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Deflation, Real Wages, and the International Great Depression: A Productivity Puzzle

Author

Listed:
  • Ron Leung
  • Harold L. Cole
  • Lee E. Ohanian

Abstract

The high real wage story is one of the leading hypotheses for how deflation caused the International Great Depression. The story is that world-wide deflation, combined with incomplete nominal wage adjustment, raised real wages in a number of countries, and these higher real wages reduced employment as firms moved up their labor demand curves. This paper studies the high real wage hypothesis in an international cross section of 17 countries between 1930-33 using dynamic, general equilibrium monetary models. We find that the high real wage story by itself does not account for output changes in the international cross section. The models make large errors predicting output in the international cross section, largely because the correlation between real wages and output in the models is -1, while this correlation is positive in the data. This means that the world-wide Depression was not just firms moving up their labor demand curves in response to high real wages. Instead, accounting for the Depression requires a shock that shifts labor demand curves differentially across countries. We add productivity shocks to the model as a candidate labor demand shifter. We find that the productivity shocks in the model are very similar to productivity changes in the data. We also find that productivity shocks account for about 2/3 of output changes, while monetary shocks account for about 1/3 of output changes

Suggested Citation

  • Ron Leung & Harold L. Cole & Lee E. Ohanian, 2004. "Deflation, Real Wages, and the International Great Depression: A Productivity Puzzle," Econometric Society 2004 North American Winter Meetings 75, Econometric Society.
  • Handle: RePEc:ecm:nawm04:75
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    Citations

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    Cited by:

    1. Andrew Atkeson & Patrick J. Kehoe, 2004. "Deflation and Depression: Is There an Empirical Link?," American Economic Review, American Economic Association, vol. 94(2), pages 99-103, May.
    2. Ester Faia & Alessia Campolmi, 2005. "Inflation Differentials and Different Labor Market Institutions in the EMU," Money Macro and Finance (MMF) Research Group Conference 2005 80, Money Macro and Finance Research Group.
    3. Jeremy Greenwood & Ananth Seshadri & Guillaume Vandenbroucke, 2005. "The Baby Boom and Baby Bust," American Economic Review, American Economic Association, vol. 95(1), pages 183-207, March.
    4. Lawrence J. Christiano & Roberto Motto & Massimo Rostagno, 2003. "The Great Depression and the Friedman-Schwartz hypothesis," Proceedings, Federal Reserve Bank of Cleveland, pages 1119-1215.
    5. Luca Pensieroso, 2007. "Real Business Cycle Models Of The Great Depression: A Critical Survey," Journal of Economic Surveys, Wiley Blackwell, vol. 21(1), pages 110-142, February.
    6. Christiano, Lawrence & Motto, Roberto & Rostagno, Massimo, 2004. "The Great Depression and the Friedman-Schwartz hypothesis," Working Paper Series 326, European Central Bank.
    7. Barry Eichengreen, 2002. "Still Fettered After All These Years," NBER Working Papers 9276, National Bureau of Economic Research, Inc.

    More about this item

    Keywords

    Great Depression; monetary shocks; productivity;

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles

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