onset of the Great Depression" argues that the stock market crash was a powerful economic shock, but not through any normal channels. In her view, the Great Crash was a shock to confidence. It generated uncertainty. The uncertainty thus produced led consumers to hold off on purchaes of durable goods--and it is this collapse in durable goods purchases that is the initial push that sends the snowball of the Great Depression rolling. What alternative channels might have been used by the Great Crash to cause the Depression? Why does Romer focus so heavily on this one particular channel?
Peter Temin argues that two key features of the gold standard set the stage for the Great Depression: first, that the gold standard put pressure on trade deficit but not trade surplus-countries to adjust their policies; second, that the form that gold standard adjustment took was not devaluation but deflation. These two facts together meant that if the world economy was subjected to a large deflationary shock--as it was both because of the crash of 1929 and because the inflation of World War I had left the world economy with a much smaller value of monetary gold to world trade--a large depression was very likely. But what, in Temin's view, is the "gold standard"? It seems much more like an ideological force constraining policies than a simple commitment to trade your currency for gold at a fixed rate.
Temin also argues that "the endogenous spread of banking and currency crises" provides another powerful propagating force for the Great Depression. Quick takeover of potentially insolvent banks and other financial institutions is key--if the government can find the resources to do it, or if the managers of the international financial system realize what was at stake. It is here that Charles Kindleberger's old "hegemonic" argument comes to bite: the Great Depression happened because Britain was no longer powerful enough to conduct the international orchestra, and the United States refused to take up the baton.
Charles Calomiris provides a very able explication of what has since become the conventional wisdom about the American side of the Great Depression. Downward shocks, initially monetary, later confidence, to aggregate demand lowered the price level. The reduction in the price level reduced collateral values and, in the context of a highly-leveraged and fragile banking system, shattered the financial system. And with a shattered financial system, investment collapsed. Calomiris focuses on how you have to know history to make sense of economic structure, and how small differences in economic structure can have enormous effects on economic vulnerability.
Christina Romer's "The Nation in Depression" takes an aggressively America-centered view of the Great Depression, seeing the Depression in Amerifca as almost exclusively caused by American factors. From my perspective, she raises three important questions work thinking about: First, would more flexible wages and prices have made the U.S. depression deeper or shallower? Second, did the Federal Reserve start the Depression by tight monetary policy to fight the growth of the stock market bubble, or was it the collapse of the bubble itself--as argued in the "The Great Crash and the Onset of the Great Depression"--that delivered the large confidence shock that set off the Depression? Third, how shall we evaluate Friedman and Schwartz's Monetary History of the United States? According to Romer, banking panics caused by declines in the value of collateral drove a large wedge between the (near zero) safe, nominal, short-term rates that monetary policy controls and the (high) risky, real, long-term rates on which business investment depends. Could monetary policy have done any more than it did to stem the Depression? If so, how? These are all questions worth thinking about...
Ben Bernanke largely repeats today's conventional wisdom on the causes of the Depression, but focuses on nominal wage rigidity as a cause of slow recovery. In his view deflation-induced financial crises caused the Depression, but increases in real wages above market-clearing levels brought about by limited nominal wage flexibility prolonged the Depression by making it worth no one's while to hire additional workers. This poses somewhat of a puzzle, because it is limited nominal wage flexibility that reduces the amount of initial deflation. Would an economy with more flexible wages have seen a shorter but sharper Depression? It's an open question.