Arnold Kling  

By Request: Monetarism and the Great Depression

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The request is for my reaction to the way that economies in the Great Depression seemed to do better after going off the gold standard. Does this provide evidence that monetary easing would help today?

In general, macroeconomic data are consistent with many interpretations. The best evidence we have for any proposition is likely to be less than decisive. I suppose that you could say that decisiveness is in the eye of the beholder. Some people find vector autoregressions decisive. Some people find 1970-vintage macro models decisive. Some people find the behavior of economies following suspension of the gold standard decisive. I do not find any of this evidence decisive.

My guess is that if we were to try a Sumnerian monetary expansion today, the effect on employment and real output would not be very great. I don't think that the misalignment between nominal wages and prices is such a big deal at the moment.


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COMMENTS (7 to date)
Silas Barta writes:

James Hamilton likewise argues strongly against the gold standard on the basis that economies emerged from the Great Depression in direct proportion to how soon they got off the gold standard.

I don't think that proves what people seem to think it does, though. Keep in mind that "going off the gold standard" literally meant taking half of people's money.

So, how surprising is it that, in bad economic times, looting the (generally) wealthier and spending it on projects can temporarily goose the numbers?

jsalvatier writes:

@Silas
Keep in mind that a lot of that was undoing the increases in the value of people's money people due to previous deflation.

Doc Merlin writes:

"I don't think that the misalignment between nominal wages and prices is such a big deal at the moment."

I agree, I think most of the problem is caused by adverse supply shocks caused by legislation expectations.
We also have some other adverse real shocks to contend with (Russian wheat harvest for example).

kurt writes:

Of course, you can also accept the hypothesis that there was no 'gold standard' to begin with, so that countries also could not go 'off it'. What does that leave monetarism with?

stanfo1 writes:

Your analysis seems to be using a closed country model.

This is all about the value of the dollar. The "dutch disease" from excess capital inflows brings the value of the dollar too high to produce things here.

Looser monetary policy, along the lines of what Bernanke is doing, would lower the value of the dollar and make production in America economically viable again. It seems most talk of monetary policy in the blogosphere references "inflation" without acknowledging it's brother, "devaluation".

Norman writes:
I do not find any of this evidence decisive.
The obvious question, then, is what sort of evidence would you find decisive? Or, to put it another way, what sort of evidence would it take for you to abandon your current favorite theory/theories?
Two Things writes:

In a way, I'm with kurt.

One big problem in the great depression (which has a strong echo in our current predicament) was that governments had "gone off the gold standard" long before the crisis-- they had issued a lot of fiat money, money they falsely avowed was backed by specie. When push came to shove governments could not cover their paper; eventually they just repudiated it (e.g., Roosevelt's devaluation). However, before the truth came out, those governments had caused an Austrian-style bubble and crack-up.

I suspect economies improved after the devaluations for two reasons. (a) They were going to anyway-- after a catastrophe people usually do rebuild. (b) All the investors waiting and hoping to realize the benefit of their savings were finally disillusioned. Once they realized there was no hope--they had been thoroughly and irreversibly robbed (in the US, see the "Gold Cases")--they went back to work trying to build up new stakes.

The recent (and ongoing) depression was not, of course, caused by problems with gold-backed currency, since we've had only fiat money since 1933. However, we are suffering from a long-unacknowledged debasement of the currency by the government. The government pushed fiat money into the housing bubble. Many investors thought they had solid claims on valuable real estate in the form of MBS and CDOs but it was all illusion. As property values sink back toward their long-term trend line, MBS and their derivatives are looking more and more like the French Assignats and Mandats of the 1790's. MBS now trade well below par; they are propped up by government force (the Fed has been trading fiat dollars (electronically, not physically) for dubious MBS and CDO securities, and the government has modified accounting standards and issued regulatory "guidance" to make banks conceal their MBS losses); and many people have lost their savings (whether invested directly in MBS or not) even if they don't quite realize it yet.

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