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The Mistake of 1937: A General Equilibrium Analysis

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  • Gauti B. Eggertsson

    (Federal Reserve Bank of New York (E-mail: Gauti. Eggertsson@ny.frb.org))

  • Benjamin Pugsley

    (University of Chicago (E-mail: pugsley@uchicago.edu))

Abstract

This paper studies a dynamic stochastic general equilibrium model with sticky prices and rational expectations in an environment of low interest rates and deflationary pressures. We show that small changes in the publicfs beliefs about the future inflation target of the government can lead to large swings in both inflation and output. This effect is much larger at low interest rates than under regular circumstances. This highlights the importance of effective communication policy at zero interest rates. We argue that confusing communications by the U.S. Federal Reserve, the President of the United States, and key administration officials about future price objectives were responsible for the sharp recession in the United States in 1937?38, one of the sharpest recessions in U.S. economic history. Poor communication policy is the mistake of 1937. Before committing the mistake of 1937, the U.S. policymakers faced economic conditions that are similar in some respects to those confronted by Japanese policymakers in the first half of 2006.

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Bibliographic Info

Article provided by Institute for Monetary and Economic Studies, Bank of Japan in its journal Monetary and Economic Studies.

Volume (Year): 24 (2006)
Issue (Month): S1 (December)
Pages: 151-190

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Handle: RePEc:ime:imemes:v:24:y:december:i:s1:p:151-190

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Related research

Keywords: Deflation; Zero bound on interest rates; Regime changes; Great Depression;

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References

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  1. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2001. "Optimal monetary policy," Working Papers 01-5, Federal Reserve Bank of Philadelphia.
  2. Michael D. Bordo & Andrew Filardo, 2004. "Deflation and Monetary Policy in a Historical Perspective: Remembering the Past or Being Condemned to Repeat It?," NBER Working Papers 10833, National Bureau of Economic Research, Inc.
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Citations

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Cited by:
  1. Edward Nelson, 2011. "Friedman's monetary economics in practice," Finance and Economics Discussion Series 2011-26, Board of Governors of the Federal Reserve System (U.S.).
  2. Kinda Hachem & Jing Cynthia Wu, 2014. "Inflation Announcements and Social Dynamics," NBER Working Papers 20161, National Bureau of Economic Research, Inc.
  3. Alan J. Auerbach & William G. Gale, 2009. "Activist fiscal policy to stabilize economic activity," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 327-374.
  4. Bordo, Michael & James, Harold, 2010. "The Great Depression analogy," Financial History Review, Cambridge University Press, vol. 17(02), pages 127-140, October.
  5. Gabriel P. Mathy, 2014. "Uncertainty Shocks and Equity Return Jumps and Volatility During the Great Depression," Working Papers 2014-02, American University, Department of Economics.
  6. Gauti B. Eggertsson, 2006. "Was the New Deal contractionary?," Staff Reports 264, Federal Reserve Bank of New York.
  7. Price Fishback, 2010. "US monetary and fiscal policy in the 1930s," Oxford Review of Economic Policy, Oxford University Press, vol. 26(3), pages 385-413, Autumn.
  8. Acocella, Nicola & Di Bartolomeo, Giovanni & Hughes Hallett, Andrew, 2008. "When Can Central Banks Anchor Expectations? Policy communication and controllability," CEPR Discussion Papers 7078, C.E.P.R. Discussion Papers.
  9. Gauti B. Eggertsson, 2010. "A Reply to Steven Horwitz's Commentary on "Great Expectations and the End of the Depression"," Econ Journal Watch, Econ Journal Watch, vol. 7(3), pages 197-204, September.
  10. Carlstrom, Chartles & Fuerst , Timothy & Paustian, Matthias, 2013. "Policy multipliers under an interest rate peg of deterministic versus stochastic duration," Bank of England working papers 475, Bank of England.
  11. Charles T. Carlstrom & Timothy S. Fuerst & Matthius Paustian, 2012. "Fiscal multipliers under an interest rate peg of deterministic vs. stochastic duration," Working Paper 1215, Federal Reserve Bank of Cleveland.
  12. Douglas A. Irwin, 2011. "Gold Sterilization and the Recession of 1937-38," NBER Working Papers 17595, National Bureau of Economic Research, Inc.
  13. Christopher P. Reicher, 2009. "Expectations, Monetary Policy, and Labor Markets: Lessons from the Great Depression," Kiel Working Papers 1543, Kiel Institute for the World Economy.

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