The Great Depression:
Why did it begin in late 1929?
And why did it last 12 years?
Has the Great Depression been
explained?
• Most previous accounts of the Great
Depression fail to explain why a severe
worldwide slump began in late 1929.
• There are explanations for the slow recovery
after 1933, but these are not well integrated
into explanations of the Great Contraction.
Output wasn’t just low in the 1930s, it was
extraordinarally unstable
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Table 1 Seasonally Adjusted Changes in Industrial Production.___________
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1/37 to 9/37
-0.9%
9/37 to 5/38
-29.1%
5/38 to 11/38
+23.0%
11/38 to 5/39
+1.5%
5/39 to 11/39
+22.4%
11/39 to 5/40
-2.0%
5/40 to 12/41
+39.8%
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Note: These are actual changes, not annualized rates of change.
Period
9/29 to 12/30
4/31 to 7/32
10/32 to 3/33
7/33 to 11/33
5/34 to 5/35
Change in IP
-29.3%
-34.8%
-9.2%
-18.8%
+3.1%
Period
12/30 to 4/31
7/32 to 10/32
3/33 to 7/33
11/33 to 5/34
5/35 to 1/37
Change in IP
+2.5%
+13.3%
+57.4%
+15.9%
+38.8%
The Relationship Between Detrended Industrial Production and Detrended
(inverted) Real Wages, 1929-39, monthly.
Causal factors in the Great Depression
What needs to be explained?
• AS shocks: 5 new deal wage shocks (other
supply shocks such as tariffs and high MTRs
may have also played a role.
• AD shocks: Changes in the price of gold, or
the purchasing power of gold.
a) P = Gs/g
b) P = Gs*(1/r)*(1/md)
c) P = (Pg)*(gs)*(1/r)*(1/md)
Accounting for the Great Deflation
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TABLE 2.2 The impact of changes in the world gold-reserve ratio, real demand for currency, real
demand for gold, and monetary gold stock, on the world price level, 1926-1932.
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Time period
Dec 1926
to
Jun 1928
Jun 1928
to
Oct 1929
Oct 1929
to
Oct 1930
Oct 1930
to
Aug 1931
Aug 1931
to
Dec 1932
Dec 1926
to
Dec 1932
(ln 1/r)
(ln 1/md)
-3.98
-4.05
-3.18
-2.94
-9.62
-4.97
+1.55
-16.18
-5.80
-13.56
-21.86
-40.80
(ln 1/g)
(ln G)
-8.03
+5.82
-6.12
+5.42
-14.59
+5.25
-14.63
+3.93
-19.36
+5.18
-62.66
+25.61
(ln P)
-2.21
-0.70
-9.34
-10.70
-14.18
-37.06
(ln 1/r) = change in the log of (the inverse of) the gold reserve ratio
(ln 1/md) = change in the log of (the inverse of) real money demand
(ln g) = change in the log of (the inverse of) the real demand for monetary gold
(ln G) = change in the log of the world monetary gold stock
(ln P) = change in the log of the world price level
A Brief Narrative of the Great Depression
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1. Mid-1928 to October 1929: The U.S. adopts a tight monetary policy (As U.S.
GRR increases.) World monetary policy remains unchanged.
2. October 1929 to October 1930: World monetary policy tightens sharply.
World GRR rises by 9.6%. Expectations change dramatically.
(Late 1929 was very similar to late 1920, late 1937, late 1981, and late 2008. In
each case, forecasts for NGDP going several years forward were scaled back
sharply.)
3. Mid-1931 to Mid-1932: Private and central bank gold hoarding increase as
German and British exchange rate crises trigger dollar devaluation fears.
– a. Gold outflows from the U.S. associated with sharp stock and commodity price declines.
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– b. Stock and commodity markets seemed to focus primarily on the world gold market,
rather than Fed policy changes.
Annualized Changes in World (Physical) Monetary Gold Stock
and Related Crises, 1929 - 1939.
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Time Period
DLG
Event
Dec. 1929 - June 1931
6.0 percent
June 1931 - Oct. 1931 -3.4 percent
German/U.K. crises
Oct. 1931 - Apr. 1932
6.7 percent
Apr. 1932 - June 1932
-8.7 percent
Deficit Fears, Fed OMPs
June 1932 - Jan. 1933
8.4 percent
Jan. 1933 - Feb. 1933 -18.8 percent
Third run on the dollar
Feb. 1933 - Apr. 1933
11.8 percent
Apr. 1933 - Jan. 1934
-0.1 percent
Dollar depreciation
Jan. 1934 - Mar. 1935
7.6 percent
Mar. 1935 - May 1935 -15.8 percent
Belgian crisis
May 1935 - Mar. 1936
5.3 percent
Mar. 1936 - Sep. 1936
0.4 percent
French crisis
Sep. 1936 - June 1937
11.3 percent
Gold Panic (revaluation fears)
June 1937 - Mar. 1938
0.0 percent
Dollar Panic (devaluation fears)
Mar. 1938 - Dec. 1939
9.8 percent
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DLG is the (annualized) first difference of the log of the world monetary gold stock.
1933: A year of “bold and persistent
experimentation.”
• 4. Early March 1933: Huge gold outflow fails to depress U.S stock
prices, as investors look forward to FDR taking office on March 4th.
• 5. March to July 1933: Dollar devaluation triggers an
extraordinary increase in stock prices, wholesale prices. Industrial
production rises 57%, the fastest increase in US history.
• 6. Late July to September 1933: Twenty percent nominal and real
wage increase (due to the NIRA) aborts recovery. Recovery
resumes in mid-1935 after the NIRA is declared unconstitutional.
Dollar devaluation raises prices despite
25% unemployment
A promising recovery is aborted after
FDR raises wages by 22%
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Table 8.1 Selected Indicators, 1933, Monthly.
Industrial
Exchange Nominal Real
Month Production WPI COL
Rate
Wages Wages
Dow
1/33
106
101
103
100
100
99
99
2/33
106
99
101
100
100
100
91
3/33
100
100
100
100
100
100
100
4/33
107
100
100
100
99
99
101
5/33
125
104
101
115
98
94
128
6/33
144
108
102
118
97
90
143
7/33
157
114
105
140
99
86
171
8/33
151
115
108
131
113
98
156
9/33
143
118
109
144
120
102
165
10/33
135
118
109
140
122
103
146
11/33
128
118
108
164
122
104
152
12/33
129
118
108
154
124
106
161
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Note: The exchange rate is the dollar price of French francs. Both the exchange rate and Dow are
mid-month figures. The real wage is deflated by the WPI.
The Relationship Between Industrial Production and Its Lagged Value,
Nominal Wages, Wholesale Prices, 1920-39, monthly.
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Period
Independent
Variable
1920-39
1920-29
1930-39
DLY-1
.509
(9.09)
.345
(3.73)
.543
(7.43)
DLW
-.459
(-3.31)
DLP
.624
(5.59)
.476
(3.91)
.898
(4.56)
Adj. R2
.453
.374
.518
.124
(0.60)
-.697
(-3.84)
n
227
107
119
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Note: The variables are defined as follows: DLY and DLY-1 are the first differences of the natural log of industrial
production, and its first lag. DLRW and DLW are the first differences of the natural logs of real and nominal wages
of production-workers, respectively, and DLP is the first difference of the natural log of the wholesale price index.
All equations included a constant term. T-statistics are in parentheses. A regression of the residuals on the lagged
residuals, and other independent variables, showed no evidence of serial correlation.
An uneven recovery
• 7. June-1936 to April-1937: Wholesale prices rise 11%. End of
international gold standard triggers rapid reductions in private gold
hoards and fears of runaway inflation.
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– a. Process culminates in “gold panic” during spring of 1937. In final stages of
panic U.S. wholesale prices fall slightly on fears of imminent dollar
revaluation.
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– b. Wagner Act triggers large wage increases that slow recovery in mid-1937.
Revaluation fears end. Gold dishoarding ends.
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• 8. Mid-1937 to Mid-1938: As economy slows, expectations shift toward
the possibility of dollar devaluation. When devaluation fears become
significant during the fall of 1937, gold hoarding resumes. Stock and
commodity prices fell sharply as future gold stock estimates are scaled
back significantly. Industrial production plummets as wages rise and
prices fall.
Four month growth rates for industrial production
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1933 wage shock
1934 wage shock
1938 wage shock
1939 wage shock
Before
+57.4%
+11.9%
+15.8%
+16.0%
After
-18.8%
-15.0%
+2.5%
-6.5%
Note: The dates of the wages shocks are assumed to be 7/33, 5/34, 11/38 and
11/39. The growth rates are not annualized.
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unionization drives is hard to date because it occurred over a
relatively long period of time. During the early stages of that wage
shock output continued to rise, as gold dishoarding pushed up
prices even faster than wages. Only when inflation slowed after
March 1937 did real wages rise sharply. It was at that point that
output growth came to a sudden halt, just as in the other four
cases.
Understanding the Great Depression
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The stock crash of 1929 did not cause the depression. It was almost identical to
the 1987 stock crash, which had zero impact on the economy. More likely, the
Depression caused the stock crash.
The Great Contraction was a worldwide phenomenon, and can only be understood
by looking at the world supply and demand for monetary gold.
The most important influence on current AD, is future expected AD, and hence
future expected monetary policy. Gold market shocks affected future expected
monetary policy.
In the absence of the NIRA, FDR’s dollar devaluation program would have resulted
in rapid recovery during 1933-34 (as in 1922.) The NIRA and later high wage
policies delayed recovery for 6 or 7 years.
Previous researchers have greatly underestimated the impact of both dollar
devaluation and the NIRA, as the programs largely canceled each other out.
Private gold hoarding did not cause the Great Depression, but it played an
important role in 1931-32, and again in 1937-38.
Lessons for today
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The crash of 2008 occurred when the Fed (and ECB and BOJ) allowed a sharp fall in
1, 2, and 3 year forward NGDP expectations, causing an immediate and precipitous
drop in current AD and current asset prices.
In the 1930s the banking and currency crises were not independent shocks, but
instead were caused by sharply falling NGDP. At the time, most people thought
financial turmoil, not tight money, caused the Great Depression. Most pundits
made the same error in 2008.
Things were somewhat different in the recent crisis. The 2007 sub-prime crash
was an exogenous shock. However the much more severe financial crisis of late
2008 and early 2009 was caused by sharply falling asset prices (stocks,
commodities, and real estate) which mostly resulted from falling NGDP
expectations, not foolish sub-prime loans.
Although Bernanke had written articles discussing the need for an aggressive price
level target once rates hit zero, and even recommended such a policy for Japan, he
refused to follow FDR’s successful policy of reflation through a price level targeting
policy. As a result, the current recovery is anemic.