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Did Monetary Forces Cause the Great Depression? A Bayesian VAR Analysis for the U.S. Economy

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  • Albrecht Ritschl
  • Ulrich Woitek

Abstract

This paper recasts Temin's (1976) question of whether monetary forces caused the Great Depression in a modern time series framework. We adopt a Bayesian estimation and forecasting algorithm to evaluate the e ects of monetary policy against nonmonetary alternatives, allowing for time-varying parameters and coeffcient updating. We nd that the predictive power of monetary policy is very small for the early phase of the depression and breaks down almost entirely after 1931. During the propagation phase of 1930-31, monetary policy is able to forecast correctly at short time horizons put in- variably predicts recovery at longer horizons. Con rming Temin (1976), we nd that nonmonetary leading indicators, particularly on residential construc- tion and equipment investment, have impressive predictive power. Already in September 1929, they forecast about two thirds of downturn correctly. Our time varying framework also permits us to examine the stability of the dy- namic parameter structure of our estimates. We nd that the monetary im- pulse responses exhibit remarkable structural instability and react clearly to changes in the monetary regime that occurred during the depression. We nd this phenomenon to be discomforting in the light of the Lucas (1976) critique, as it suggests that the money/income relationship may itself have been en- dogenous to policy and was not in the set of deep parameters of the U.S. economy. Given the instability and poor predictive power of monetary instru- ments and the strong showing of leading indicators on real activity, we remain skeptical with regard to a monetary interpretation of the Great Depression in the U.S.

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Bibliographic Info

Paper provided by Business School - Economics, University of Glasgow in its series Working Papers with number 2000_07.

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Date of creation: Jun 2000
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Handle: RePEc:gla:glaewp:2000_07

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  1. Edward C. Prescott, 1999. "Some observations on the Great Depression," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 25-29.
  2. Klug, Adam & Landon-Lane, John S. & White, Eugene N., 2005. "How could everyone have been so wrong? Forecasting the Great Depression with the railroads," Explorations in Economic History, Elsevier, vol. 42(1), pages 27-55, January.
  3. Temin, Peter & Wigmore, Barrie A., 1990. "The end of one big deflation," Explorations in Economic History, Elsevier, vol. 27(4), pages 483-502, October.
  4. Uhlig, Harald, 1994. "What Macroeconomists Should Know about Unit Roots: A Bayesian Perspective," Econometric Theory, Cambridge University Press, vol. 10(3-4), pages 645-671, August.
  5. repec:cup:etheor:v:10:y:1994:i:3-4:p:645-71 is not listed on IDEAS
  6. Mayer, Thomas, 1978. "Money and the Great Depression: A critique of professor Temin's thesis," Explorations in Economic History, Elsevier, vol. 15(2), pages 127-145, April.
  7. Sims, Christopher A & Uhlig, Harald, 1991. "Understanding Unit Rooters: A Helicopter Tour," Econometrica, Econometric Society, vol. 59(6), pages 1591-99, November.
  8. Nathan Balke & Robert J. Gordon, 1986. "Appendix B Historical Data," NBER Chapters, in: The American Business Cycle: Continuity and Change, pages 781-850 National Bureau of Economic Research, Inc.
  9. Thomas Doan & Robert B. Litterman & Christopher A. Sims, 1983. "Forecasting and Conditional Projection Using Realistic Prior Distributions," NBER Working Papers 1202, National Bureau of Economic Research, Inc.
  10. Hamilton, James D., 1987. "Monetary factors in the great depression," Journal of Monetary Economics, Elsevier, vol. 19(2), pages 145-169, March.
  11. Ray C. Fair & Matthew D. Shapiro & Kathryn M. Dominguez, 1989. "Forecasting the Depression: Harvard Versus Yale," NBER Working Papers 2095, National Bureau of Economic Research, Inc.
  12. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
  13. Ben S. Bernanke, 1983. "Non-Monetary Effects of the Financial Crisis in the Propagation of the Great Depression," NBER Working Papers 1054, National Bureau of Economic Research, Inc.
  14. 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.
  15. Robert J. Gordon & James A. Wilcox, 1978. "Monetarist Interpretations of the Great Depression: An Evaluation and Critique," NBER Working Papers 0300, National Bureau of Economic Research, Inc.
  16. 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.
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Cited by:
  1. Barry Eichengreen, 2002. "Still Fettered After All These Years," NBER Working Papers 9276, National Bureau of Economic Research, Inc.
  2. Aleksander Berentsen & Guillaume Rocheteau, . "Money and the Gains from Trade," IEW - Working Papers 100, Institute for Empirical Research in Economics - University of Zurich.
  3. Alex Klein & Keisuke Otsu, 2013. "Efficiency, Distortions and Factor Utilization during the Interwar Period," Studies in Economics 1317, Department of Economics, University of Kent.
  4. Wolf, Nikolaus & Ritschl, Albrecht, 2003. "Endogeneity of Currency Areas and Trade Blocs: Evidence from the Inter-War Period," Papers 2004,10, Humboldt-Universität Berlin, Center for Applied Statistics and Economics (CASE).
  5. Aleksander Berentsen & Guillaume Rocheteau, 2004. "Money and Information," Review of Economic Studies, Wiley Blackwell, vol. 71(4), pages 915-944, October.
  6. Aleksander Berentsen & Guillaume Rocheteau, . "On the Efficiency of Monetary Exchange:How Divisibility of Money Matters," IEW - Working Papers 101, Institute for Empirical Research in Economics - University of Zurich.
  7. Schenk-Hoppe, Klaus Reiner & Schmalfu[ss], Bjorn, 2001. "Random fixed points in a stochastic Solow growth model," Journal of Mathematical Economics, Elsevier, vol. 36(1), pages 19-30, September.
  8. Klein, Alexander & Leunig, Tim, 2013. "Gibrat’s Law and the British Industrial Revolution," CAGE Online Working Paper Series 146, Competitive Advantage in the Global Economy (CAGE).
  9. Reto Foellmi & Urs Meister, 2004. "Product-Market Competition in the Water Industry: Voluntary Nondiscriminatory Pricing," Working Papers 0032, University of Zurich, Institute for Strategy and Business Economics (ISU).

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