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Did Monetary Forces Cause the Great Depression?

  • Ritschl, Albrecht
  • Woitek, Ulrich

This paper recasts Temin's (1976) question of whether monetary forces caused the Great Depression in a modern time series framework. We analyse money-income causalities and predict US 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 examination of 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 US 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 US.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2547.

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Date of creation: Sep 2000
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Handle: RePEc:cpr:ceprdp:2547
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  1. Eugene N. White & John Landon-Lane & Adam Klug, 2002. "How Could Everyone Have Been So Wrong? Forecasting The Great Depression With The Railroads," Departmental Working Papers 200209, Rutgers University, Department of Economics.
  2. 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.
  3. repec:cup:etheor:v:10:y:1994:i:3-4:p:645-71 is not listed on IDEAS
  4. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
  5. Sims, Christopher A & Uhlig, Harald, 1991. "Understanding Unit Rooters: A Helicopter Tour," Econometrica, Econometric Society, vol. 59(6), pages 1591-99, November.
  6. 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.
  7. 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.
  8. Dominguez, Kathryn M & Fair, Ray C & Shapiro, Matthew D, 1988. "Forecasting the Depression: Harvard versus Yale," American Economic Review, American Economic Association, vol. 78(4), pages 595-612, September.
  9. 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.
  10. Martin Evans & Paul Wachtel, 1992. "Were Price Changes during the Great Depression Anticipated? Evidence from Nominal Interest Rates," Working Papers 92-12, New York University, Leonard N. Stern School of Business, Department of Economics.
  11. 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.
  12. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
  13. 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.
  14. 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.
  15. Hamilton, James D., 1987. "Monetary factors in the great depression," Journal of Monetary Economics, Elsevier, vol. 19(2), pages 145-169, March.
  16. Edward C. Prescott, 1999. "Some observations on the Great Depression," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 25-29.
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