Money and Unemployment in the Great Depression

Dr. X posted the following chart on his blog. It may raise more questions than it answers, but it’s good grist for the mill. Does it mean we want both quantitative easing amd fiscal stimulus?

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About J@m3z Aitch

J@m3z Aitch is a two-bit college professor who'd rather be canoeing.
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27 Responses to Money and Unemployment in the Great Depression

  1. AMW says:

    One thing to note is that when the government spent money in WWII, that wasn’t only spending. The war effort also drafted millions of people into the army, employing them by fiat. I’m not sure the magnitude of this impact in the grand scheme of things, but if it’s significant we wouldn’t be able to get a similar drop in unemployment by simply spending money. We would have to start forcing people into jobs at the same time.

    I don’t think many Americans would go for that.

  2. James Hanley says:

    AMW,

    Yes, but that didn’t start until after Nov. of 1941. The graph shows a steep decline in unemployment between 1938 and 1941, no?

  3. D. C. Sessions says:

    1937 also saw tax increases, BTW.

    If you ask an economist such as Krugman or DeLong, they’ll tell you that monetary policy works best (per Friedman) as long as you’re not up against the zero bound. At the zero bound, monetary policy loses its most powerful tool, although other less powerful tools continue to have some effect. Meanwhile fiscal policy still has plenty of traction but is slow to respond (barring automatic stabilizers, which Friedman took for granted in his analyses.)

    So, yes, in a severe situation (notably eighty years ago and today) both monetary and fiscal policy are best used. Not least because the faster and harder the government counters the shock, the more rapidly the economy (and notably employment) recover. The faster employment in particular recover, the less the government spends on secondary measures such as unemployment insurance, the less revenue is lost to unemployment, and the less damage is done by loss of skills etc.

    Some current analyses indicate that at least some fiscal measures are actually net revenue-positive for exactly the above reasons — and that doesn’t count stuff like infrastructure spending on deferred maintenance, which is just plain good business anyway.

  4. Dr X says:

    I’ll come back with my thoughts about what’s different now from then, and what I think the implications of those differences might be. In the meantime, though, outside the various short term approaches to stimulus (monetary & fiscal), Jeffrey Sachs has some completely different thoughts about this, and not much confidence in short-term stimulus. Sachs always seems to have a different take that falls outside the parameters of loudest participants in these arguments, but he’s so damned smart, I think his ideas are worthy of serious consideration. And, of course, there are others advocating things similar to what he proposes. I’m a little dubious about government strategically investing huge amounts of money for the long term, and I’d expect liberals to be far more open to his idea than conservatives who would reject it without even superficial examination, but I do think what he has to say should be considered.

    http://www.huffingtonpost.com/jeffrey-sachs/a-real-jobs-program_b_955357.html

  5. Dr X says:

    And a question, if anyone knows about the beginnings of social security. They instituted the payroll tax in 1937, which was one the contraction forces that year. How and when did payment of benefit begin? Did people over 65 or whatever the retirement age was start receiving benefits even though they hadn’t paid into the system? Was there some delay in instituting benefits after the payroll tax was introduced? How did it work in the beginning?

  6. AMW says:

    James H,

    Very good point; the draft can’t explain the full pattern of the data.

  7. Dr X says:

    @AMW to James:
    “Very good point; the draft can’t explain the full pattern of the data.”

    And after the draft commenced, the reported unemployment rate actually understates the full extent of idle capacity put to work. Remember the women who joined the work force in all sorts of defense jobs, including the kinds of jobs traditionally held by men. Many were not counted as unemployed before the war. So in a sense, the war led to more than 100 percent employment when our bases for comparison are the unemployment rates of the prior 12 years. That’s something the graph does not show.

  8. This chart seems like having your cake and eating it too. Aren’t Keynesians always the ones talking about sticky prices and lag effects?

  9. James Hanley says:

    D.C.,
    If you ask an economist such as Krugman or DeLong, they’ll tell you that monetary policy works best (per Friedman) as long as you’re not up against the zero bound. At the zero bound, monetary policy loses its most powerful tool

    The zero-bound problem is promoted strongly by Krugman, Delong, et.al, but not accepted by all economists. I’m afraid I don’t clearly understand Krugman on the issue, though. As I understand him, when you’ve reached the zero-bound state, a good solution is some intentional inflation (essentially, scare people into buying today–hence stimulating the economy–because they know it’s going to be more expensive tomorrow). But to me that sounds just like a vigorous dose of monetary policy. I’m sure there’s more to it; I just don’t get it yet.

  10. D. C. Sessions says:

    The reason that the zero bound reduces the option in monetary policy is that rate reductions are the monetary policy tool of choice. Can’t go below zero. The problem with tools like increasing inflation expectations is that it’s basically all a bluff: if people don’t believe the talk, what do you do?

    Yes, the Fed could just flood the market with dollars. I believe that one economist came up with a number of 10 trillion to resolve the current mess. Nobody appears to have remotely that kind of nerve, so it ain’t happening. Fiscal policy can accomplish the same thing rather cheaper; the calculation on that runs to around two trillion of new Treasuries, with more positive and fewer negative effects.

  11. Dr X says:

    James, I think you’re right on Krugman. And I believe that the zero-bound comes about in a liquidity trap. The businesses have cash to invest, but don’t invest it because they can’t see anything better than cash. The opportunity cost of holding cash, is lower when there is no obvious place to be reasonably assured of a better return. So, in effect, insufficient demand is behind the zero-bound point.

    And yes, deliberate inflation is one way to push through, and the other way is spending. The government becomes a big customer, giving business a place to spending their cash on increased production and hiring.

    I think DeLong and Krugman both believe that monetary policy is the first course of action and that it is usually sufficient. But when the demand side isn’t there because of high unemployment, businesses hold their cash. You can ease money, but businesses won’t borrow if they don’t know what to do with what they have.

    This is why many believe that as more rounds of easing occur without breaking the liquidity trap, the more it seems that the point of futility has been reached.

    I’m leaning toward thinking that’s where we are now, and spending, may be our only way out of a Japan-type situation.

  12. D. C. Sessions says:

    What’s holding the overall economy back right now is the private (not public, not corporate) debt overhang. The American public is deleveraging as fast as it can, either through paying down debt or by bankruptcy. The benefit of increased inflation (crude a tool as it might be) is that it accelerates that process and hastens the day when people start spending money again, starting the production/hiring/spending cycle up. Inflation may be a poor tool, but it beats bankruptcy and lets the banks out of their current problem of unacknowledged bad debts.

    I’d be a lot less happy about fiscal stimulus if it weren’t for the enormous amount of stupid deferred maintenance on basic infrastructure and (can we agree this is insane?) cuts to essential government services like police, fire, and education. Never mind research etc.

  13. D. C. Sessions says:

    Ask and ye shall be answered: Krugman addresses this point this morning.

    http://krugman.blogs.nytimes.com/2011/09/22/meh-and-i-mean-that/

  14. Dr X says:

    @ DC:
    “The benefit of increased inflation (crude a tool as it might be) is that it accelerates that process and hastens the day when people start spending money again, starting the production/hiring/spending cycle up. Inflation may be a poor tool, but it beats bankruptcy and lets the banks out of their current problem of unacknowledged bad debts.”

    Yes, a very good point. And while lenders may not like i it, could avert some bankruptcies as you say, and, given that so much of the lending was reckless, it wouldn’t really bother me all that much if lenders were repaid in somewhat devalued dollars.,

  15. D. C. Sessions says:

    The received wisdom was that the 70s were horrible, but if you look at metrics like constant-dollar median income they were better than the decades since — and if you look at wealth distribution, they were very good for all but the wealthiest portions of the population precisely because working people could buy a house with a reasonable expectation of affording to pay it off readily.

    Perhaps the worst thing about the 70s (besides fixating economic theory on some notions that have since proven untenable) was that it set expectations that people have tried to pursue since. Things like, buy a house you can barely make payments on early in life because your income will increase rapidly and the payments won’t. And look where that has brought us.

  16. James Hanley says:

    D.C.The problem with tools like increasing inflation expectations is that it’s basically all a bluff: if people don’t believe the talk, what do you do?
    Dramatically increasing the money supply isn’t a bluff. It’s not talk but a real action because the money’s really out there. And consequently dollars do become less valuable, so holding them becomes less desirable. But the key to inflation working is that the spending has to occur before prices go up, or it’s all a wash. If prices go up right away, you get the same amount of goods sold that you would have without the inflation, so it might not hasten recovery or give incentive to the production/hiring cycle. So it’s a tricky policy–people will spend, but their increased spending may only be nominal, not real.

    Dr. XI think DeLong and Krugman both believe that monetary policy is the first course of action and that it is usually sufficient.
    Yes, Krugman, at least, has said this explicitly (even our Keynesian nowadays are monetarists!). But the concept of a liquidity trap is what’s contested by Krugman’s critics. It’s a hypothesis with a good chain of logic behind, but it’s not got lots of empirical evidence. The Japanese case is quite arguable, as there was a whole lot else going on, particularly the government’s insistence that banks make favorable loans to favored corporations that weren’t necessarily profitable (like GM, many Japanese manufacturers focused more on market share than profitability), and the inability of businesses to pay back loans was a major part of the problem. Krugman’s not an institutionalist, so he tends to not focus on such things, whereas an institutionalist is likely to be impatient with abstractions such as liquidity traps and look at what rules are in place and whether they’re creating bad incentives. I’m an institutionalist myself, so naturally I tend to be more inclined that way than Krugman’s way.

    D.C.–Re: Inflation and infrastructure/service spending.
    I’m old enough to remember my mom fretting over how she was going to feed us as prices spiraled in the ’70s. I’m an inflation-hawk. And yet I would accept some inflation now if it will help revive the economy, because I don’t for a moment think the Fed would more than temporarily shift away from it’s long-term inflation goals. But we still face the problem that there may only be a nominal increase in spending, not a real one, so I’m not super-confident it will really work.

  17. James Hanley says:

    Re: The Krugman article referenced by D.C. What if Krugman is simply wrong to be focusing on an aggregate demand model? What if Arnold Kling is right?

  18. James Hanley says:

    The received wisdom was that the 70s were horrible, but if you look at metrics like constant-dollar median income they were better than the decades since

    This is a different argument than I’ve heard before. What I have heard is that median income has stagnated, not that it has declined. Did you intend to imply that it has declined, and if so, can you provide a link to the data?

  19. D. C. Sessions says:

    RE: “Dramatically increasing the money supply.” Mechanisms count. The Fed doesn’t just print up a bunch of Benjamins and drop them from airplanes; most of the “money supply” is created like electron/positron pairs in empty space is: by one bank sending another bank a message.

    The #1 way that money is created is by (I know this seems backwards) the Government spending it. To counter that, money is “destroyed” by the Government taxing it. Which is how fiscal policy affects inflation and overall economic activity. The Fed has a secondary role in its control over banks and their reserve requirements, but that amounts to it telling primary banks “Hi, we’ll lend you money at X%”

    What’s happening now is there aren’t enough takers on that offer, even when the Fed offers to loan money at 0%. Which is part of why there’s a lot of cash and equivalents sitting around: it’s as good as a bond and just that tiny bit better in that even a bond at 0% interest has a nonzero risk of default, but cash doesn’t.

  20. D. C. Sessions says:

    What if Krugman is simply wrong to be focusing on an aggregate demand model? What if Arnold Kling is right?

    Every economist in the world has been applying their models to the system for the past four-plus years. By now we have a pretty good idea of which ones are consistently wrong (like the weekly claims of hyperinflation now, NOW, NOW!!!!) and which ones have done better.

    Krugman has been pretty clear about his expectation since 1998, with The Return of Depression Economics — and it’s getting to the point where David Frum is posting mea culpa essays on the relative fates of those who trusted the Wall Street Journal for economic forecasts over the past three-plus years vs. those who trusted Professor Krugman.

    But that’s the nice thing about science: you don’t have to trust anyone. You can take the models that Krugman and others are using and check their theories yourself. Compare to the natural experiment, and judge.

  21. D. C. Sessions says:

    RE: the 70s. Since the late 70s (approximately the beginning of the Volker Recession) median household incomes have been nearly flat. Not quite, but close. That, I’m pretty sure, is what you’ve seen reported.

    Left out of that is the question of how many hours it takes to earn that median household income. Effectively, the median wage. The trick is to observe that there have been more and more women entering the workplace to make up household incomes, and there has been an increase in women’s wages relative to men (from suicidally shameful to merely disgraceful.)

    Aggregate median wages have been near enough as matters totally flat, and men’s median wages actually peaked quite a few years ago. 1973, for wages in private industry:
    http://www.huppi.com/kangaroo/Wages.htm (cites BLS data series.)

  22. James Hanley says:

    The #1 way that money is created is by (I know this seems backwards) the Government spending it. To counter that, money is “destroyed” by the Government taxing it.
    Eh? The money the government spends is basically money that’s already in the economy. The Fed adds new money to the economy and pulls money out.

    Every economist in the world has been applying their models to the system for the past four-plus years. By now we have a pretty good idea of which ones are consistently wrong (like the weekly claims of hyperinflation now, NOW, NOW!!!!) and which ones have done better.
    I don’t think we actually do have a “pretty good idea” which ones are consistently wrong except for the moronically simplistic ones like “hyperinflation now, NOW, NOW!!!!”

    Krugman has been pretty clear about his expectation since 1998, with The Return of Depression Economics — and it’s getting to the point where David Frum is posting mea culpa essays on the relative fates of those who trusted the Wall Street Journal for economic forecasts over the past three-plus years vs. those who trusted Professor Krugman.
    That’s a dishonest switch. You were talking about comparing economic models–by which I presumed you somehow someway meant actual economists-then you compare Krugman to Frum and the WSJ, neither of which is an economist. Sure, Krugman’s doom-and-gloom predictions have come true, but they’re perfectly consistent with the expectations of a number of economists who disagree with his models. E.g., Robert Barro’s criticism of high levels of government indebtedness result in the same predictions over the past several years.

    Krugman’s model has has neither been proved wrong nor right. It hasn’t had the test he’s asked for, so it’s left untested. And when others also make predictions about how bad things are going to be, but based on a different set of current polices, it’s simply impossible to say his model’s been proved correct through testing in a natural experiment.

    Re: the 1970s. If you could freeze time, and were required to make the choice, would you freeze time in 1973 or 2005? You’re actually making a mistake in your analysis–you refer to how many hours it was necessary to work to get the median wage, but what you should be asking is how many hours it’s necessary to work to purchase the consumer goods and services we want. Most things now require fewer hours work to purchase them. To hell with 1973, when it took a week’s work or more to buy a fuzzy black and white TV and months of work to buy a car that wouldn’t last even 100,000 miles.

  23. D.A. Ridgely says:

    Note typo “amd” in post.

  24. Lance says:

    D.A. Ridgely,

    I like your Mr. Peabody avatar.

    Do you have access to his WABAC machine? Perhaps you could start your own blog called Improbable History.

  25. James Hanley says:

    You’d think after snubbing us for months Mr. Ridgely might have more to say…

  26. Matty says:

    Why don’t they drop money from planes? If nothing else it would make the financial news more interesting.

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