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Prices during the Great Depression: Was the Deflation of 1930-32 really unanticipated?

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  • Stephen G. Cecchetti

Abstract

Several explanations for the depth of the Great Depression presume that the -30% deflation of 1930-32 was unanticipated. For example, the debt-deflation hypothesis originally put forth by Irving Fisher is based on the notion that unanticipated deflation increases the burden of nominal debt, adversely affecting the banking system and the aggregate economy. Other theories imply on ex ante real interest rates being low during the period, and so it is essential that the deflation was unanticipated. This paper measures inflationary expectations from data on prices, interest rates and money growth in order to investigate whether the deflation could have been anticipated. Current econometric techniques are used to compute expectations implied both by the univariate time series properties of the price level, and by the information contained in nominal interest rates. The major conclusion is that price changes were substantially serially correlated, and so once the deflation began, people expected it to continue. This implies both that the deflation was anticipated, and that real interest rates were very high during the initial phases of the Great Depression. These results call into question the validity of theories that rely on contemporary agents' belief in reflation during the early 1930s, and provide further support for the proposition that monetary contraction was the driving force behind the economic decline.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3174.

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Date of creation: Nov 1989
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Publication status: published as American Economic Review, Vol. 82, No. 1, March 1992, pp. 141-156.
Handle: RePEc:nbr:nberwo:3174

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  1. Barsky, Robert B., 1987. "The Fisher hypothesis and the forecastability and persistence of inflation," Journal of Monetary Economics, Elsevier, Elsevier, vol. 19(1), pages 3-24, January.
  2. Lucas, Robert E, Jr & Rapping, Leonard A, 1969. "Real Wages, Employment, and Inflation," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 77(5), pages 721-54, Sept./Oct.
  3. Mishkin, Frederic S., 1981. "The real interest rate: An empirical investigation," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 15(1), pages 151-200, January.
  4. Hansen, Lars Peter & Hodrick, Robert J, 1980. "Forward Exchange Rates as Optimal Predictors of Future Spot Rates: An Econometric Analysis," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 88(5), pages 829-53, October.
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  7. Cecchetti, Stephen G, 1988. "The Case of the Negative Nominal Interest Rates: New Estimates of the Term Structure of Interest Rates during the Great Depression," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 96(6), pages 1111-41, December.
  8. Huizinga, John & Mishkin, Frederic S., 1986. "Monetary policy regime shifts and the unusual behavior of real interest rates," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 24(1), pages 231-274, January.
  9. Dominguez, Kathryn M & Fair, Ray C & Shapiro, Matthew D, 1988. "Forecasting the Depression: Harvard versus Yale," American Economic Review, American Economic Association, American Economic Association, vol. 78(4), pages 595-612, September.
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  11. N. Gregory Mankiw & Jeffrey A. Miron, 1985. "The Changing Behavior of the Term Structure of Interest Rates," NBER Working Papers 1669, National Bureau of Economic Research, Inc.
  12. Brown, Stephen J & Dybvig, Philip H, 1986. " The Empirical Implications of the Cox, Ingersoll, Ross Theory of the Term Structure of Interest Rates," Journal of Finance, American Finance Association, American Finance Association, vol. 41(3), pages 617-30, July.
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  14. Hamilton, James D., 1987. "Monetary factors in the great depression," Journal of Monetary Economics, Elsevier, Elsevier, vol. 19(2), pages 145-169, March.
  15. Bordo, Michael David & Ellson, Richard Wayne, 1985. "A model of the classical gold standard with depletion," Journal of Monetary Economics, Elsevier, Elsevier, vol. 16(1), pages 109-120, July.
  16. Dickey, David A & Fuller, Wayne A, 1981. "Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root," Econometrica, Econometric Society, Econometric Society, vol. 49(4), pages 1057-72, June.
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