Romer “The Great Crash and the Onset of the Great Depression” Economics 639 / American University / Vaughan

Background Why? Romer (Great Crash) and Olney explain why. Consumption fell dramatically from 1929 to 1930 before banking panics began. Indeed, from 1929-1930, real consumption expenditure fell by 5.4% - accounting for more than 2/3rds of decline in real GDP. Why? Romer (Great Crash) and Olney explain why.

Romer – Great Crash Key Point 1929 stock-market crash/continued stock-price gyrations in 1930 created uncertainty about future of economy/future income. Uncertainty led consumers to postpone purchases of irreversible durable goods. Evidence of Uncertainty: Decline in surety expressed by contemporary forecasters. Evidence Uncertainty Affected Consumer Behavior: Drastic decline in spending on consumer durables in late 1929, while spending on perishable goods rose slightly. Robustness Check: Importance of effect confirmed by “significant” negative relationship between stock-market variability and spending on consumer durables (relative to nondurables) following 1987 stock- market crash.

Other Evidence Forecaster uncertainty spiked in 1930, relative to 1920s. Equation estimates for 1987 stock market crash show similar effects (i.e., uncertainty lowered spending on consumer durables), but effect shorter lived.

Critical Analysis of Paper Strengths: Use of quantitative (regressions) as well as qualitative evidence (measures of forecaster uncertainty) Weakness: – No formal micro-foundation model, just narrative (?)

Story Thus Far… Recession Starts Morphing into Depression Long-Run Aggregate Supply (Potential Output) Price Level Short-Run Aggregate Supply (Sticky Wages) AD2– Tight Money (1928) Aggregate Demand (AD)1 – Original AD3 - Uncertainty after Stock-Market Crash (1930) Y3 P3 C Stock-market gyrations caused uncertainty about future income, which in turn led consumers to postpone expenditures on irreversible durables. Decline in consumption spending (AD) reduced price level and real output further than decline initially caused by tight money. P1 A P2 B Real Output Y2 Y1= Yp