A Monetary Policy Primer: US s Great Depression

Transcription

1 A Monetary Policy Primer: US s Great Depression NETA 2015 Cengage Teaching Conference Max Gillman U. of Missouri-St. Louis Max Gillman U. of Missouri-St. Louis () 1 / 38

2 Macro Policy Primer: With Money & Banking Great Recession vs Great Depression Era Keynes & Depression Era Economics US Bank Collapse & Government Response Banking & Monetary Policy Turning Point of Great Depression Gold and Money Role The Day After Gold: Deposit Insurance Enacted Money Supply & Inflation in Depression Succeeding US Banking Acts of the 1930s Government Spending in Depression Phillips Curves and Deb-Deflation Max Gillman U. of Missouri-St. Louis () 2 / 38

3 Crisis Economics & Macroeconomics "Great Recession" compared to "Great Depression" Much macroeconomic policy focused on comparison. Crisis Economics: Still ongoing as is spread Worldwide; De ation now in Europe; Euro falling relative to US Dollar; Banks still struggling to recover. Macro Policy Debated today formed largely as in 1930s. Max Gillman U. of Missouri-St. Louis () 3 / 38

4 Historical Study of "Depression Economics" "Depression Economics" Samuelson 1949 to 19th ed. in Based on Lack of investment in Depression, solved by Govt. Created Keynesian based theory of aggregate economics. Endures with 2 Theories: Keynesian Cross & "IS LM models, Supplemented by Nominal Price AS-AD analysis & DSGE. Two main Results of Cross & IS-LM: Increase Govt. Money Supply, Spending: increases GDP. Today, equilibrium conditions derived: Ask same questions. How economy changes over "normal" business cycle How changes over long periods of time with economic growth. How changes in Crisis Periods: Banking collapse of Great Depression & (&Vietnam Stagflation period). Phillips Curves, "Debt-Deflation" & "Rare Event" Theories Related? Max Gillman U. of Missouri-St. Louis () 4 / 38

5 Ramsey (RBC, Solow Growth) Ignored by Keynes 1933 : Essays in Biography: "But he has left behind him in print (apart from his philosophical papers) only two witnesses to his powers - his papers published in the Economic Journal on "A Contribution to the Theory of Taxation" in March 1927, and on "A Mathematical Theory of Saving" in December The latter of these is, I think, one of the most remarkable contributions to mathematical economics ever made, both in respect of the intrinsic importance and diffi culty of its subject, the power and elegance of the technical methods employed, and the clear purity of illumination with which the writer s mind is felt by the reader to play about its subject. The article is terribly diffi cult reading for an economist, but it is not diffi cult to appreciate how scientific and aesthetic qualities are combined in it together (p. 295, original edition, Harcourt, Brace and Company, New York)." Max Gillman U. of Missouri-St. Louis () 5 / 38

6 "Real Time" Depression Era Economics Combined Banking, Monetary & Govt. Spending policies. Policy Begins: 1930 Tariff Act (Smoot-Hartley) : decreased trade, growth. Impending legislation "causes?" Stock market crash, bank sector collapse, system-wide bank panic + severe recession. Pres. Hoover Worsens Disaster: Balanced budget Act in 32; increases Corp. Tax Rt; Pers. Tax Rt 25 63%. Depression threat to foundations of democratic societies. Urgent action required but unclear what to do. 1 Bank law & regulation reform one answer, 2 another: Keynes s (1930, 1936) increase in Govt spending; 3 also monetary policy appeared important (not to Keynes?). Max Gillman U. of Missouri-St. Louis () 6 / 38

7 Keynes s Economics Keynes (1936): excess savings not invested by private sector. 1 Govt should do investment in place of private sector. 2 Monetary policy ineffective in Depression. Govt to do public investment & take up slack in economy. Keynes s famous 1936 General Theory: 3 years after Depression Trough. Did not emphasize bank reform or Monetary Policy. 1 graph: Savings Supply shifts out more than Invest Demand; similar to 1930 Treatise emphasis on excess savings. US policy in Great Depression: emphasized banking, monetary policy & government spending. Great Depression influences still how Macroeconomics taught today. Max Gillman U. of Missouri-St. Louis () 7 / 38

8 US Bank Collapse & Government Response 1 January 22, Reconstruction Finance Corp (RFC) Act of 1932, federal loans available to entire banking industry plus + life insurance co.+ railroads. 2 February 27, 1932, enacted Banking Act of 1932, co-sponsored by Senator Glass and Representative Steagall, Fed Res Bank could make loans to banks in special cases, began as "lender of last resort" instead of RFC. 3 Revenue Act 1932, June 6, raised Pers Income tax 25% to 63%. 4 June 1932: Dow Jones Industrial Average hit Depression Low 5 July 21, allowed RFC loans funds to state, munic. govt; designed to increase employment through public works projects; The Emergency Relief and Construction Act of July 22, 1932, Federal Home Loan Bank Act of 1932 US chartered and regulated savings and loan industry. Max Gillman U. of Missouri-St. Louis () 8 / 38

9 March 1933 & Bank Shutdown 1933 unemployment 25%, real GDP down 30%, bank crisis. 1 on March 1, 1933; Federal Reserve Bank of New York gold reserves below 40% required gold reserves relative to Federal Reserve Bank currency notes (the money stock). Max Gillman U. of Missouri-St. Louis () 9 / 38

10 March 1933 & Bank Shutdown 1933 unemployment 25%, real GDP down 30%, bank crisis. 1 on March 1, 1933; Federal Reserve Bank of New York gold reserves below 40% required gold reserves relative to Federal Reserve Bank currency notes (the money stock). 2 On March 3, 1933: Federal Reserve Bank of New York adopts resolution for nationwide bank holiday Max Gillman U. of Missouri-St. Louis () 9 / 38

11 March 1933 & Bank Shutdown 1933 unemployment 25%, real GDP down 30%, bank crisis. 1 on March 1, 1933; Federal Reserve Bank of New York gold reserves below 40% required gold reserves relative to Federal Reserve Bank currency notes (the money stock). 2 On March 3, 1933: Federal Reserve Bank of New York adopts resolution for nationwide bank holiday to stop panic and outflow of gold reserves Max Gillman U. of Missouri-St. Louis () 9 / 38

12 March 1933 & Bank Shutdown 1933 unemployment 25%, real GDP down 30%, bank crisis. 1 on March 1, 1933; Federal Reserve Bank of New York gold reserves below 40% required gold reserves relative to Federal Reserve Bank currency notes (the money stock). 2 On March 3, 1933: Federal Reserve Bank of New York adopts resolution for nationwide bank holiday to stop panic and outflow of gold reserves as people cashed in their currency for gold Max Gillman U. of Missouri-St. Louis () 9 / 38

13 March 1933 & Bank Shutdown 1933 unemployment 25%, real GDP down 30%, bank crisis. 1 on March 1, 1933; Federal Reserve Bank of New York gold reserves below 40% required gold reserves relative to Federal Reserve Bank currency notes (the money stock). 2 On March 3, 1933: Federal Reserve Bank of New York adopts resolution for nationwide bank holiday to stop panic and outflow of gold reserves as people cashed in their currency for gold (under the gold standard that held at the time). Max Gillman U. of Missouri-St. Louis () 9 / 38

14 March 1933 & Bank Shutdown 1933 unemployment 25%, real GDP down 30%, bank crisis. 1 on March 1, 1933; Federal Reserve Bank of New York gold reserves below 40% required gold reserves relative to Federal Reserve Bank currency notes (the money stock). 2 On March 3, 1933: Federal Reserve Bank of New York adopts resolution for nationwide bank holiday to stop panic and outflow of gold reserves as people cashed in their currency for gold (under the gold standard that held at the time). President-elect Roosevelt reportedly unwilling to consider this. Max Gillman U. of Missouri-St. Louis () 9 / 38

15 March 1933 & Bank Shutdown 1933 unemployment 25%, real GDP down 30%, bank crisis. 1 on March 1, 1933; Federal Reserve Bank of New York gold reserves below 40% required gold reserves relative to Federal Reserve Bank currency notes (the money stock). 2 On March 3, 1933: Federal Reserve Bank of New York adopts resolution for nationwide bank holiday to stop panic and outflow of gold reserves as people cashed in their currency for gold (under the gold standard that held at the time). President-elect Roosevelt reportedly unwilling to consider this. 3 On March 4, 1933, the Federal Reserve s 12 Regional Banks took decision: Max Gillman U. of Missouri-St. Louis () 9 / 38

16 March 1933 & Bank Shutdown 1933 unemployment 25%, real GDP down 30%, bank crisis. 1 on March 1, 1933; Federal Reserve Bank of New York gold reserves below 40% required gold reserves relative to Federal Reserve Bank currency notes (the money stock). 2 On March 3, 1933: Federal Reserve Bank of New York adopts resolution for nationwide bank holiday to stop panic and outflow of gold reserves as people cashed in their currency for gold (under the gold standard that held at the time). President-elect Roosevelt reportedly unwilling to consider this. 3 On March 4, 1933, the Federal Reserve s 12 Regional Banks took decision: locked all 12 Regional Banks, Max Gillman U. of Missouri-St. Louis () 9 / 38

17 March 1933 & Bank Shutdown 1933 unemployment 25%, real GDP down 30%, bank crisis. 1 on March 1, 1933; Federal Reserve Bank of New York gold reserves below 40% required gold reserves relative to Federal Reserve Bank currency notes (the money stock). 2 On March 3, 1933: Federal Reserve Bank of New York adopts resolution for nationwide bank holiday to stop panic and outflow of gold reserves as people cashed in their currency for gold (under the gold standard that held at the time). President-elect Roosevelt reportedly unwilling to consider this. 3 On March 4, 1933, the Federal Reserve s 12 Regional Banks took decision: locked all 12 Regional Banks, closed/restricted operations of private banks in 37 US States. Max Gillman U. of Missouri-St. Louis () 9 / 38

18 The US Bank Holiday: March March 4, 1933, F.D.Roosevelt sworn into Offi ce of US President. Inaugural: reduce unemployment & regulate bank sector. 2 1a.m. March 6, Roosevelt suspended all banking transactions; "Bank Holiday" lasted until March 9, Fed Reserve Board classifies private banks into 3 groups A, B, & C, with A being solvent & able to be reopened now, B being possibly able to be reopened with some restructuring, C being insolvent & unable to be reopened. 4 March 9, President signs Emergency Banking Act of 1933, retroactively approved nationwide bank holiday and set out how government could regulate bank reopenings. 5 March 13, 1933, 12 regional Fed Res Banks reopen. 6 By March 15, more than 90% of private banks reopened and deposits poured in much faster than withdrawals private banks, 1700 savings & loans declared failed-closed. 7 Dow Jones Ind Av never again fell below March 1933 average. Max Gillman U. of Missouri-St. Louis () 10 / 38

19 The Turning Point of the Great Depression Max Gillman U. of Missouri-St. Louis Figure: () US Real GDP in the 1930s. 11 / 38

20 Figure: US Nominal GNP Max Gillman U. of Missouri-St. Louis () 12 / 38

21 Gold Standard Ended, Money Supply Increased 1 April 5, 1933 proclamation: return gold coins & notes to Fed. by May 1, 1933, exchanged for Federal Reserve notes. 2 April 19, 1933: Gold export prohibited, offi cially violating Gold Standard rules. 3 April 19, 1933, Senator Thomas drafted the "Inflation Bill" via Agric. Adjustment Act, reducing gold content of dollar by 50%. And required Fed to purchase $3 billion of US Treasury with Fed Notes. 4 May 10: $800 million in gold coins & notes returned to Fed. 5 May 12, Agric Adjust Act enacted; gold value of dollar now 1/2 of orginal. 6 June 5, 1933 Cong Resolution to Suspend Gold Standard & Abrogate Gold Clause eliminated right to claim payment on debt in gold (note or coin). Max Gillman U. of Missouri-St. Louis () 13 / 38

22 The Day After Gold: Deposit Insurance Enacted 1 June 6, 1933, Banking Act of 1933 enacted. Day after US gold standard ended, Glass (D-VA) - Henry Steagall (D-AL) sponsored, restrictions within-state, interstate branching, speculative invest. by banks. divided banks into commercial or investment banking; 2 Act Permitted federal bank deposit insurance which Roosevelt threatened to veto, but did not. Established Federal Deposit Insurance Corporation (FDIC) deposit insurance ( $2500 per deposit account) for FDIC member banks. FDIC deposit insurance fund capitalized by US Treasury loan $289 million. 3 Established Federal Open Market Committee Max Gillman U. of Missouri-St. Louis () 14 / 38

23 Money Supply and Inflation in the Depression October 1929-March 1933 wholesale prices fell 37%, and farm prices fell 65%, stock prices fell 80% real output two-thirds of 1929 level. 1 January 30, 1934 Gold Reserve Act of 1934 enacted, fixed the price of gold at $35 (from $20.67) transferred ownership of all US gold to US Treasury raised US gold stock value by 69.3%. 2 February 1934, US monetary base accelerated upwards. 3 March 33- Feb 34: 16% point change in inflation rate Max Gillman U. of Missouri-St. Louis () 15 / 38

24 Figure 3 Figure: Real US Monetary Gold Stock Value: Max Gillman U. of Missouri-St. Louis () 16 / 38

25 Figure: US Monetary Base: Currency Plus Reserves at Private Banks, Max Gillman U. of Missouri-St. Louis () 17 / 38

26 Figure: Percentage Change in US Consumer Price Index, Max Gillman U. of Missouri-St. Louis () 18 / 38

27 Private versus Public Money Supply Monetary Base in Figure 1.4 was rising reasonably strongly throughout deflation. Private bank money was not: Banks create "money that circulates" when make loans: Private bank money, keeping only fraction of deposits as reserves. Ratio of currency to (demand plus time deposits) tells dramatic story From 17.27% in March 1933 to 12% in August Similar timing to Stock Market Reversal. Fed monetary policy: after 1951 "Accord" of US Treasury & Fed. Max Gillman U. of Missouri-St. Louis () 19 / 38

28 Figure: US Currency to Demand Deposit Ratio, Max Gillman U. of Missouri-St. Louis () 20 / 38

29 Stock Market Reversal When Deposits Back In Bank Figure: US, , Dow Jones Industrial Stock Index (red) and Currency/[Currency+Deposits] (blue). Max Gillman U. of Missouri-St. Louis () 21 / 38

30 Irving Fisher (1933) with the Last Word Point 39. Those who imagine that Roosevelt s avowed reflation is not the cause of our recovery but that we had "reached the bottom anyway" are very much mistaken (Fisher, 1933, p. 346). Max Gillman U. of Missouri-St. Louis () 22 / 38

31 Succeeding US Banking Acts of the 1930s 1 May 12, 1933, Emergency Farm Mortgage Act: loans to farms 2 May 27 Executive order creating the Farm Credit Administration (FCA) 3 May 27, Securities Act of 1933: regulated and enforced disclosure 4 June 13, Home Owners Loan Act: emerg relief: home loans. 5 June 16, The Farm Credit Act of 1933: for Land, Credit, Coop Banks 6 June 26, 1934, Federal Credit Union: Federal Credit Union System. 7 June 6, Securities Exchange Act of 1934: Sec&Exch Comm (SEC) 8 June 28, National Housing Act of 1934: created Federal Savings and Loan Insurance Corporation (FSLIC) provide deposit insurance to "savings and loans" banks (FDIC in 89). 9 The Banking Act of 1935 made the FDIC permanent; $5000 limit : US Treasury gold vault built at Fort Knox to hold huge gold stock. Max Gillman U. of Missouri-St. Louis () 23 / 38

32 Government Spending in the Depression 1 July 21, 1932 Emerg Relief Construction Act: 1.5 Bill public works. 2 Economy Act of 1932: fed govt could buy from fed agencies. 3 March 20, 1933, Govt Econ.Act: reduce federal pay,veteran ben. 4 March 22, end of prohibition with Beer-Wine Revenue Act. 5 March 31, Emerg Conservation Work Act: Civilian Cons Corps (CCC). jobs for otherwise unemployed, with Army help: road building, telephone wiring, tree planting, national park work. 6 May 12, Fed Emerg Relief Act of 1933: unemployment hardship. 7 May 12, Agricultural Adjustment Act: first of modern farm bills 8 May 18, Tennessee Valley Authority Act: Appalachia public works 9 June 16 National Industrial Recovery Act of 1933: minimum wage, public works. 10 June 16, 1933, Emergency Railroad Transportation Act: railroad consolidation. Max Gillman U. of Missouri-St. Louis () 24 / 38

33 Figure: US Unemployment Rate, Max Gillman U. of Missouri-St. Louis () 25 / 38

34 US Government Spending: Historical Experience Real GDP recovered to above 1929 levels in 1936, unemployment still at 15% in January Fell to near-0 level of August 1929 only in June From WWII Govt Spending. Wartime spending important for unemployment falling. Figure shows unparalleled increase in US real Govt/GDP, peaking about double that of WWI, at 40%. Max Gillman U. of Missouri-St. Louis () 26 / 38

35 Total Government Spending share of GDP since 1929 Figure: US Total Government Expenditure as a Share of GDP. Max Gillman U. of Missouri-St. Louis () 27 / 38

36 Figure: US Defense Spending as Share of GDP, Max Gillman U. of Missouri-St. Louis () 28 / 38

37 Unemployment and Govt Defense Spending Unemployment still at 10% as 1941 began. Govt expenditures already above 20% of GDP by 1931 and stayed relatively constant at that level until WWII. Defense in Iraq wartime: share of GDP rising to 4.9%, then to 5.6% in 2009:3. Share of defense in GDP below 5% before WWII, and peaked at 41% of GDP during WWII ; had a 22% peak during WWI. Max Gillman U. of Missouri-St. Louis () 29 / 38

38 Figure: US Defense as Share of GDP, Max Gillman U. of Missouri-St. Louis () 30 / 38

39 Figure: US Real GDP Max Gillman U. of Missouri-St. Louis () 31 / 38

40 Figure: Phillips Curve During US Stock Market Crash & Great Recession Max Gillman U. of Missouri-St. Louis () 32 / 38 Phillips Curve & Stock Prices: July 2008 to May 2009 Dow Jones Industrial Average: 11,555 on August 1, 2008 to 7063 on February 1, 2009, a 39% fall; correlated with Phillips Curve:

41 Great Depression % Change Dow Jones Industrials July 2008 to May 2009 Figure: Great Recession Stock Crash from July 2008 to May 2009 Max Gillman U. of Missouri-St. Louis () 33 / 38

42 Rare Events & Lost Decades Consider US "rare events" of 1. Great Depression, 2. Great Recession, & 3. "lost decade" of 1970 s stagflation. Great Depression has Phillips curve, for Three years! starting from May 1929, going to May Max Gillman U. of Missouri-St. Louis () 34 / 38

43 Great Depression 3-year Phillips Curve Figure: US Phillips Curve During Great Depression Max Gillman U. of Missouri-St. Louis () 35 / 38

44 Relation between Stock Prices and Phillips Curves Dow Jones Stock average percentage change from year ago, for same period of May 1929 to May Strong negative correlation between Phillips Curve & broad stock price measure. Shows how decline in inflation rate correlated with decline in asset values. This is idea in Irving Fisher s theory of debt-deflation. Asset price deflation can lead to aggregate price level deflation. Max Gillman U. of Missouri-St. Louis () 36 / 38

45 Great Depression Percentage Change In Stock Prices Figure: Dow Jones Industrial Average Percentage Change in Great Depression Max Gillman U. of Missouri-St. Louis () 37 / 38

46 Excluding Money, Banking: Keynes & Depression Evidence No Money in Keynesian Cross which Keynes set out as theory of Real Price of average cost plus profit; profit is investment minus savings. No Private Bank Money is IS-LM analysis: fixed money supply needed for upward sloping LM; private bank money would make Money Supply slope upwards. Nominal Price is common AS-AD, with "Real" Oil shocks. Killian (2012): Money, Inflation Granger causes 70 s Oil shocks New-Keynesian DSGE keeps inflation as change in price of goods as average cost plus monop profit. No money, no sustained inflation source. Banking Theory & Policy Missing from Standard Macro but can be integrated in Ramsey AS-AD (Gillman, 2011). Max Gillman U. of Missouri-St. Louis () 38 / 38