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The great depression and the Friedman-Schwartz hypothesis

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Author Info
Lawrence Christiano () (Department of Economics, Northwestern University, 2001 Sheridan Road, Evanston, Illinois 60208, USA)
Roberto Motto () (European Central Bank, Kaiserstr. 29, D-60311 Frankfurt am Main, Germany)
Massimo Rostagno () (European Central Bank, Kaiserstr. 29, D-60311 Frankfurt am Main, Germany)

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Abstract

We evaluate the Friedman-Schwartz hypothesis that a more accommodative monetary policy could have greatly reduced the severity of the Great Depression. To do this, we first estimate a dynamic, general equilibrium model using data from the 1920s and 1930s. Although the model includes eight shocks, the story it tells about the Great Depression turns out to be a simple and familiar one. The contraction phase was primarily a consequence of a shock that induced a shift away from privately intermediated liabilities, such as demand deposits and liabilities that resemble equity, and towards currency. The slowness of the recovery from the Depression was due to a shock that increased the market power of workers. We identify a monetary base rule which responds only to the money demand shocks in the model. We solve the model with this counterfactual monetary policy rule. We then simulate the dynamic response of this model to all the estimated shocks. Based on the model analysis, we conclude that if the counterfactual policy rule had been in place in the 1930s, the Great Depression would have been relatively mild.

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Paper provided by European Central Bank in its series Working Paper Series with number 326.

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Length: 104 pages
Date of creation: Mar 2004
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Handle: RePEc:ecb:ecbwps:20040326

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Related research
Keywords: General equilibrium; Lower bound; Deflation; Shocks;

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Find related papers by JEL classification:
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
N12 - Economic History - - Macroeconomics and Monetary Economics; Growth and Fluctuations - - - U.S.; Canada: 1913-

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