What ended the Great Depression?
There has been recent circulation of the older view that it is World War II, as a kind of giant public works project, which ended the Great Depression. This claim is not consistent with our best knowledge of the subject. To survey the cutting edge of the literature briefly:
Christina Romer writes:
This paper examines the role of aggregate demand stimulus in ending the
Great Depression. A simple calculation indicates that nearly all of the
observed recovery of the U.S. economy prior to 1942 was due to monetary
expansion. Huge gold inflows in the mid- and late-1930s swelled the
U.S. money stock and appear to have stimulated the economy by lowering
real interest rates and encouraging investment spending and purchases
of durable goods. The finding that monetary developments were crucial
to the recovery implies that self-correction played little role in the
growth of real output between 1933 and 1942.
Here is another interesting paper on the topic; it focuses on productivity issues and mean reversion. Here is from a paper by Cullen and Fishback:
We examine whether local economies that were the centers of federal
spending on military mobilization experienced more rapid growth in
consumer economic activity than other areas. We have combined
information from a wide variety of sources into a data set that allows
us to estimate a reduced-form relationship between retail sales per
capita growth (1939-1948, 1939-1954, 1939-1958) and federal war
spending per capita from 1940 through 1945. The results show that the
World War II spending had virtually no effect on the growth rates in
consumption that we examined.
Further debunking of the WWII idea can be found in this paper by Robert Higgs, who stresses the difference between standard gdp measures and actual economic welfare.
I also find the experience of the Latin American economies convincing. The economic recovery of Argentina, for instance, clearly was due to monetary policy, not fiscal policy, which remained tight throughout the period of recovery. Mexico recovered from the Great Depression relatively quickly and this history also does not fit the fiscal policy view. Later on, most of the Latin economies experienced commodity booms because of wartime demands and again this was not fiscal policy and of course they were not fighting the war themselves. The two countries where fiscal policy played a significant role in recovery are, not surprisingly, Germany and Japan and here I am referring to their prewar spending.
Assorted links
1. Brasilia photos, via Yana
3. Lots of job market advice, with links
4. Chart of what Presidents have done in their first 100 days
A simple theory of which economists cultivate Ph.d. students
If your contribution as an economist is very fundamental, other people will use that contribution whether or not they were your students. Lots of people use, or critique, the assumption of rational expectations. So the inventors of RE don’t need students to propagate their fame. Alfred Marshall’s fame today is mostly independent of the students he had (or did not have).
Having fundamental contributions is correlated with quality but within the top tier of quality there is considerable variation. Arrow and Lucas had relatively fundamental contributions but in contrast Milton Friedman, Larry Summers, Robert Barro, and Olivier Blanchard are all more applied. Their demand for students should be higher. If you are an empirical economist, but invented an econometric technique which is fundamental, your demand for students should be relatively low. Students might also prefer advisors who are less "fundamental," for fear of being overshadowed or from wanting to avoid the winner-take-all tier of the market.
Since at top schools the percentage of "fundamental" economists is declining over time, we would expect the distribution of doctoral students, across faculty, to become more even.
I thank Amanda Agan and some of her friends for a useful conversation on this topic.
Understanding Fiscal Policy During the Great Depression
My little spat with with Rauchway regarding unemployment during the Great Depression draws in Paul Krugman. Krugman doesn’t respond to any of my arguments but he does give us the old line that fiscal policy didn’t fail during the Great Depression it wasn’t tried.
Now, you might say that the incomplete recovery shows that “pump-priming”, Keynesian fiscal policy doesn’t work. Except that the New Deal didn’t pursue Keynesian policies. Properly measured, that is, by using the cyclically adjusted deficit, fiscal policy was only modestly expansionary, at least compared with the depth of the slump. Here’s the Cary Brown estimates, from Brad DeLong…Net stimulus of around 3 percent of GDP – not much, when you’ve got a 42 percent output gap.
Now there is actually a lot of truth to this but the way in which Krugman, Rauchway, DeLong and others present this point is esoteric and likely to mislead even many economists. What Krugman seems to be saying is that the government didn’t spend enough during the thirties (Rauchway, who also cites Cary Brown, says directly "there was never enough spending to achieve the desired effect.") Yet federal spending during this time increased tremendously. So what is really going on? The answer is actually quite simple.
During the Great Depression federal expenditures increased tremendously but so did taxes. Thus, the reason spending was not stimulative was not that spending wasn’t tried it’s that taxes were also raised to prohibitive levels. But don’t take my word for it. Read Cary Brown (JSTOR) whom Krugman, Rauchway, DeLong all cite but none of whom quote at length. Here is Brown:
The primary failure of fiscal policy to be expansive in this period is attributable to the sharp increases in tax structures enacted at all levels of government. Total government purchases of goods and services expanded virtually every year, with federal expansion especially marked in 1933 and 1934. [But] the federal Revenue Act of 1932 virtually doubled full employment tax yields…
…the highly deflationary impact of this tax law has not been fully appreciated…The Revenue Act of 1932 pushed up rates virtually across the board, but notably on the lower and middle income groups….Personal income tax exemptions were slashed, the normal-tax as well as surtax rates were sharply raised, and the earned-income credit equal to 25 percent of taxes on low income was repealed. Less drastic changes were made in the corporate income tax, but its rate was raised slightly and a $3000 exemption eliminated. Estates tax rates were pushed up, exemptions sharply reduced, and a gift tax was provided. Congress toyed with a manufacturers’ sales tax, but finally rejected it in favor of a broad new list of excise taxes and substantially higher rates for old ones….
The Revenue Act of 1932 was followed by many further tax increases (e.g. Brown notes "…social security taxes began in 1937 to exert a pronounced effect…") many of them, under pressure from the Huey Long wing, designed to "Share our Wealth." Here is a graph of the highest marginal income tax rate which went from 25% to 79% between 1929 and 1940 and here is a graph of the lowest marginal income tax rate which (from a low base) increased by a factor of 10. (Hat tip to Carpe Diem).
Thus, an accurate portrayal of fiscal policy during the Great Depression – entirely consistent with Krugman – is that we had much greater spending, much greater taxes and not much economic stimulus. And if supporters of the New Deal argue that fiscal policy was only "modestly expansionary" then it’s quite reasonable to think that once we take into account the supply side effect of taxes and the increase in regime uncertainty then the net effect might even have been contractionary.
The meta-lists, this time for classical music
The end of the year is coming and so I will digest the numerous "best of" lists for you once again. These picks are for classical music CDs and they are from Fanfare, the number one source of criticism for new classical releases. Here are the CDs that appeared more than once on their reviewers’ "best of the year" lists:
Vincent Persichetti: Piano Sonatas; knotty American piano music.
Morton Feldman: The Viola in My Life, I-IV.
Alkan Organ Works, vol.II, by Kevin Bowyer
Bach, Brandenburg Concerti, rerecorded by Trevor Pinnock.
Brahms, Sonatas for Clarinet and Piano, by Manasse and Nakamatsu.
Thomas Simaku, String Quartets; intense, from Albania.
As usual, classical "best of" lists give disproportionate weight to material which had not previously been recorded, in this case the Persichetti which of all the entries is named the most often. The Brahms is the one most likely to please you, or the Pinnock. I can vouch for the quality of the others but when it comes to genre they won’t convert the unpersuaded.
The Chinese economic stimulus package
China on Sunday announced a huge economic stimulus package aimed at bolstering its weakening economy and perhaps helping fight the effects of a global economic slowdown. In a sweeping move at a time when major projects are being put off
around the world, Beijing said it would spend an estimated $586 billion
by 2010 on wide array of national infrastructure and social welfare
projects, including constructing new railways, subways, airports and
rebuilding communities devastated by an earthquake in southwest China
in May.
Here is the story. Most of this money they would have spent anyway, so what is the net change in the stimulus? And over how many years is this sum spent? I think of this as mostly a public relations move. China wants to tell other countries it is doing lots and it wants to tell its own citizens that it feels their pain and is pro-active.
Is there a gentle way to glide down from 10 to 5 percent growth? I tend to doubt it. Are you prepared for a China with negative economic growth for a few years (or more)? I tend to doubt that too.
Matt Yglesias has interesting commentary; I guess now we’ll see how much an economic surplus is worth when the core macro problem is something other than lack of aggregate nominal demand.
Addendum: Here is further comment.
2666
It comes out Tuesday, here is a splendid review (more reviews here).
Credit default swaps, here and here
Let the Right One In is the movie to see, not Synecdoche
Restore confidence first
The NYT asked me to give policy advice to our President elect. Here is my piece and here is an excerpt from my very simple argument:
Rebuilding confidence might seem a small matter, but it is not. The
truth is this: America is a wonderful and magnanimous nation when it is
a winner, but Americans are not used to losing and Americans are not
used to panic.Often we respond to negative events badly, so we need to be especially careful when we are in a losing or risky position.
Very
bad events can cause a panic among the citizenry or its leaders, which
translates into subsequent bad decisions. For a classic example of a
negative policy dynamic, look at 9/11. The United States lost 3,000
lives and a great deal of wealth and confidence. The government then
took actions, most of all the Iraq war, which led to even greater
losses.We are in danger of getting stuck in another negative
dynamic, but this time in the realm of economics. We might follow up
the financial crisis with some worse responses and policies.It’s
not just the country’s future that is on the line. Despite the
commonality of anti-American rhetoric, the United States sets the tone
for much of the world.
Addendum: Here are related pieces.
Wealth Shock
It’s surprising how often I agree with Dean Baker. In It’s the Housing Bubble, Not the ***** Credit Crunch he writes:
No one will lend me $1 billion, that’s how bad the credit crunch has gotten. There are probably reporters at major news outlets who would print that.
…they are still badly misinforming the public, first and foremost by attributing the economic downturn to a credit crunch.
This is truly incredible. Homeowners have lost more than $5 trillion in housing wealth. There is a very well established wealth effect whereby $1 of housing wealth is estimated as leading to 5 to 6 cents of annual consumption. This implies that the loss of wealth to date would cause consumption to fall by $250 billion to $300 billion annually (1.7 percent to 2.0 percent of GDP). If you add in the loss of around $6 trillion in stock wealth, with an estimated wealth effect of 3-4 cents on the dollar, then you get an additional decline of $180 billion to $240 billion in annual consumption (1.2 percent to 1.6 percent of GDP).
These are huge falls in consumption that would lead to a very serious recession, like the one we are seeing. This would be predicted even if all our banks were fully solvent and in top flight financial shape. Even the soundest bank does not make loans to borrowers who it does not think can pay the loans back (except during times of irrational exuberance).
Mankiw to the President-Elect
Greg Mankiw’s memo to the president-elect is excellent.
AIG sentences to ponder
First came the bailout. Now comes talk of a bailout from the bailout.
Here is the article. Felix Salmon offers related commentary. This reminds me of problems in public utility theory. To get optimal cooperation, the regulator allows the regulated firm to set price above marginal cost so that the regulated firm has some incentive to obey. But what do you do when the regulated firm is essentially wiped out?
Ben Bernanke on the New Deal
I’ve been rereading some of the essays in Ben Bernanke’s Essays on the Great Depression, which of course is self-recommending. I thought this passage summed up some relevant truths:
Our [with Martin Parkinson] own view is that the New Deal is better characterized as having "cleared the way" for a natural recovery (for example, by ending deflation and rehabilitating the financial system), rather than as being the engine of recovery itself.
Bernanke notes that there were "remarkably strong" productivity gains throughout much of the 1930s, even though there was no capital deepening. This is a central puzzle which any account of the New Deal, or New Deal recovery, must incorporate. These gains seem to span more sectors than could be accounted for by New Deal policy alone, and note that most government interventions, even good ones, don’t bring productivity gains over such a short time horizon and in such a regular and sustained fashion.
Bernanke does suggest that some of the gains came from forced unionization and "efficiency wage" effects and yes that would credit the New Deal. But I doubt that is the best hypothesis and of course it contradicts the traditional account of profit-seeking behavior from businesses (why weren’t they paying the higher wages in the first place?). Rick Szostak’s work suggests that the New Deal saw lots of labor-saving, process innovations, which meant both high productivity gains and pressure on labor markets at the same time. In my view most of these gains were simply the result of working through the implications of the earlier fundamental breakthroughs of the preceding twenty years.
Whatever is the case (and we genuinely don’t know), these productivity gains are central to the story of New Deal recovery. Roosevelt may deserve credit for some of them, or for allowing them to proceed, but don’t assume that the New Deal caused such gains just because you see them in the gross data.
You can find different drafts of the relevant Bernanke-Parkinson paper here, with various forms of gating.
Heroes and Cowards, part II
The single most important determinant of camp survival was the number of men in POW camps. If everyone had been in a camp holding 7,500 men, survival probabilities would have been less than 60 percent instead of more than 80 percent. With greater camp populations survival probabilities would have been even lower. Another important determinant of camp survival was age. Had all men been of Thomas Withington’s age (47), only 70 percent of them would have survived. The next most important determinants of camp survivial were the number of friends, rank, and height. Men who were not either commissioned or noncommissioned officers fared poorly, as did those with no friends and those of Hnery Haven’s height.
Of course that is from the Civil War and it is from the new book by Dora Costa and Matthew Kahn. Here is my previous post about the book, see also the links suggested by Matt in the comments. You can buy the book here.
China market of the day
From a loyal MR reader:
I just read that there is a company in China hiring young females who are paid to get pregnant and deliever a baby for couples suffering from infertility.The interesting thing is the price discrimination. There are eight types of females with different "qualities".Example： Females who are middle school graduates and are not very pretty receive 40,000 RMB.Females who have bachelor’s degree and are pretty receive 100,000 RMB.
Unemployment During the Great Depression
Regarding unemployment during the Great Depression, Andrew Wilson writing at the WSJ recently said:
As late as 1938, after almost a decade of governmental “pump priming,” almost one out of five workers remained unemployed.
Historian Eric Rauchway says this is a lie, a lie spread by conservatives to besmirch the sainted FDR. Nonsense. In 1938 the unemployment rate was 19.1%, i.e. almost one out of five workers was unemployed, this is from the official Bureau of Census/Bureau of Labor Statistics data series for the 1930s. You can find the series in Historical Statistics of the United States here (big PDF) or here. The graph is at right. Rauchway knows this but wants to measure unemployment using an alternative series which shows a lower unemployment rate in 1938 (12.5%). Nothing wrong with that but there’s no reason to call people who use the official series liars.
So why are there multiple series on unemployment for the 1930s? The reason is that the current sampling method of estimation was not developed until 1940, thus unemployment rates prior to this time have to be estimated and this leads to some judgment calls. The primary judgment call is what do about people on work relief. The official series counts these people as unemployed.
Rauchway thinks that counting people on work-relief as unemployed is a right-wing plot. If so, it is a right-wing plot that exists to this day because people who are on workfare, the modern version of work relief, are also counted as unemployed. Now if Rauchway wants to lower all estimates of unemployment, including those under say George W. Bush, then at least that would be even-handed but lowering unemployment rates just under the Presidents you like hardly seems like fair play.
Moreover, it’s quite reasonable to count people on work-relief as unemployed. Notice that if we counted people on work-relief as employed then eliminating unemployment would be very easy – just require everyone on any kind of unemployment relief to lick stamps. Of course if we made this change, politicians would immediately conspire to hide as much unemployment as possible behind the fig leaf of workfare/work-relief.
There is a second reason we may not want to count people on work-relief as employed and that is if we are interested in the effect of the New Deal on the private economy. In other words, did the fiscal stimulus work to restore the economy and get people back to work? Well, we can’t answer that question using unemployment statistics if we count people on work-relief as employed. Notice that this was precisely the context of the WSJ quote.
One final thing that one could do is count people on work-relief as neither employed nor unemployed, i.e. not part of the labor force which is what we do for people in the military. Rauchway has data on this and it shows almost the same thing, nearly one in five unemployed, as the original series. (In this case, however, Rauchway counts nearly one in five unemployed as a win for the New Deal because the same series also shows higher unemployment earlier in the Great Depression.)
Any way you slice it there is no right-wing plot to raise unemployment rates during the New Deal and a historian should not go around calling people liars just because their judgment offends his wish-conclusions.
Hat tip to Mark Thoma.