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Technology
Department of Economics
Working Paper Series
MassQchusetts
Institute of
Using the General Equilibrium Growth Model
to Study Great Depressions:
A Rejoinder to Kehoe and Prescott
Peter
Temin
Working Paper 09-04
February 27, 2009
Room
E52-251
50 Mennorial Drive
Cambridge,
MA 021 42
This paper can be downloaded without charge from the
Social Science Research
Network Paper Collection
http;//ssrn.coiii/abstract=
1352095
at
f
Using the General Equilibrium Growth Model
A Rejoinder to Kehoe and
Peter
to
Study Great Depressions:
Prescott
Temin
Abstract
The reply by Kehoe and Prescott restates their position but does not answer the criticism
made in my review of their book (Temin 2008). argued that the general equilibrium
model of economic growth to study income fluctuations does not lead to a useftil research
I
program; the use of closed-economy models
to
understand the world problems of the
1930s and the Latin-American problems of the 1980s
Kehoe and
Prescott' s
recommended approach do
other branches of economics.
I
is
not helpful; and the authors using
not use data with the care standard
stand by those criticisms.
JEL Codes E32,N10
Key words:
Depressions, economic fluctuations, general equilibrium models
Department of Economics, MIT. Contact: ptemin@mit.edu.
in
Using the General Equilibrium Growth Model
A Rejoinder to
Kehoe and
Study Great Depressions:
Kehoe and Prescott
Prescott (2008) express their unhappiness with
2008) of their book (Kehoe and Prescott, 2007).
hives a
to
my
review (Temin,
understand their unhappiness; no one
I
bad review. They score a couple of cheap shots off me ("IVlexico
America.").
They do
understand that too;
I
not
it
North
could not resist scoring some cheap shots off them.
I
however confront the main argument of my review, and
opportunity to rescue
is in
from the blizzard of detail
in
I
taice this
Kehoe and Prescotfs
They
reply.
chose to restate their methodology and quibble over details and definitions without
confronting the main issues
I
made
three
economic growth
at stake.
main points
to study
in
attempt to redress this balance here.
1
my
review. First, the general equilibrium model of
income fluctuations does not lead
to a useful research
program.
Second, the use of closed-economy models to understand the world problems of the
1930s and the Latin-American problems of the 1980s
using
Kehoe and
become standard
Prescott's
in
is
recommended approach do
other branches of economics.
The following paragraph from
As Cole and Ohanian
1
not use data in the
discuss these points
their reply sets
stress, this sort
not helpful. Third, the authors
ways
that
have
in turn.
up the debate:
of exercise, which takes the behavior of
productivity as exogenous, does not provide us with a satisfactory theory of the U.S.
Great Depression. Nonetheless,
precisely
what a
we
learn a lot from the exercise because
satisfactory theory needs to do:
productivity over the period 1929-33, and
from 1929
recovered.
model
is
to
A
it
It
it
defines very
needs to account for the sharp
needs to explain
why
hours
fell
fall in
so sharply
1933 and stayed so depressed afterwards even though productivity
theory that cannot accomplish these tasks using a modified version of the
not a successful theory in the context of the research agenda developed in G}-eat
Depressions of the Twentieth Century (Kehoe and Prescott, 2008,
p. 6)
.T,:...
agenda
Kehoe and
Prescott argue that their
for studies
of large economic downturns. They
Cole and Ohanian's lead essay
fell
in their
model
useful because
is
volume. The
list
so sharply in the Great Depression. But the observed
comes
end of the arguments
at the
should have
come
at the
in the
beginning.
My
essays
in
defines a research
two questions
question
first
it
fall in
Kehoe and
is
from
that arise
why
productivity
productivity typically
Prescott (2007),
many
review reproduced statements from
posing but not answering the same question that Kehoe and Prescott assert
when
is
it
essays
one of the
aims of their approach. This suggests that the Kehoe and Prescott research strategy
highlights this question but provides
The essays
collected in the
question for research.
starting point, but
example
set
strategy.
this question.
The primary question
falls into
answering
it.
this not a useful
essays took Cole and Ohanian (1999) as their
by Cole and Ohanian and translated
of output
in
reviewed therefore suggest
1
none of them answered
total factor productivity.
translation
book
Many of those
guidance
little
I
falls in
Instead, they followed the
aggregate production into
raised in
my
productivity declines resulted
review
is
whether
The general equilibrium model of economic growth frequently
foresight. This
may be
as well suited to the study of large
depressions, great or otherwise,
investors and policy
occurs. This
depression.
is
makers
is
good assumption
a
income
fluctuations.
that they
One
is
is
negative.
closed by
for the long run. but
it
is
not
characteristic of large
almost always are unexpected. Private
find out that they are in the midst
of a large fluctuation as
very important for the analysis of policies undertaken
Assuming
this
a promising research
in
The evidence from Great Depressions of the Twentieth Century
assuming perfect
falls in
perfect foresight rules
some of the most
in the
interesting
it
course of the
problems of
Digitized by the Internet Archive
in
2011 with funding from
Boston Library Consortium
Member
Libraries
http://www.archive.org/details/usinggeneralequiOOtemi
large
income fluctuations off the
table.
kind of analysis for policy advice
We watched
It
also reduces the lessons
the current (2008-09)
in
this fall in the
and Freddie Mac, Bear Steams, and even earlier failures
Capital
Management. Yet
perfect foresight
was not
vanished; Treasury Secretary Paulson proposed
to get
ahead of the developing financial
know
early to
would
if this
decline
is
crisis.
new
As
the start of another
classify as a great depression.
But
it
I
in
from 1929
was
New
week
Many
Hours
write this in spring 2009,
that
Kehoe and
it
is
too
Prescott
abundantly clear that perfect
by Kehoe and Prescott
fell
Mae
as he struggled
is
made
in the short run.
"why hours
fell
so sharply
1933 and stayed so depressed afterwards." The obvious answer
a Great Depression.
decade.
the
to
listed
takeover of Fannie
policies every
is
quarter of
evidence. President Bush simply
foresight fails to illuminate the policy choices that need to be
The second question
in the fourth
Enron and Long Term
like
downturn
already
this
economic decline.
with horror as the financial system collapsed
2008. There had been anticipatory steps toward
one can draw from
is
that there
because unemployment rose and stayed high for a
economists and economic historians have asked whether the policies of
Deal contributed to the continuing high employment. Despite sharply differing
underlying models, the answers appear to be remarkably similar. Temin (1989) and Cole
and Ohanian (2004) used very different models to reach similar conclusions. In fact
conclusion
is
no more complicated than the example of price supports
in
elementary
economics. Kehoe and Prescott defined two tasks for a satisfactory theory
paragraph quoted. The
research program.
first
this
in the
task appears too hard and the second too easy for a serious
'.I.-'.'
I
my
also argued in
to analyze large
income fluctuations
and growth slowdowns
do not confront
this
economy model
fruitful
1980s
review that models of closed economies are not the best
in different
in the
in their
in their reply;
about the
reply does not advance this discussion.
common
difficulties
of so
many
parts
Kehoe and
think that the most
I
Latin
in
(1989). Here
is
a short version of the latter view:
the Great Depression from country to country
"To
in the
in
Friedman and
Eichengreen (1994) and Temin
a first approximation, the spread of
short and straightforward: fixed
is
under the gold standard transmitted negative demand shocks (Temin,
exchange
rates
1993)."
argued
I
in
America
of the world. The classic
statement of the national view of the Great Depression can be found
Schwartz (1963); the international view can be found
Prescott
the reiteration of a closed-
debate about the Great Depression and the problems
is
The various depressions
twentieth century.
countries were interconnected.
fundamental question
way
in
my
review that inattention
to this
debate was a defect of Great
1
am
sorry that
Prescott fault
me
for not finding their
Depressions of the Twentieth Century.
Kehoe and
Prescott did not
respond.
Finally,
Kehoe and
making some data
review, but
it
I
now
errors.
extend
from the book. The
hard to find
if
1
feel
my
URL
badly that
review
is
given
I
did not find the website before writing
to say that a
in
you do not already know
website
the book, as
it
book's data website and
exists.
is
only
Kehoe and
The website
useftil if
in
the
Ohanian, even
first
in their
chapter by
Kehoe and
it
is
very
not mentioned in the
Table of Contents, the Forward, the Preface, and the List of Contributors.
mentioned
people can find
Prescott say, but
is
my
It is
not
Prescott or the second chapter by Cole and
appendices and notes on data. The website was mentioned on the
flyleaf of the
book and
in a
few data appendices of later chapters, but
highlighted in the parts of the book that a reader sees
it
when approaching
was not
the
book
a
in
normal matter.
My main
was about
point about data
the lack of hypothesis testing.
and Prescott uses
lots
a turn
away from
marks
this research
reply by
was not about
of theory, but
the footnoting or
tests
program as an idiosyncratic approach. There are
Kehoe and
seem only
Prescott, but they
to
be used to
important hypothesis to test about large income fluctuations.
book and challenge Kehoe and Prescott
by the empirical methods
tested
1
made some
at
use
data mistakes in
Journal of Economic Literature to
in the rest
my
point listed here.
I
am
sorry that
I
is
of graphs
my
hypotheses that can be
in
my
I
raised in
we
all
volume
me
1
reviewed. Yet
to join
in the
my
review.
was an
in
January
"Nobel laureate Ed
now Keynesians and
burden of government, we
economists are
support a big increase
the
None of
my
assertion that there
Prescott" and sign on to the following statement.
that
in
Prescott chose to center their reply to
received an e-mail from the Cato Institute inviting
all
of
review; they are relevant only to the third
Prescott in their reply take issue with
Notwithstanding reports that
criticism
(Temin, forthcoming).
set the record straight
Kehoe and
the
not the most
review, and a Corrigendum will appear
my
in
of economics.
underlying political agenda to the studies collected
I
is
hypothesis that
reiterate
review on these data mistakes instead of confronting the questions
Kehoe and
lots
test the
to generate testable
these mistakes affect the main arguments of
2009
of hypotheses. This
the pervasive growth of hypothesis testing in the rest of economics and
various countries had a great depression by their definition. This
the
it
The methodology being championed by Kehoe
does not lead to formal
it
numbers being used;
1-'
:i'
more government spending is a way
improve economic performance. More government spending by Hoover
and Roosevelt did not pull the U.S. economy out of the Great
Depression in the 1930s. More government spending also did not solve
Japan's "lost decade" in the 1990s. As such, it is a triumph of hope
over experience to believe that more government spending will help
the United States today. To improve the economy, policy makers
should focus on reforms that remove impediments to work, saving
investment, and production. Lower tax rates and a reduction of the
burden of government are the best ways to use fiscal policy to boost
growth (Niskanin, 2009).
the undersigned do not believe that
to
This looks
like a political
agenda
to
me. The policy
in
question
government out of the economy and allow the competitive market
this policy
is
to
maximize GDP. No thought
economy growing,
the distribution of
income
is
given to the time
that
would
it
to
is
to take
work. The aim of
would take
result, or policies to
to get the
ease the
pain of people caught in the economic firestorm. If economists argue like this, then
little
wonder
This
is
it
that they are relegated far to the side in policy discussions that affect us
the underlying political
agenda
in
the
book
1
reviewed.
is
all.
References
Cole, Harold L., and Lee E, Ohanian. 2004.
the Great Depression:
Economy,
A
"New
Deal Policies and the Persistence of
General Equilibrium Analysis." Journal of Political
112: 779-816 (August).
Eichengreen. Barry, 1992. Golden Fetters: The Gold Standard and the Great
Depression, 1919-1939.
Friedman, Milton, and Anna
J.
New
York: Oxford.
Schwartz, 1963.
A Monetary Histoiy of the United States,
1867-1960. Princeton: Princeton University Press.
Kehoe, Timothy
Century
and Edward C. Prescott, 2007. Great Depressions of the Twentieth
J.,
Minneapolis: Federal Reserve Bank of Minneapolis.
(eds.).
Kehoe, Timothy
and Edward C. Prescott, 2008. "Using the General Equilibrium
J.,
Growth Model
to Study Great Depressions:
Federal Reserve
Niskanin.
Bill,
.
A
Reply
to
Temin." Staff Report 418,
Bank of Minneapolis Research Department (December).
2009. E-mail (January
16).
MIT
Temin,
Peter, 1989.
Lessons ft-oni the Great Depression. Cambridge:
Temin,
Peter, 1993.
"Transmission of the Great Depression." Journal of Economic
Perspectives,
Temin,
Peter, 2008.
of Timothy
Century,
"
J.
7:
Press.
87-102 (Spring).
"RBC Views
of the Great Depression and Recent Events:
Kehoe and Edward C
Prescott's Great Depressions
A
Review
of the Twentieth
Journal of Economic Literature, 46: 669-84 (September).