David R. Henderson  

Robert Murphy on the 1920-21 Depression

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Paul Krugman has recently reraised the topic of the 1920-21 Depression. It was a very deep depression but it ended quickly. Robert Murphy has an interesting response.

Some highlights of Murphy's response. First, how he got interested in the issue:

What happened in my case is that (in the winter of 2008/09) I was doing research for my book The Politically Incorrect Guide to the Great Depression and the New Deal. I was going through the common arguments for why the 1930s depression was so awful, and I eventually realized that all of the main reasons you typically hear-often from both Keynesians and Chicago School monetarists-made no sense, because things were much much worse in each of these dimensions in 1920-1921.

Specifically, the Keynesians will say that Herbert Hoover didn't increase federal spending enough. Monetarists will say that the Fed didn't ease sufficiently. And both camps will say that the crushing deflation, in combination with sticky wages, led to a downward spiral in spending that caused unemployment to reach record highs.


Next, here's what he found. These numbers are really striking:
So in reaction to those types of claims-which remember, are supposed to show us why the 1930s mushroomed into the Great Depression, yielding a decade of despair-I pointed out that in the previous depression of 1920-21:

==> Far from boosting spending, the federal government (under Wilson/Harding) slashed spending 82 percent over three years (that's not a typo), going from $18.5 billion in Fiscal Year 1919 to $3.3 billion in FY 1922.

==> Far from easing, the Fed engaged in literally unprecedented tightening, with discount rates rising to all-time highs (since the founding of the Fed) and with the monetary base collapsing some 15 percent year/year (though that's using the seasonally adjusted data, so some may quibble with the figure).

==> Prices fell more rapidly in one year than at any 12-month span during the Great Depression. From its peak in June 1920 the Consumer Price Index fell 15.8 percent over the next 12 months. In contrast, year-over-year price deflation never even reached 11 percent at any point during the Great Depression.

==> Far from being "rigid downward," nominal wages fell 20 percent in a single year, according to Vedder and Gallaway.


Note that Murphy references the academic work on this issue by Daniel Kuehn, a frequent commenter on this site.


Comments and Sharing






COMMENTS (8 to date)
Daniel Kuehn writes:

On the fiscal tightening it's important to keep the timing in mind. The vast majority of it occurred before the recession even started, under Wilson. At face value it looks like a potential contributor to the depression that might be worth exploring.

Selgin and Woods have interesting thoughts up on the monetary point - not 100% sure what I think yet, but worth looking at them.

E. Harding writes:

1920-21≈1981-82
1929≈2007

Andrew_FL writes:

I think the main argument why wages fell has typically been that people expected deflation after a major war. Except the last point of reference they would have had for such a deflation was about 1865-1871. Someone the age of say, 18 in 1865, would have been in their 70's already-in other words, most people who would have living memory of a post-war deflation would have been dead, and many more probably not firm enough to work if they were alive. So the expectations story requires a long folk memory for economic phenomena, which I find rather doubtful, personally, but not impossible I suppose.

It seems to me that "sticky wages" are not a law of nature but largely a relatively recent development in economic history.

@E. Harding-Implicitly, then, 1923-1929 ≈ 2003-2007, right?

Richard A. writes:

From 1929 to 1933, nominal GDP declined by one half. How much did it decline in the early 20s?

From the equation GDPn = P x GDPr, if GDPn declines by 1/2, then P is going to have to decline by 1/2 in order to prevent a decline in GDPr. Because of natural price and wage stickiness, this adjustment will occur too slowly to prevent a decline in GDPr in the short run. Guess what our government did in the early 30s--it actually interfered with this downward price and wage adjustment causing the drop in real GDP to be larger than what it would have been.

A writes:

Andrew_FL, Daniel Kuehn's paper [see below] characterizes the collapse in nominal wages as part of a countercyclical policy by the Fed under Strong. In contrast to the recent recession in which the market adjusted to the fact that the Fed wouldn't defend an output level, Kuehn argues that the people of 1920 viewed the rate hikes as deliberate strategy, and therefore temporary.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1591030

Daniel Kuehn writes:

Thanks for sharing A - I honestly forget all the ways it changed, but I know the SSRN version is quite different from the published version, so if anyone's reading closely it might be worth tracking that down.

Link here, if you have access (not that it's not TOTALLY worth $39.95!!): http://link.springer.com/article/10.1007%2Fs11138-010-0131-3

Enial Cattesi writes:
Kuehn argues that the people of 1920 viewed the rate hikes as deliberate strategy, and therefore temporary.
I never really understood this omniscience attributed to all the people at the same time. How many people even knew that the FED existed and the name of its chairman?
Seth writes:

If you let the market correct, it corrects? Correct?

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