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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 analyze money-income causalities and predict U.S. 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 to examine 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 U.S. 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 U.S.

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Paper provided by Institute for Empirical Research in Economics - University of Zurich in its series IEW - Working Papers with number 050.

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Handle: RePEc:zur:iewwpx:050

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Keywords: money/income causality; Great Depression; recursive estimates; conditional forecasts;

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  1. 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.
  2. Mayer, Thomas, 1978. "Money and the Great Depression: A critique of professor Temin's thesis," Explorations in Economic History, Elsevier, Elsevier, vol. 15(2), pages 127-145, April.
  3. 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.
  4. Ray C. Fair & Matthew D. Shapiro & Kathryn M. Dominguez, 1986. "Forecasting the Depression: Harvard Versus Yale," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 808, Cowles Foundation for Research in Economics, Yale University.
  5. Sims, Christopher A & Uhlig, Harald, 1991. "Understanding Unit Rooters: A Helicopter Tour," Econometrica, Econometric Society, Econometric Society, vol. 59(6), pages 1591-99, November.
  6. Temin, Peter & Wigmore, Barrie A., 1990. "The end of one big deflation," Explorations in Economic History, Elsevier, Elsevier, vol. 27(4), pages 483-502, October.
  7. Hamilton, James D., 1987. "Monetary factors in the great depression," Journal of Monetary Economics, Elsevier, Elsevier, vol. 19(2), pages 145-169, March.
  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. Martin Evans & Paul Wachtel, 1992. "Were Price Changes during the Great Depression Anticipated? Evidence from Nominal Interest Rates," Working Papers, New York University, Leonard N. Stern School of Business, Department of Economics 92-12, New York University, Leonard N. Stern School of Business, Department of Economics.
  10. Edward C. Prescott, 1999. "Some observations on the Great Depression," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Win, pages 25-29.
  11. 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, Elsevier, vol. 42(1), pages 27-55, January.
  12. repec:cup:etheor:v:10:y:1994:i:3-4:p:645-71 is not listed on IDEAS
  13. Hamilton, James D, 1992. "Was the Deflation during the Great Depression Anticipated? Evidence from the Commodity Futures Market," American Economic Review, American Economic Association, American Economic Association, vol. 82(1), pages 157-78, March.
  14. Uhlig, Harald, 1994. "What Macroeconomists Should Know about Unit Roots: A Bayesian Perspective," Econometric Theory, Cambridge University Press, Cambridge University Press, vol. 10(3-4), pages 645-671, August.
  15. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, Econometric Society, vol. 48(1), pages 1-48, January.
  16. Thomas Doan & Robert B. Litterman & Christopher A. Sims, 1986. "Forecasting and conditional projection using realistic prior distribution," Staff Report, Federal Reserve Bank of Minneapolis 93, Federal Reserve Bank of Minneapolis.
  17. 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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Cited by:
  1. Barry Eichengreen, 2002. "Still Fettered After All These Years," NBER Working Papers 9276, National Bureau of Economic Research, Inc.
  2. Klaus Reiner Schenk-Hoppé & Björn Schmalfuss, . "Random Fixed Points in a Stochastic Solow Growth Model," IEW - Working Papers, Institute for Empirical Research in Economics - University of Zurich 065, Institute for Empirical Research in Economics - University of Zurich.
  3. Aleksander Berentsen & Guillaume Rocheteau, . "On the Efficiency of Monetary Exchange:How Divisibility of Money Matters," IEW - Working Papers, Institute for Empirical Research in Economics - University of Zurich 101, Institute for Empirical Research in Economics - University of Zurich.
  4. Reto Foellmi & Urs Meister, 2004. "Product-Market Competition in the Water Industry: Voluntary Nondiscriminatory Pricing," Working Papers, University of Zurich, Institute for Strategy and Business Economics (ISU) 0032, University of Zurich, Institute for Strategy and Business Economics (ISU).
  5. 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.
  6. Aleksander Berentsen & Guillaume Rocheteau, 2003. "Money and the Gains from Trade," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 44(1), pages 263-297, February.
  7. Aleksander Berentsen & Guillaume Rocheteau, . "Money and Information," IEW - Working Papers, Institute for Empirical Research in Economics - University of Zurich 099, Institute for Empirical Research in Economics - University of Zurich.
  8. Wolf, Nikolaus & Ritschl, Albrecht, 2003. "Endogeneity of Currency Areas and Trade Blocs: Evidence from the Inter-War Period," Papers, Humboldt-Universität Berlin, Center for Applied Statistics and Economics (CASE) 2004,10, Humboldt-Universität Berlin, Center for Applied Statistics and Economics (CASE).

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