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Was the New Deal contractionary?

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  • Gauti B. Eggertsson

Abstract

Can government policies that increase the monopoly power of firms and the militancy of unions increase output? This paper studies this question in a dynamic general equilibrium model with nominal frictions and shows that these policies are expansionary when certain "emergency" conditions apply. I argue that these emergency conditions-zero interest rates and deflation-were satisfied during the Great Depression in the United States. Therefore, the New Deal, which facilitated monopolies and union militancy, was expansionary, according to the model. This conclusion is contrary to the one reached by Cole and Ohanian, who argue that the New Deal was contractionary. The main reason for this divergence is that the current model incorporates nominal frictions so that inflation expectations play a central role in the analysis. The New Deal has a strong effect on inflation expectations in the model, changing excessive deflation to modest inflation, thereby lowering real interest rates and stimulating spending.

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  • Gauti B. Eggertsson, 2006. "Was the New Deal contractionary?," Staff Reports 264, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednsr:264
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    Keywords

    Financial crises ; Depressions ; Inflation (Finance) ; Economic forecasting;

    JEL classification:

    • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • J51 - Labor and Demographic Economics - - Labor-Management Relations, Trade Unions, and Collective Bargaining - - - Trade Unions: Objectives, Structure, and Effects

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