Gauti Eggertsson
Was the New Deal (= NIRA) Contractionary?
A world of
• Monopoly power
• Sticky prices and wages
• Deflationary shocks
• Zero lower bound (ZLB)
NIRA (a supply restriction) reduced “natural
output” but increased actual output.
Borrowed Slides
• Cole and Ohanian find a possible answer to
the weak recovery in the cartelization of the
US manufacturing sector.
• This arose out of the creation of the NIRA
• Individual firms could not set prices below
cartel established floors
• If they did other cartel firms would exert
pressure and the NIRA chief would publicly
berate the “offending” firm
• Manufacturing wages were set in the same
political/administrative manner.
• Cole and Ohanian postulate that qualitatively this
shock (NIRA) seems promising in explaining why
output was so much and so consistently below
trend from 1934-1939.
– Eggertsson berates them for ignoring the “mistake of
1937” which had nothing to do with NIRA
– Eggertsson berates them for assuming 1929 output
was at trend rather than 10% above trend
• Cole and Ohanian conclude by stating that they
are currently in the process of researching and
quantifying the NIRA shock to employment,
investment, consumption, output and wages.
Changing Expectations
• After Roosevelt’s inauguration he stated that
the prime goal was to reflate prices to predepression levels within 1-3 years
• Roosevelt made it no secret what is goals
were, often his quotes would show up in
newspapers
• Reflationary Quote from Roosevelt
“We are agreed in that our primary need is to insure an
increase in the general level of commodity prices. To this
end simultaneous actions must be taken both in the
economic and the monetary fields.”
Changing Expectations
• Saying that inflation is going to take place and
doing is two completely different things.
• Roosevelt knew he had to make his
reflationary talk credible
• He did this by expanding the government
through deficit spending.
Eggertsson’s Model With Distortionary “Wedges “
Representative household utility function
• Dixit-Stiglitz consumption of differentiated products
• Introduces monopoly power into modeled economy
Labor supply by industry
β = time preference discount
θ = substitution elasticity between products > 1
• Intertemporal budget constraint
“Complete” financial markets  no limit on borrowing
Nominal interest rate links current and future periods
• i >= 0
Real interest rate enters household optimization condition
• Arbitrage between current and future utility
Eggertsson’s Model With Distortionary “Wedges “
Labor market
Real Wage = (1 + ω1)(MPL/MUc)
ω1 = “Labor market markup”  regulations favoring labor
Nominal Profits increase with “monopoly markup” = ω2
Policies encouraging collusion between monopolistic competitors
Always maximize profit
Solutions
Flexible price solution
p = [θ/(θ – 1)] [W /(1 – ω2 )]
AS: (θ – 1)/θ = [(1 + ω1 )/(1 – ω2 ) ] MPL/MUc
• For efficiency, set markups to eliminate distortion owing to monopoly
power of firms
(1 + ω1 )/(1 – ω2 ) = (θ – 1)/θ
• Optimum is independent of i  M-policy ineffectiveness
Sticky price solution (each firm’s prices fixed for random
period)
π = f(πe ,expected output growth, policy wedge)
Policy wedge = (1 + ω1 )/(1 – ω2 )
The greater the policy wedge, the greater is π and the greater is πe
• For efficiency… policy matters
i = 1/β - 1
Eggertsson’s Insights
• Policy wedges reduce output in flexible price
economy … but increase it in the face of sticky
prices and “emergency” conditions
• “Emergency” conditions:
– Zero lower bound
– Grinding deflation
Solution: Commit to higher inflation
Conclusions
• Depression was driven by high real interest rates
• Dramatic recovery (1933-37) driven by New Deal
• Mistake of 1937 kept economy from recovering to trend
before WWII (Eggertsson’s trend treats 1929 as 10% above
trend)