UNIVERSITY of CALIFORNIA Economics 134 DEPARTMENT of ECONOMICS Spring 2018 Professor David Romer

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 Economics 134 David Romer Spring 2018

LECTURE 2 Overview of the Great Depression

January 22, 2018 Announcements • A second reader, which contains the outside readings that are available online and is optional, is now available at Copy Central. • You can order it in person at Copy Central, or online at https://copycentral.redshelf.com/book/842423/e con-134-vol-2-optional-reading-macroeconomic- policy-from-the-great-depression-to-today- 842423-none-romer • 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. Real GDP Growth, 1919-1929

10 GDP Growth

Percent -5

-10

-15

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

Issue: Was GDP growth above the growth rate of potential output? Real GDP Growth and Inflation 1919-1929 15

10 GDP Growth

Percent -5

-10

-15 Inflation

-20 1919 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 Income Inequality in the United States

50%

45%

40%

35%

30% Share of total income going to Top 10% Top incometotalgoing to Share of

25% 1917 1922 1927 1932 1937 1942 1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007

Issue: What effect might increasing inequality have on short-run fluctuations? Stock Prices, 1922:1-1929:8 36.5

31.5

26.5

21.5

16.5

11.5

6.5 Monthly S&P Stock Price Index Price Stock S&P Monthly

1.5 Jul 1924 Jul 1929 Jul Jan 1922 Jan 1927 Jun1922 Jun1927 Oct 1925 Oct Apr 1923 Apr 1928 Apr Sep 1923 Sep 1924 Feb 1928 Sep 1929 Feb Dec 1924 Dec Aug 1926 Aug Nov 1922 Nov 1927 Nov Mar 1926 May 1925 May 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. Stock Prices, 1922:1-1929:12

36.5

31.5

26.5

21.5

16.5

11.5

6.5 Monthly S&P Stock Price Index Index Price Stock S&P Monthly 1.5 Jul 1924 Jul 1929 Jul Jan 1922 Jan 1927 Jun1922 Jun1927 Oct 1925 Oct Apr 1923 Apr 1928 Apr Sep 1923 Sep 1924 Feb 1928 Sep 1929 Feb Dec 1924 Dec 1929 Dec Aug 1926 Aug Nov 1922 Nov 1927 Nov Mar 1926 May 1925 May

Issue: What role did the Great Crash play in the onset of the Depression? Industrial Production (Logarithms) 1.2 1.4 1.6 1.8 2.2 2.4 1 2 IndustrialProduction, 1929- 1929-01 1929-04 1929 August 1929-07 1929-10 October 1929 October 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 1933-04 1933-07 1933-10 Bank Suspensions 506 456 406 356

306 256

Number 206 156 106 56 6 Jul 1929 Jul 1930 Jul 1931 Jul 1932 Jan 1930 Jan 1931 Jan 1932 Jan 1933 Sep 1929 Sep 1930 Sep 1931 Sep 1932 Nov 1929 Nov 1930 Nov 1931 Nov 1932 Mar 1930 Mar 1931 Mar 1932 May 1930 May 1931 May 1932 Money Supply and Banking Crises 1929-1935

29 27 25 23 21

M1 (Billions of $) 19 17 15 Jan 1929 Jan 1930 Jan 1931 Jan 1932 Jan 1933 Jan 1934 Jan 1935 Sep 1929 Sep Sep 1930 Sep Sep 1931 Sep Sep 1932 Sep Sep 1933 Sep Sep 1934 Sep Sep 1935 Sep May 1929 May May 1930 May May 1931 May May 1932 May May 1933 May May 1934 May May 1935 May 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? Producer Price Index 3

2.9

2.8

2.7

2.6

Logarithms 2.5

2.4

2.3

2.2 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941

Issue: What role did actual and expected deflation play? Issue: Can fiscal contractions ever be expansionary? Issue: What role did the gold standard play in spreading the Depression throughout the world? Unemployment Rate, 1920-2010 30

15 Percent

0 1920 1924 1928 1932 1936 1940 1944 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008

III. THE RECOVERY FROM THE GREAT DEPRESSION Industrial Production (Logarithms) 1.2 1.4 1.6 1.8 2.2 2.4 1 2

1929-01 IndustrialProduction, 1929- 1929-08 1929 August 1930-03 1930-10 1931-05 1931-12

1932-07 March 1933 1933-02 1933-09 1934-04 1934-11 1935-06 1936-01 1936-08 1937-03 1937-10 1938-05

1938-12 1941 1939-07 1940-02 1940-09 1941-04 1941-11 Commercial Paper Rate, 1920-1941 9 8 7 6 5 4 3 2 1 (Percent) Commercial Rate Paper 0 01/03/1920 10/09/1920 07/16/1921 04/22/1922 01/27/1923 11/03/1923 08/09/1924 05/16/1925 02/20/1926 11/27/1926 09/03/1927 06/09/1928 03/16/1929 12/21/1929 09/27/1930 07/03/1931 04/09/1932 01/14/1933 10/28/1933 08/04/1934 05/11/1935 02/15/1936 11/21/1936 08/28/1937 06/04/1938 03/11/1939 12/16/1939 09/21/1940 06/27/1941

Issue: Can monetary expansion still be helpful at the zero lower bound on nominal interest rates? Money Supply, 1929-1941 50

M1 (Billions of $) 25

15 Jul 1932 Jul 1939 Jan 1929 Jan 1936 Jun 1935 Oct 1930 Oct 1937 Apr 1934 Apr 1941 Feb 1933 Sep 1933 Feb 1940 Sep 1940 Dec 1931 Dec 1938 Aug 1929 Aug 1936 Nov 1934 Nov 1941 Mar 1930 Mar 1937 May 1931 May 1938 Government Spending as a Percent of GDP

Issue: Does fiscal stimulus work? Industrial Production, 1929-1941

2.4

2.2 May 1937 August 1929 2

1.8

1.6 June 1938

1.4

1.2 March 1933

Industrial Industrial Production (Logarithms) 1 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

Issue: What caused the recession of 1937-38? Real GDP 8.5

7.5

6.5

Real GDP (Billions GDP Real of2005$, Logarithms) 6 1929 1931 1933 1935 1937 1939 1941 1943 1945 1947 1949 1951 1953 1955 1957 1959 1961 1963 1965 1967 1969 Real GDP and Government Spending 9 8.5 GDP 8 7.5 G 7 6.5 6 5.5 5 Billions2005$, of Logarithms 4.5 4 1929 1931 1933 1935 1937 1939 1941 1943 1945 1947 1949 1951 1953 1955 1957 1959 1961 1963 1965 1967 1969 Issue: Can wars provide evidence on the impact of government spending? U.S. Debt-to-GDP Ratio 120.0

100.0

80.0

60.0 Percent

40.0

20.0

0.0 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

Issue: What are the impacts of high government debt?

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.