Temin and Wigmore: The End of One Big Deflation• US recovery from the Great Depression in the second

quarter of 1933—Roovelt’s Inauguration– Sargent’s (1983) regime change paradigm

• Dollar devaluation was key to recovery...signaled change in policy regime and reversed expectations of deflation– Romer maintains that money growth mattered• Fiscal stimulus was weak and statistically insignificant

Hoover: stuck in gold standard mindsetFDR: take action• That action was devaluation...taken soon after inauguration– Signaled the abandonment of the gold standard

expansionary effects on American industry

• Stock market as index of expectations– Stock prices rose because of expected inflation“change in expectations, therefore, stimulated business investment and expenditures on consumer durables, not consumption”• Rise in the demand for automobiles encouraged a rise in auto

production, steel production, and industrial production

• Grain and cotton prices rose as the value of the dollar fell farmers had higher incomes

Temin and Wigmore conclude• If Hoover had done what FDR did, the economy would have

recovered earlier• But would economy recover on its own?

Natural rate hypothesis Inherent stabilityReview Phillips Curve/Natural Rate models

Bernanke and Parkinson: Unemployment, Inflation, and Wages in the American Depression: Are There Lessons for Europe (AER, May 1989)

Puzzles: US in the 1930s/Europe in the 1980s/US today• Persistence of high unemployment– Wither self-correction? Is economy inherently stable?

• Insensitivity of inflation to high unemployment (a “floating NAIRU”?)• Increasing real wage despite high unemployment (not now)But note:• High growth rates (in manufacturing sector) during the 1933-37 and

1938-40 recoveries

strong self-correction consistent with natural rate

Error correction model (in logs) for manufacturing employment1924:2 – 1941:4

Δnt = constant + a(L)Δnt + b(n*t-1 – nt-1) + c0(πt – πe

t ) + c0(πt-1 – πet-1 ) + et

In wordsManufacturing employment growth corrected for autocorrelation responds to inflation surprises and closes the gap between “normal” and actual manufacturing employment in prior quarter.

n*t = (Fraction of labor force employed in mfg in 1929:1)

x (Labor force in quarter t) = “normal” employment πt – πe

t = inflation surprise

= residual when inflation estimated using lagged inflation and commercial paper interest rates

Findc > 0, consistent with Lucas-Rapping supply curveb = .15, consistent with self-correction, homeostasis hypothesis

n* - n half-life = 3 quarters

Error correction Phillips CurveΔnt = constant + a(L)Δnt + b(n*

t-1 – nt-1) + c0(πt – πet ) + c0(πt-1 – πe

t-1 ) + et

Findc > 0, consistent with Lucas-Rapping supply curveb = .15, consistent with self-correction, homeostasis hypothesis

n* - n half-life = 3 quartersCritique: Recovery was due to aggressive New Deal policiesResponse: New Deal “cleared the way for recovery” but did not drive it

Critique: Other sectors may have been less resilient than manufacturingResponse: No data to test assertion

Bernanke and Parkinson conclude/suggest that the economy is inherently stable

self-correcting mechanisms work...not stuck in “trap”• Since employment responded to inflation, monetary reflation—

increased money growth—may have assisted recovery (per Romer)

Puzzle: High and Increasing Real Wage in Depression• Real wage increased not just when price level fellNew Deal transition to an “efficiency wage”?• Shorter work-week (work sharing) but weekly reservation wage• Strong unions reinforced by New Deal legislation• Improved working conditions• Higher wages• Strong productivity growthBernanke and Parkinson• Efficiency wage explains productivity growth supply side growth• High real wage spurred spending and output demand side growth