UNIVERSITY OF CALIFORNIA Economics 134 DEPARTMENT OF ECONOMICS Spring 2018

Professor David Romer

LECTURE 2

OVERVIEW OF THE GREAT DEPRESSION January 22, 2018

I. THE 1920S A. GDP growth and inflation B. Rising inequality C. Stock price increases II. THE GREAT DEPRESSION A. Centered in the U.S., but spread to the rest of the world B. Stock market crash C. Financial panics, the decline in the money supply, and deflation D. Fiscal policy E. International factors F. Severity of the downturn III. THE RECOVERY FROM THE GREAT DEPRESSION A. Timing and strength B. Monetary policy at the zero lower bound C. Fiscal expansion D. The recession of 1937-38 E. World War II 1. Impact of the fiscal expansion 2. Consequences of rising debt IV. INTRODUCTION TO POSTWAR MACROECONOMIC FLUCTUATIONS A. Basic facts: The behavior of real GDP and unemployment B. Recessions 1. What is a recession? 2. Postwar recessions 3. The 3 largest postwar recessions before the Great Recession C. The labor market in recessions 1. Okun’s law 2. The sources of Okun’s law D. Short-run fluctuations and the components of output

LECTURE 2 Overview of the Great Depression

January 22, 2018

Economics 134 David Romer Spring 2018

Announcements

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• The price is $29.50.

I. THE 1920S

By the 1920s:

• The U.S. economy was no longer primarily a agricultural.

• There was substantial nominal rigidity.

• Monetary policy was determined by the Federal Reserve.

• Federal revenues and spending were large enough that they could have a substantial impact on the economy.

Issue: Was GDP growth above the growth rate of potential output?

1919 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929-20

-15

-10

-5

0

5

10

15

Perc

ent

Real GDP Growth, 1919-1929

GDP Growth

1919 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929-20

-15

-10

-5

0

5

10

15

Perc

ent

Real GDP Growth and Inflation 1919-1929

Inflation

GDP Growth

Issue: What effect might increasing inequality have on short-run fluctuations?

25%

30%

35%

40%

45%

50%

1917

1922

1927

1932

1937

1942

1947

1952

1957

1962

1967

1972

1977

1982

1987

1992

1997

2002

2007

Shar

e of

tota

l inc

ome

goin

g to

Top

10%

Income Inequality in the United States

1.5

6.5

11.5

16.5

21.5

26.5

31.5

36.5

Jan

1922

Jun

1922

Nov

192

2

Apr 1

923

Sep

1923

Feb

1924

Jul 1

924

Dec

1924

May

192

5

Oct

192

5

Mar

192

6

Aug

1926

Jan

1927

Jun

1927

Nov

192

7

Apr 1

928

Sep

1928

Feb

1929

Jul 1

929

Mon

thly

S&

P St

ock

Pric

e In

dex

Stock Prices, 1922:1-1929:8

Issue: What do we mean by a bubble?

II. THE GREAT DEPRESSION

Depression was worldwide, but likely began in the U.S.

Depression was faster, larger, and longer in the U.S.

Why do we think Depression began in the U.S.?

• Circumstantial evidence – timing, severity, etc.

• Can identify shocks in the U.S. and transmission mechanism to the rest of the world.

The fundamental cause of the Great Depression was a collapse in aggregate demand caused by:

• Stock market crash.

• Banking panics and a decline in the money supply.

• Misguided macroeconomic policy.

• International factors.

Issue: What role did the Great Crash play in the onset of the Depression?

1.5

6.5

11.5

16.5

21.5

26.5

31.5

36.5

Jan

1922

Jun

1922

Nov

192

2Ap

r 192

3Se

p 19

23Fe

b 19

24Ju

l 192

4De

c 19

24M

ay 1

925

Oct

192

5M

ar 1

926

Aug

1926

Jan

1927

Jun

1927

Nov

192

7Ap

r 192

8Se

p 19

28Fe

b 19

29Ju

l 192

9De

c 19

29

Mon

thly

S&

P St

ock

Pric

e In

dex

Stock Prices, 1922:1-1929:12

1929

-01

1929

-04

1929

-07

1929

-10

1930

-01

1930

-04

1930

-07

1930

-10

1931

-01

1931

-04

1931

-07

1931

-10

1932

-01

1932

-04

1932

-07

1932

-10

1933

-01

1933

-04

1933

-07

1933

-10

1

1.2

1.4

1.6

1.8

2

2.2

2.4In

dust

rial

Prod

uctio

n (L

ogar

ithm

s)

Industrial Production, 1929-1933

August 1929 October 1929

6

56

106

156

206

256

306

356

406

456

506

Jul 1

929

Sep

1929

Nov

192

9

Jan

1930

Mar

193

0

May

193

0

Jul 1

930

Sep

1930

Nov

193

0

Jan

1931

Mar

193

1

May

193

1

Jul 1

931

Sep

1931

Nov

193

1

Jan

1932

Mar

193

2

May

193

2

Jul 1

932

Sep

1932

Nov

193

2

Jan

1933

Num

ber

Bank Suspensions

15

17

19

21

23

25

27

29Ja

n 19

29M

ay 1

929

Sep

1929

Jan

1930

May

193

0Se

p 19

30Ja

n 19

31M

ay 1

931

Sep

1931

Jan

1932

May

193

2Se

p 19

32Ja

n 19

33M

ay 1

933

Sep

1933

Jan

1934

May

193

4Se

p 19

34Ja

n 19

35M

ay 1

935

Sep

1935

M1

(Bill

ions

of $

)

Money Supply and Banking Crises 1929-1935

Vertical lines show the dates of waves of panics identified by Friedman and Schwartz.

Issue: What was the impact of the banking panics and the collapse of the money supply?

Issue: What role did actual and expected deflation play?

2.2

2.3

2.4

2.5

2.6

2.7

2.8

2.9

3

1922

1923

1924

1925

1926

1927

1928

1929

1930

1931

1932

1933

1934

1935

1936

1937

1938

1939

1940

1941

Loga

rithm

s

Producer Price Index

Issue: Can fiscal contractions ever be expansionary?

Issue: What role did the gold standard play in spreading the Depression throughout the world?

0

5

10

15

20

25

30

1920

1924

1928

1932

1936

1940

1944

1948

1952

1956

1960

1964

1968

1972

1976

1980

1984

1988

1992

1996

2000

2004

2008

Perc

ent

Unemployment Rate, 1920-2010

III. THE RECOVERY FROM THE GREAT DEPRESSION

1929

-01

1929

-08

1930

-03

1930

-10

1931

-05

1931

-12

1932

-07

1933

-02

1933

-09

1934

-04

1934

-11

1935

-06

1936

-01

1936

-08

1937

-03

1937

-10

1938

-05

1938

-12

1939

-07

1940

-02

1940

-09

1941

-04

1941

-11

1

1.2

1.4

1.6

1.8

2

2.2

2.4

Indu

stria

l Pr

oduc

tion

(Log

arith

ms)

Industrial Production, 1929-1941

August 1929

March 1933

Issue: Can monetary expansion still be helpful at the zero lower bound on nominal interest rates?

0

1

2

3

4

5

6

7

8

9

01/0

3/19

2010

/09/

1920

07/1

6/19

2104

/22/

1922

01/2

7/19

2311

/03/

1923

08/0

9/19

2405

/16/

1925

02/2

0/19

2611

/27/

1926

09/0

3/19

2706

/09/

1928

03/1

6/19

2912

/21/

1929

09/2

7/19

3007

/03/

1931

04/0

9/19

3201

/14/

1933

10/2

8/19

3308

/04/

1934

05/1

1/19

3502

/15/

1936

11/2

1/19

3608

/28/

1937

06/0

4/19

3803

/11/

1939

12/1

6/19

3909

/21/

1940

06/2

7/19

41

Com

mer

cial

Pap

er R

ate

(Per

cent

)

Commercial Paper Rate, 1920-1941

15

20

25

30

35

40

45

50

Jan

1929

Aug

1929

Mar

193

0

Oct

193

0

May

193

1

Dec

1931

Jul 1

932

Feb

1933

Sep

1933

Apr 1

934

Nov

193

4

Jun

1935

Jan

1936

Aug

1936

Mar

193

7

Oct

193

7

May

193

8

Dec

1938

Jul 1

939

Feb

1940

Sep

1940

Apr 1

941

Nov

194

1

M1

(Bill

ions

of $

)

Money Supply, 1929-1941

Government Spending as a Percent of GDP

Issue: Does fiscal stimulus work?

Issue: What caused the recession of 1937-38?

1929

-01

1929

-08

1930

-03

1930

-10

1931

-05

1931

-12

1932

-07

1933

-02

1933

-09

1934

-04

1934

-11

1935

-06

1936

-01

1936

-08

1937

-03

1937

-10

1938

-05

1938

-12

1939

-07

1940

-02

1940

-09

1941

-04

1941

-11

1

1.2

1.4

1.6

1.8

2

2.2

2.4In

dust

rial

Prod

uctio

n (L

ogar

ithm

s)

Industrial Production, 1929-1941

August 1929

March 1933

May 1937

June 1938

6

6.5

7

7.5

8

8.5

1929

1931

1933

1935

1937

1939

1941

1943

1945

1947

1949

1951

1953

1955

1957

1959

1961

1963

1965

1967

1969

Real

GDP

(Bill

ions

of 2

005$

, Log

arith

ms)

Real GDP

Issue: Can wars provide evidence on the impact of government spending?

4

4.5

5

5.5

6

6.5

7

7.5

8

8.5

9

1929

1931

1933

1935

1937

1939

1941

1943

1945

1947

1949

1951

1953

1955

1957

1959

1961

1963

1965

1967

1969

Billi

ons o

f 200

5$, L

ogar

ithm

s

Real GDP and Government Spending

GDP

G

Issue: What are the impacts of high government debt?

0.0

20.0

40.0

60.0

80.0

100.0

120.0

1940

1943

1946

1949

1952

1955

1958

1961

1964

1967

1970

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

2012

Perc

ent

U.S. Debt-to-GDP Ratio

IV. INTRODUCTION TO POSTWAR MACROECONOMIC FLUCTUATIONS

GDP does not grow smoothly.

Unemployment varies significantly, and sometimes rises sharply.

What Is a Recession? • Recessions are identified judgmentally by the

National Bureau of Economic Research.

• The NBER’s definition: “A recession [is] a significant decline in economic activity [that] spreads across the economy and can last from a few months to more than a year” (emphasis added).

Postwar recessions vary in frequency, duration, and size.

Output Movements Vary Greatly across Recessions

Example: Quarterly GDP Movements in the 3 Largest Postwar Recessions before

the Great Recession • 1957–58: –4.0%, –10.0%.

• 1973–75: –3.3%, +1.1%, –3.8%, –1.6%, –4.7%.

• 1981–82: –4.6%, –6.5%.

Note: All figures are at an annual rate.

Okun’s Law

A shortfall of GDP growth from normal of 2 percentage points is usually associated with a rise in the unemployment rate of about 1 percentage point.

In recessions, the work week and output per hour usually fall. (And labor force participation usually falls as well.)

Short-run fluctuations in output are distributed very unevenly over the components of output.