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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. Temin, Peter & Wigmore, Barrie A., 1990. "The end of one big deflation," Explorations in Economic History, Elsevier, vol. 27(4), pages 483-502, October.
  3. Bernanke, Ben S, 1983. "Nonmonetary Effects of the Financial Crisis in Propagation of the Great Depression," American Economic Review, American Economic Association, vol. 73(3), pages 257-76, June.
  4. Ray C. Fair & Matthew D. Shapiro & Kathryn M. Dominguez, 1986. "Forecasting the Depression: Harvard Versus Yale," NBER Working Papers 2095, National Bureau of Economic Research, Inc.
  5. Evans, Martin & Wachtel, Paul, 1993. "Were price changes during the Great Depression anticipated? : Evidence from nominal interest rates," Journal of Monetary Economics, Elsevier, vol. 32(1), pages 3-34, August.
  6. Christopher A. Sims & Harald Uhlig, 1988. "Understanding unit rooters: a helicopter tour," Discussion Paper / Institute for Empirical Macroeconomics 4, Federal Reserve Bank of Minneapolis.
  7. 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.
  8. Thomas Doan & Robert B. Litterman & Christopher A. Sims, 1986. "Forecasting and conditional projection using realistic prior distribution," Staff Report 93, Federal Reserve Bank of Minneapolis.
  9. 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.
  10. 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.
  11. 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.
  12. 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.
  13. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
  14. Hamilton, James D., 1987. "Monetary factors in the great depression," Journal of Monetary Economics, Elsevier, vol. 19(2), pages 145-169, March.
  15. Edward C. Prescott, 1999. "Some observations on the Great Depression," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 25-29.
  16. repec:cup:etheor:v:10:y:1994:i:3-4:p:645-71 is not listed on IDEAS
  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. 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.
  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. Barry Eichengreen, 2002. "Still Fettered After All These Years," NBER Working Papers 9276, National Bureau of Economic Research, Inc.
  4. 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.
  5. 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).
  6. repec:cge:warwcg:146 is not listed on IDEAS
  7. Alex Klein & Keisuke Otsu, 2013. "Efficiency, Distortions and Factor Utilization during the Interwar Period," Studies in Economics 1317, Department of Economics, University of Kent.
  8. Aleksander Berentsen & Guillaume Rocheteau, . "Money and Information," IEW - Working Papers 099, Institute for Empirical Research in Economics - University of Zurich.
  9. Reto Föllmi & Urs Meister, . "Product-Market Competition in the Water Industry: Voluntarily Nondiscriminatory Pricing," IEW - Working Papers 115, Institute for Empirical Research in Economics - University of Zurich.

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