This paper recasts Temin's (1976) question of whether monetary forces caused the Great Depression in a modern time series framework. We analyse money-income causalities and predict US output in a recursive Bayesian framework, allowing for information updating and time-varying coefficients. The predictive power of money aggregates and the Fed discount rate is in general very weak and collapses after the crisis of the gold standard in 1931. In contrast, non-monetary variables, particularly leading indicators of residential construction and equipment investment, have impressive forecasting power, forecasting almost half the output decline already in mid-1929. Our recursive framework also allows examination of the stability of our estimated dynamic parameters. Recursive estimates of the monetary impulse responses exhibit remarkable structural instability and strongly react to monetary regime changes during the depression. This phenomenon is discomforting in the light of the Lucas (1976) critique, as it suggests that the money/income relationship may be endogenous to policy and was not in the set of deep parameters of the US economy. Given the instability and poor predictive power of monetary instruments and the strong showing of leading indicators of real activity, we remain skeptical about a monetary interpretation of the Great Depression in the US.
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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number
2547.
Find related papers by JEL classification: C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Other Model Applications E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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Nathan Balke & Robert J. Gordon, 1986.
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National Bureau of Economic Research, Inc.
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