Blog Roll: The Great Depression

 

The Great Depression of the Early 20th Century is (and was) a systemic event between World War I and World War II that has been intensely analyzed, if over-analyzed (see References below). The one viewpoint that seems to have been under-analyzed is the perspective of Systems Theory. The following is a Blog Roll of my postings on the topic:

• How do we define Great Depressions? From the standpoint of Systems Theory, not correctly.
• Shock Theories of Great Depressions An obvious but inadequate perspective.
• Did the Great Depression hit at a conjuncture of Technological Change? Maybe, but there have been a lot of Technological Long Waves and Conjunctures.
• Measuring the Great Depression Obsessive focus on the collapse of Gross Domestic product is myopic. 
• The Minsky-Kindleberger Framework So far, the best qualitative systemic framework. It needs to be tested.
• War and Normalcy: (1914-1929)  The Roaring Twenties Bubble was "popped" by the 1929 Stock Market Crash after which the US Economy returned to the long-run attractor path.
• Forecasting the Great Depression in France Not easy (or maybe even possible) since France reinvented itself after WWI and responded very conservatively to the shocks of the Great Depression.
• Black Thursday, Monday and Tuesday The Stock Market Crash.
• Are there Feedback Loop that Control The Economy? Yes, but...
• Ben Bernanke and the Great Depression You have to be a little sympathetic...
• The Fed Now has Better NowCasting Models So let's apply the models to the Great Depression.
• US Debt and the Great Depression The Deficit Scolds don't understand History.
• Political Philosophy and the Great Depression We are still stuck in the 1930's.
• One Problem with the Keynesian Plan It's Political!
• The Great Depression in France A difficult forecasting problem!
• Prohibition and Regulation OK, not all regulation makes sense!
• Income Inequality and the Great Depression Income Inequality peaked right before the Great Depression!
• American Values and Inequality It's a laugh!
• Are there Economic Stabilizers in the Economy? Maybe!
• Do We need Income Inequality for Growth? No!
• Is Income Inequality Inevitable? No!
• Tariffs and the Great Depression. Most politicians must have flunked ECON 101.
• Might MORE Capitalism help? No!
• Scenes from the Great Depression. Rewriting History.

Systems Theory opens up an entirely new perspective on the Great Depression. I will keep adding posts to this Blog Roll until I think I've attacked all the issues and competing explanations.

Notes

Readings

• Peter Fearon (1987) War, Prosperity and Depression, The US Economy 1917-1945. A good summary of the Economic Thinking on the Great Depression
• Charles Kindleberger (2013) World in Depression, 1929-1939 The best understanding of the Great Depression as a World-wide, Systemic Event
• Charles Kindleberger (2015) Manias, Panics and Crashes: A History of Financial Crises What causes departures from the Attractor Path 
• US Government (2008) Outline of US History, Chapter 10, War, Prosperity and Depression. The "official" history for the US! 
• Immanuel Wallerstein (2004) World-Systems Analysis: An Introduction
• Ludwig von Bertalanffy (2015) General System Theory: Foundations, Development, Applications Kindle Edition

Models, Data and US Federal Reserve Policy Decisions

 

One January 11, 2024, the PBS News Hour interviewed Raphael Bostic, president of the Atlanta Federal Reserve Bank. One interesting part of the interview was the description of how models vs. data are used in the Federal Reserve decision making process, at least by Dr. Bostic. The role of economic models in decision making is interesting because on July 20, 2010 the US House of Representatives Committee on Science and Technology held a hearing on the topic (transcript here) and concluded the models were not very useful. My conclusion is that the US Fed is on the right path with some of the new models being developed. Future posts will give my recommendations (as a statistician) and my reasons for making them. It is essentially my forecast for the future of US Fed model building.

In the interview above, Amna Nawaz asked when Bostic expected the economy to reach the US Fed's 2% Inflation rate target. Bostic answered:

Well, we have models, and models will give us an answer...[but]...I don't put too much stock in any of those longer-term issues...I just try to keep an eye on where things are going month to month and try to just have a clear understanding about where we stand.

In other words, the models give us some long term predictions about Inflation and Economic Growth but, for month-to-month decision making we use data.

So what exactly can we get from models? I would hope that that the Atlanta Fed gets Prediction Intervals telling them that, say, Inflation might be between 1% and 3%, bracketing he 2% target. Then, as the data come in, it can be evaluated to answer Anna Nawaz's question. And, I would hope that the state of the economy would have some role in predicting the time path of inflation. Something like the prediction intervals produced by Climate Models:

The original topic of the News Hour interview was to gage the actual strength of the economy and consumers expectations about economic growth (although most of the interview concentrated on Inflation).

 For the strength of the economy, let's look at the Atlanta Fed's GDPNow forecast for economic growth (quarterly percentage change in real GDP). The output from the GDPNow app (presented above) compares the GDPNow forecast to the range of the top and bottom ten Blue Chip forecasts. GDPNow predicts GDP percentage changes well outside the Blue Chip forecasts until we get into March of 2023. What's going on here and why is this happening?

Maybe it would help to look at a longer time period. The St. Louis Fed publishes the GDPNow output from 2014-2024 (above and here). We can very clearly see the COVID shock, the economy's response, and the return to approximately at 2% growth rate. Note that it took approximately three years to recover from the COVID shock.

There is a lot to scratch your head about in the NewsHour interview and the outputs of the GDPNow model before we even get to thinking about the problem of inflation. Why don't the Blue Chip forecasts show the COVID shock? Why does the GDPNow cellphone App not go back to 2019, before COVID, to report results? And, which forecast should we believe, if any? 

It sounds as if, from Dr. Bostic's comments, that the FED ignores the forecasts and just waits for data to come in when making decisions about the economy. That's OK, but the FED spends a lot of time and money on large-scale, Dynamic Stochastic General Equilibrium  (DSGE) models (here), the models criticized in the Congressional Hearings, models that produce yet another set of forecasts. Worse yet, the DSGE models are based on assumptions that economic agents use models to form expectations about economic variables and use these expectations to make decisions, decisions that DSGE models attempt to predict.

But, which models specifically are economic agents using: the GDPNow model, the consensus of the twenty-or-so Blue Chip forecasting models, the forecasts of the DSGE models, or some other model entirely (I have my own models that are similar to but, I argue, an improvement over the GDPNow approach). I know the Fed is trying to be transparent and lay everything out on the table but what I'm looking at appears contradictory as it must have looked to Congressional Committees. And,  some commentators (here) and Congressmen (here) want to get rid of the Federal Reserve, Fed forecasts and Fed policy manipulations entirely.

Interestingly enough, the current problems with Economic Policy all point back to our failure to understand the Great Depression* and the effects of economic shocks (such as the WWI-WWII shocks and the COVID shock). In future posts, I'll try to untangle this mess** because I think it is interesting and important but not because I think any economic agents (to include the Fed and the ECB***) will be interested. Eventually, I will get around to looking at Inflation and Deflation!

Notes

* ChatGPT (here) lists the following causes for the Great Depression: (1) Stock Market Crash of 1929, (2) Bank Failures, (3) Reductions in Consumer Demand, (4) High Tariffs and Trade Barriers, (5) Monetary Policy Mistakes, (6) Debt Deflation, (7) Decline in International Economic Activity and (8) The Dust Bowl and Agricultural (Environmental) Collapse. 

** My working hypothesis is that we need to embed the US Economy within the World-System to not only understand the Great Depression but also to understand current economic policy confusions. The Fed doesn't really have a role for the World-System in its models.

*** The failure of Macro-economic models was also felt by the European Central Bank (ECB): "Macro models failed to predict the crisis and seemed incapable of explaining what was happening to the economy in a convincing manner".

Rewriting History

Over the last decade, there has been a concerted effort to rewrite the history of the Great Depression (here, here, and here). Historian Robert McElvaine (here) and economist Paul Krugman (here) have both attempted to challenge the revisionists.

Basically, the revisionists have argued that the policies of the New Deal were either ineffective or actually caused the Great Depression. Revisionists point to the 1937 Recession as proof of their assertions.

The challengers argue that the 1937 Recession was caused precisely by contractionary spending policies the Roosevelt administration mistakenly pursued after Roosevelt's 1936 re-election. They argue that, like the Obama administration during the late-2000s Great Recession, the Roosevelt administration failed to stimulate the economy enough until the spending spigot was opened during World War II.

After reading both side of the debate, it still seems an open question whether anything short of putting the entire economy on a war footing (that is, conventional deficit spending, tax cuts, monetary manipulations, etc.) would be an effective policy response. Part of the problem is defining what a "return to normalcy" would actually mean when the period before the collapse was being driven by an economic bubble.

One definition would be a return to full employment but "normal" employment was itself distorted by the bubble: people who would normally not be in the labor market were drawn in during the bubble and people were pushed out who should not have been as a result of the crash.

I don't think we really appreciate the distortionary effects of bubbles and the importance of preventing bubbles from expanding in the first place.

Being Bernanke and The Great Depression

Whatever you think about Ben Bernanke, chairman of the U.S. Federal Reserve, you have to be a little sympathetic. Put yourself in his shoes and try to answer this barrage of disconnected questions and comments from Rep. Ron Paul, R-Texas in the video (above).

I'll just state this list as questions but Rep. Paul actually asks very few questions: (1) Is the Fed monetizing the debt? (2) Are Fed actions hurting mortgage holders? (3) Is the Fed funding the IMF? (4) Are bank examiners new or already on the payroll? (5) Are more bank examinations required or is the problem really the Fed easy money, low interest rate policy? (6) Do low interest rates rig the markets and give bad information to investors? (7) Can capital come from a printing press rather than savings? (8) Does an easy money policy reject every notion of free-market capitalism? (9) Why is the IMF asking for more money to bail out Greece? (10) Who pays money to the IMF? Where does the money come from? Will this all come out of the printing press once again? Are we expected to bail out the world? (11) Is the US bankrupt? (12) What are we going to do when a state "gets under the gun" and needs to be bailed out? Are our States approaching the situation Greece is in? (13) Can Congress find out what the Fed is doing? (14) Can the Fed do anything it wants and create as much money as it wants?

Chairman Bernanke gets to answer about three of these questions.

With Ron Paul now saying that Bernanke is "cocky" (here) and with Ron Paul now chairing the House Subcommittee on Domestic Monetary Policy (an obscure committee Paul wants to turn into the Fed watch dog), Ron Paul is Ben Bernanke's worst nightmare.

It's really too early to say whether the Fed performed better during the current financial crisis (the Great Recession) when compared to Fed performance during the Great Depression. What can be said about Ben Bernanke is that he studied the Great Depression and was convinced that the Fed made mistakes during the Great Depression (here) and was intent on not repeating those mistakes during the Great Recession. Whether you agree or not with his analysis and conclusions, he does have a reasonable basis for the way he has conducted himself in public life.

The Financial Crisis Could Reduce U.S. Income Inequality

The role of income inequality in the Financial Crisis of 2007-2010 will be analyzed and debated for many years in the future. The time series above plots the percent of income being received by the top 99-100% of income earners in the US (the data are from Emmanuel Saez, here, and are controversial--read both sides here). What is very interesting is that income inequality peaked right before the Great Depression and right before the Great Recession. The coincidence (?) suggests a number of hypothesis about income inequality and financial speculation (here).

In this post, I'm going to beg the obvious question "If there is too much income inequality in the U.S., how much income should the upper 1% of income earners be making?" One approach to answering this question is to assume that the earnings of the top 1%, like the earnings of every other worker, should be tied to growth in the U.S. economy. If the economy grows by 4%, however, how much of that 4% growth premium should be captured by the upper 1%? All of it? Some of it? None of it?
What turns out to be a better model and one that fits the data better is that, regardless of growth in the U.S. economy, the share of income to the upper 1% should remain at about 13%, about where it is right now in 2010 after the Financial Crisis. Interestingly, from 1950 to about 1990, the upper 1% weren't getting their share! Something changed after 1990 (a nice topic for analysis and speculation) and that innovation, whatever it was, created a huge inequality bubble--a bubble that was popped by the Subprime Mortgage Crisis.
For the future, the model predicts that we will return to the level of income inequality that marked the U.S. economy from WWI to the 1990s. What new innovation might come along to create the next inequality bubble? We can't know the future but the model predicts that without shocks, the income of the top 1% would stabilized around 13%--something I probably won't see in my lifetime.

The Drunkard's Walk and the Moment of Truth

The National Commission on Fiscal Responsibility and Reform has finally issued their report on the U.S. Deficit, "The Moment of Truth". They are not the only ones trying to seize the moment. The Economic Policy Institute has issued its report "Investing in America's Economy: A Budget Blueprint for Economic Recovery and Fiscal Responsibility." And, the Bipartisan Policy Center has released its report "Restoring America's Future." There are enough recommendations in and questions raised by these reports to keep many policy analysts busy blogging for many years in the future. Before jumping into the issues, I'd like to put a stake in the ground.

What do we expect to see when we look at a historical time plot of the U.S. Deficit? If the deficit hawks are right, we should see the deficit increasing uncontrollably over time when, in fact, the deficit should always be zero. The Keynesian viewpoint is that we should see periods of deficits during recessions followed by periods of surplus during recoveries. In other words the deficit should be a drunkard's walk, randomly moving from surplus to deficit based on shocks to the economy. The only issue is the range of movement: conservatives think there should be very little, if not zero movement and liberals say it depends on economic conditions.

The first figure above, using data from the CBO, fits a random walk model to the U.S. deficit. Although the fit is not bad, it looks like the model is always "catching up" and missing the turning points. What is striking about the graphic is that the deficit "excursions" are increasing in amplitude: economic shocks getting worse, spending responses ("bailouts") and attempts to "stabilize an unstable economy" getting more desperate.

Both the conservative and Keynesian views miss seeing that the U.S. deficit is part of a system. During an economic downturn, there is a flight to quality. Investors want to unload their higher-risk investments for the safety of U.S. debt which is covered by the "full faith and credit" of the U.S. government. During normal times, purchasing U.S. debt allows country's with trade imbalances (e.g. China) to do something safe with their dollars.

When we add debt held by the public into the random walk model, the predicted fit is much better (second graphic above). For the U.S. deficit to exist, there has to be a counter-cyclical market for U.S. debt. The market is somewhat self-correcting. If investors don't want to purchase U.S. debt, the only other way to create a deficit (as is the case in many "debt crisis" countries) is to print money.

What does this all have to do with the common explanations for the U.S. deficit being repeated in the policy echo chamber? Is it those mandatory entitlement expenditures such as Social Security, Medicare and Medicaid that must be eliminated to eliminate the deficit? Is this a reasonable conclusion from the graphics and discussion above? Is it the entitlement programs or the shocks to an "unstable economy" that are driving the deficit? It all depends on the time path of the entitlement programs compared to the time path of the deficit, a topic I'l talk about in future posts.

Unemployment Insurance and Employment

Yesterday, the U.S. Senate rejected the Unemployment Insurance Stabilization Act of 2010 that would have continued unemployment benefits until January 2012. Evidently, Republicans first want the Bush era tax cuts extended for their wealthy constituents.

Aside from the naked class-based motivation for not also extending unemployment insurance (UI), what are the likely consequences of the Senate's action?

The graphic on the right summarizes the arguments (read more here, here, here, here, here, and here). The Great Recession created our current unemployment problem by reducing GDP growth. UI, enacted during the Great Depression, is one of the built-in stabilizers in the economy that allows employees to ride out brief economic downturns. UI also provides an immediate boost to consumption since the unemployed immediately spend what they receive in benefits.

The right-wing criticism of UI is that it reduces job search. Granting that there might be some small reduction in search activity due to UI (the data, however, show that UI actually increases job search), if the jobs are not there, it doesn't matter how hard one searches. Until the Great Recession is over, employment will continue to be depressed. And, the failure by the Senate to extend UI will only serve to prolong the Great Recession through a reduction in consumption.

Supply Side vs. Demand Side

This Sunday on CNN's Fareed Zakaria GPS, Fareed interviewed Paul Krugman (Princeton University Department of Economics) and Raghuram Rajan (University of Chicago School of Business). It was as clear an exposition as I've heard of supply-side vs. demand-side economics and worth watching (here and for more Rajan, here, more Krugman, here, and more Zakaria on this topic, here).

Rajan argued for supply-side measures to return US competitiveness (increased business confidence, improved labor force skill levels, tax cuts to stimulate investment, etc.) while Krugman made the Keynesian argument (the subprime mortgage crisis has reduced consumer demand, business have excess capacity and won't invest or expand until there is more demand, and therefore government has to step in with economic stimulus).

It's hard not to agree with both positions since each is right, in theory. As a practical matter, however, the supply-side solutions only work in the long-term (how long will it take to retrain the US workforce?) and the demand-side solutions may not work at all (the US political system is unable to act quickly enough and with enough unity of purpose to enact a stimulus that would be large enough to have any impact).

Eventually, the economy will heal itself or at least find a new equilibrium. There's just no guarantee that the new equilibrium will be at a high level of either growth or employment.

The President's New Plan

It's getting close to the mid-term elections in the US and President Obama has a new plan for business tax breaks. Robert Reich gave a great commentary on NPR's Market Place and the commentary seemed to be based (with some embellishment) on the causal model above (click on the graphic for an enlarged view).

The president is proposing corporate tax cuts for R&D. Tax cuts will lead to the development of labor-saving technology that reduces jobs. Profits might also generate some investment (if there is demand). Otherwise, profits will be expended on CEO pay and Shareholder dividends which fuel the Stock Market casino (didn't that all start the Great Recession in the first place, that is, too much easy money sloshing around).

The problem we're having right now is inadequate demand created by the Great Recession (you can see the vicious circle in the graph: lack of demand leads to lack of sales leads to lack of production which leads to unemployment which decreases demand, etc.). Interest rates could be lowered by the Federal Reserve but they are almost at zero (the zero-bound) right now. Exports could be increased but the rest of the world is also in recession. Imports could be reduced (e.g., automobiles) but that requires demand for US products.

What remains is the Keynesian economic prescription: government spending. There is only one problem with increased government spending: it is being blocked by deficit hawks, fiscal conservatives, sound money evangelists, and bond vigilantes. The same dynamic played out during the Great Depression until WWII intervened.

So, the President's New Plan will be counterproductive (R&D tax cuts could decrease jobs), the Fed is at the zero-bound, and government expenditure will not increase unless we have another World War. What's going to happen?

Eventually, the markets will have their way and, in the words of Andrew Mellon (Herbert Hoover's Treasury Secretary), the markets will:

...liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate… it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.

For people that believe in markets and for people that do not, Mellon makes an important point. All markets will eventually adjust to bubbles created in other markets (e.g., housing and the stock market). The adjustments are brutal and painful if not necessarily swift. Subdivided ghost towns will be bulldozed or left to decay, jobs will be shipped to low-wage countries, companies will fail, people will drop out of the work force or take jobs below their skill level, and eventually there will be a new equilibrium.

The politics of all this are a little infantile: The US father figure (the president) is expected to fix the mess yet, at the same time that he is expected get out of the economy by reducing expenditure and regulation. I just heard another great Catch-22 in NPR Marketplace tonight: all the stimulus funds have not been spent because there are not enough federal workers to manage the contracts.

History Repeating: 1937

In 1937, the Federal Reserve and the Roosevelt administration decided the Great Depression was over and that it was time to stop spending. The result of the fiscal and monetary tightening was a second downturn in Gross Domestic Product (GDP). Today, the Obama administration has decided to seek spending freezes and to trim deficits. Is history repeating?

Hopefully not, but a time plot of real GDP during the great Depression shows that the bottom was hit around 1932. The episode in 1937 was a brief downturn compared to the Crash itself.

Black Thursday, Monday and Tuesday

This week marks the 79th anniversary of the Great Depression. On October 24, 1929 "Black Thursday," the stock market bubble burst and a pool of bankers attempted to prop up the market with an investment of money. On October 28, 1929 "Black Monday," the stock market fell 22.6% as did markets around the world. On October 29, 1929 "Black Tuesday," panic set in and a record 16 millions shares were sold. Reviewing the history of the Great Depression in the middle of the Subprime mortgage crisis (Great Depression II) is particularly salient. One of the best reviews is currently running on the PBS American Experience "The Crash of 1929".

The history of the Great Depression touches a number of current policy questions: (1) Did government policy before the crash create the bubble and did government policy after the crash make the Depression worse? (2) Should we bring back the Glass-Steagall Act of 1933 that separated banking and financial organizations and was repealed in 1999? (3) Did the stock market crash cause the Great Depression or were there other forces operating in the US economy and the world system? (4) Is our financial system becoming increasingly unstable with larger boom-and-bust episodes? (5) Did anyone see the Great Depression developing? Did anyone see the Subprime mortgage crisis developing? If they did, how were their forecasts received? (6) Is it even possible to forecast recessions and depressions?