Romer What Ended the Great Depression? Vaughan / Economics 639

Research Question Question: What ended Great Depression? Why is the question important? Conventional Wisdom: WWII ended GD. It did, but not in the way generally thought. How strong is economy’s self-correcting mechanism?

Basic Story Output grew dramatically from 1933 to 1937 (over 8% per year) and from 1938 to 1941 (over 10%). As a result, economy returned to trend growth in 1942. Rapid growth of money supply, propelled by gold inflows, were largely responsible for growth. Fiscal policy played almost no role. Rapid monetary growth worked through standard transmission mechanism – lowering real interest rate, which in turn, boosted interest-sensitive spending (aggregate demand stimulus)

Output Growth in the 1930s Between 1933 and 1937, U.S. real GNP grew by an average rate of over 8 percent per year; between 1938 and, 1941, it grew over 10 percent per year. These growth rates were spectacular, even for an economy pulling out of severe depression.

Approach to Research Question Estimate policy multipliers during severe recessions of 1921 and 1938. (output, monetary change relative to average for 1923-27) Use multipliers with actual values of monetary and fiscal policy for 1933-37 and 1938-41 to estimate contribution of each to output growth.

Approach to the Research Question

Contribution of Fiscal Policy

Small Fiscal Policy Contribution: Small Values for Fiscal Policy Variable

Aside: Fiscal Policy in the 1930s E. Cary Brown: “Fiscal policy, then, seems to have been an unsuccessful recovery device in the 1930s – not because it did not work, but because it was not tried. “ CONTRAST From 2009:Q1 to 2012:Q1, Net Government Saving (all levels)-to- Potential Output averaged -8.5%. It peaked in 2009:Q1 at -9.6%

Contribution of Monetary Policy

Large Monetary Policy Contribution: Large Values for Monetary Policy Variable

Transmission Mechanism (I)

Transmission Mechanism (II)