Monday, March 24, 2008

2008=1929?

Greg Mankiw has a lot of great posts on his blog, but this time I have to strongly disagree with him. In reaction to a post from Paul Krugman, he argues that the Fed was responsible of the Great Depression because of its deflationary policy. Given that the current policy is inflationary, we should have nothing to worry about. He quotes his intermediate macro textbook to support this.

I agree with the assessment that we are not facing a depression. I disagree with the assertion that the Fed is responsible for the great one. We all agree that money is neutral in the long run, right? When is the long run? Could we truly believe that the impact of the deflationary policy at the very start of the depression would have persisted all through the depression? Never would have the impact of monetary policy have been so persistent. And what about the fact that the monetary policy reverted to an inflationary one after 1933? Would that suddenly have no impact?

Research support for my claims: Cole, Ohanian and Leung show that there is no systematic relationship between money and output during the great depression. Cole and Ohanian show that it was the New Deal that prolonged the Great Depression. Cole and Ohanian, again, show that the 1929-1932 deflation was as deep as the 1920-1922 one (20%), but lead to a decrease of GDP of 36% compared to 4% in the earlier episode.

6 comments:

Vilfredo said...

The IS-LM model is already flawed for short-term analysis, so imagine how it is flawed in the longer run...

Anonymous said...

It would good to get that myth that FDR and the New Deal saved America out of the mind of Americans. As the quoted papers have showed, it is just the opposite.

As long as the Democrats do not get similar ideas, we are going to be fine.

Gabriel said...

And then there's this angle...

What Many of the Great Depression Comparisons Miss

Independent Accountant said...

Amazing I agree with you. The Fed did not cause the great depression. In my opinion it was a delayed reaction to WWI. The world needed to have consumption restricted to pay for the war. In 1946 many economists predicted a depression. It never happened. Instead we have a regime of perpetual inflation. Got gold? Get more!

Vilfredo said...

Independent accountant: There was debt after the war, but is was purely in accounting terms. It was also owed to someone else. It was purely financial, if that financial debt gets paid off, it does not mean that the total quantity of goods is decreased.

Anonymous said...

How can you be so unpatriotic? The New Deal saved America. This is what all History textbooks (TM) say.