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Depression Econometrics: A FAVAR Model of Monetary Policy During the Great Depression

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  • Ahmadi, Pooyan Amir
  • Ritschl, Albrecht

Abstract

The prominent role of monetary policy in the U.S. interwar depression has been conventional wisdom since Friedman and Schwartz [1963]. This paper presents evidence on both the surprise and the systematic components of monetary policy between 1929 and 1933. Doubts surrounding GDP estimates for the 1920s would call into question conventional VAR techniques. We therefore adopt the FAVAR methodology of Bernanke, Boivin, and Eliasz [2005], aggregating a large number of time series into a few factors and inserting these into a monetary policy VAR. We work in a Bayesian framework and apply MCMC methods to obtain the posteriors. Employing the generalized sign restriction approach toward identification of Amir Ahmadi and Uhlig [2008], we find the effects of monetary policy shocks to have been moderate. To analyze the systematic policy component, we back out the monetary policy reaction function and its response to aggregate supply and demand shocks. Results broadly confirm the Friedman/Schwartz view about restrictive monetary policy, but indicate only moderate effects. We further analyze systematic policy through conditional forecasts of key time series at critical junctures, taken with and without the policy instrument. Effects are again quite moderate. Our results caution against a predominantly monetary interpretation of the Great Depression.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7546.

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Date of creation: Nov 2009
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Handle: RePEc:cpr:ceprdp:7546

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Keywords: Bayesian FAVAR; Dynamic Factor Model; Friedman Schwartz Hypothesis; Great Depression; Monetary policy;

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References

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  1. Harold L. Cole & Lee E. Ohanian, 2001. "New Deal policies and the persistence of the Great Depression: a general equilibrium analysis," Working Papers, Federal Reserve Bank of Minneapolis 597, Federal Reserve Bank of Minneapolis.
  2. Uhlig, H.F.H.V.S., 1999. "What are the Effects of Monetary Policy on Output? Results from an Agnostic Identification Procedure," Discussion Paper, Tilburg University, Center for Economic Research 1999-28, Tilburg University, Center for Economic Research.
  3. Ben S. Bernanke & Jean Boivin & Piotr Eliasz, 2004. "Measuring the Effects of Monetary Policy: A Factor-Augmented Vector Autoregressive (FAVAR) Approach," NBER Working Papers 10220, National Bureau of Economic Research, Inc.
  4. Hamilton, James D., 1987. "Monetary factors in the great depression," Journal of Monetary Economics, Elsevier, Elsevier, vol. 19(2), pages 145-169, March.
  5. Dominguez, Kathryn M & Fair, Ray C & Shapiro, Matthew D, 1988. "Forecasting the Depression: Harvard versus Yale," American Economic Review, American Economic Association, vol. 78(4), pages 595-612, September.
  6. Harrison, Sharon G. & Weder, Mark, 2006. "Did sunspot forces cause the Great Depression?," Journal of Monetary Economics, Elsevier, Elsevier, vol. 53(7), pages 1327-1339, October.
  7. Peter Temin, 1991. "Lessons from the Great Depression," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262700441, December.
  8. Christiano, Lawrence & Motto, Roberto & Rostagno, Massimo, 2004. "The Great Depression and the Friedman-Schwartz hypothesis," Working Paper Series, European Central Bank 0326, European Central Bank.
  9. Ritschl, Albrecht & Woitek, Ulrich, 2000. "Did Monetary Forces Cause the Great Depression?," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2547, C.E.P.R. Discussion Papers.
  10. Bernanke, Ben S & Carey, Kevin, 1996. "Nominal Wage Stickiness and Aggregate Supply in the Great Depression," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 111(3), pages 853-83, August.
  11. Michael D. Bordo & Christopher J. Erceg & Charles L. Evans, 1997. "Money, sticky wages, and the Great Depression," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 591, Board of Governors of the Federal Reserve System (U.S.).
  12. Kadiyala, K Rao & Karlsson, Sune, 1997. "Numerical Methods for Estimation and Inference in Bayesian VAR-Models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 12(2), pages 99-132, March-Apr.
  13. Ben S. Bernanke & Jean Boivin, 2001. "Monetary Policy in a Data-Rich Environment," NBER Working Papers 8379, National Bureau of Economic Research, Inc.
  14. Hamilton, James D, 1992. "Was the Deflation during the Great Depression Anticipated? Evidence from the Commodity Futures Market," American Economic Review, American Economic Association, vol. 82(1), pages 157-78, March.
  15. Monique Ebell & Albrecht Ritschl, 2007. "Real Origins of the Great Depression: Monopolistic Competition, Union Power, and the American Business Cycle in the 1920s," SFB 649 Discussion Papers SFB649DP2007-006, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  16. Harold L. Cole & Lee E. Ohanian & Ron Leung, 2005. "Deflation and the International Great Depression: A Productivity Puzzle," NBER Working Papers 11237, National Bureau of Economic Research, Inc.
  17. James H. Stock & Mark W. Watson, 2005. "Implications of Dynamic Factor Models for VAR Analysis," NBER Working Papers 11467, National Bureau of Economic Research, Inc.
  18. Eric M. Leeper & Christopher A. Sims & Tao Zha, 1996. "What Does Monetary Policy Do?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(2), pages 1-78.
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Citations

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Cited by:
  1. Helmut L├╝tkepohl, 2014. "Structural Vector Autoregressive Analysis in a Data Rich Environment: A Survey," Discussion Papers of DIW Berlin 1351, DIW Berlin, German Institute for Economic Research.
  2. Dedu, Vasile & Stoica, Tiberiu, 2014. "The Impact of Monetaru Policy on the Romanian Economy," Journal for Economic Forecasting, Institute for Economic Forecasting, Institute for Economic Forecasting, vol. 0(2), pages 71-86, June.
  3. Klein, Alexander & Otsuy, Keisuke, 2013. "Efficiency, Distortions and Factor Utilization during the Interwar Period," CAGE Online Working Paper Series, Competitive Advantage in the Global Economy (CAGE) 147, Competitive Advantage in the Global Economy (CAGE).
  4. Alex Klein & Keisuke Otsu, 2013. "Efficiency, Distortions and Factor Utilization during the Interwar Period," Studies in Economics, Department of Economics, University of Kent 1317, Department of Economics, University of Kent.
  5. Harald Uhlig & Pooyan Amir Ahmadi, 2012. "Measuring The Dynamic Effects Of Monetary Policy Shocks: A Bayesian Favar Approach With Sign Restriction," 2012 Meeting Papers, Society for Economic Dynamics 1060, Society for Economic Dynamics.
  6. Amir-Ahmadi, Pooyan & Matthes, Christian & Wang, Mu-Chun, 2014. "Drifts, Volatilities, and Impulse Responses Over the Last Century," Working Paper, Federal Reserve Bank of Richmond 14-10, Federal Reserve Bank of Richmond.

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