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Deflation and the International Great Depression: A Productivity Puzzle

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

Abstract

This paper develops the first dynamic, stochastic, general equilibrium analysis of the International Great Depression. We construct a new version of Lucas?s (1972) monetary misperceptions model, with a real shock (productivity) and a nominal shock (money supply). We use the model with a newly assembled panel data set from 17 countries between 1929-33 to quantify the fraction of output change and price change that is accounted for by these two shocks. Data limitations require us to develop a new procedure for identifying the two shocks. The identified productivity shock has a large country-specific component, and is highly correlated with actual productivity. The identified monetary shock has a large common component, and is highly correlated with money supply changes. We find that the model accounts for most of the variation in macroeconomic activity in the panel of countries. About 2/3 of output change is accounted for by the real (productivity) shock, and virtually all of the change in nominal prices is accounted for by the nominal (money supply) shock. The only variable we find that is highly correlated with the productivity shock is stock prices. We conclude that financial friction models are potentially the most promising class of models for understanding the Solow Residual during this period, and thus the Great Depression.

Suggested Citation

  • Harold L. Cole & Lee E. Ohanian & Ron Leung, 2005. "Deflation and the International Great Depression: A Productivity Puzzle," NBER Working Papers 11237, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:11237
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    Cited by:

    1. AKIYOSHI Fumio & KOBAYASHI Keiichiro, 2007. "Bank Distress and Productivity of Borrowing Firms: Evidence from Japan," Discussion papers 07014, Research Institute of Economy, Trade and Industry (RIETI).
    2. Price Fishback, 2010. "US monetary and fiscal policy in the 1930s," Oxford Review of Economic Policy, Oxford University Press, vol. 26(3), pages 385-413, Autumn.
    3. Gregor W. Smith, 2006. "The spectre of deflation: a review of empirical evidence," Canadian Journal of Economics, Canadian Economics Association, vol. 39(4), pages 1041-1072, November.
    4. Albrecht Ritschl & Monique Ebell, 2007. "Real Origins of the Great Depression: Monopoly Power, Unions and the American Business Cycle in the 1920s," 2007 Meeting Papers 712, Society for Economic Dynamics.
    5. Keiichiro Kobayashi & Noriyuki Yanagawa, 2007. "Bank Distress and the Borrowers' Productivity," CIRJE F-Series CIRJE-F-521, CIRJE, Faculty of Economics, University of Tokyo.
    6. Heer, Burkhard & Schubert, Stefan Franz, 2012. "Unemployment and debt dynamics in a highly indebted small open economy," Journal of International Money and Finance, Elsevier, vol. 31(6), pages 1392-1413.
    7. Klein, Alexander & Otsuy, Keisuke, 2013. "Efficiency, Distortions and Factor Utilization during the Interwar Period," CAGE Online Working Paper Series 147, Competitive Advantage in the Global Economy (CAGE).
    8. Pedro S. Amaral & James C. MacGee, 2012. "Re-Examining the Role of Sticky Wages in the U.S. Great Contraction: A Multi-sector Approach," University of Western Ontario, Economic Policy Research Institute Working Papers 20125, University of Western Ontario, Economic Policy Research Institute.
    9. Schubert, Stefan F., 2011. "The effects of total factor productivity and export shocks on a small open economy with unemployment," Journal of Economic Dynamics and Control, Elsevier, vol. 35(9), pages 1514-1530, September.
    10. Alex Klein & Keisuke Otsu, 2013. "Efficiency, Distortions and Factor Utilization during the Interwar Period," Studies in Economics 1317, School of Economics, University of Kent.
    11. Christian Alexander Belabed, 2015. "Income Distribution and the Great Depression," IMK Working Paper 153-2015, IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute.
    12. Fabien Tripier, 2009. "Elasticity of factor substitution and the rise in labor's share of income during the Great Depression," Working Papers hal-00419343, HAL.
    13. Ahmadi, Pooyan Amir & Ritschl, Albrecht, 2009. "Depression Econometrics: A FAVAR Model of Monetary Policy During the Great Depression," CEPR Discussion Papers 7546, C.E.P.R. Discussion Papers.
    14. Luca Pensieroso, 2011. "The Great Depression in Belgium from a Neoclassical Perspective," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 14(2), pages 389-402, Arpil.
    15. Carapella, Francesca, 2015. "Banking panics and deflation in dynamic general equilibrium," Finance and Economics Discussion Series 2015-18, Board of Governors of the Federal Reserve System (U.S.).
    16. KOBAYASHI Keiichiro & YANAGAWA Noriyuki, 2008. "Banking Crisis and Borrower Productivity," Discussion papers 08003, Research Institute of Economy, Trade and Industry (RIETI).
    17. Ebell, Monique & Ritschl, Albrecht, 2007. "Real Origins of the Great Depression: Monopolistic Competition, Union Power, and the American Business Cycle in the 1920s," CEPR Discussion Papers 6146, C.E.P.R. Discussion Papers.
    18. repec:eee:moneco:v:92:y:2017:i:c:p:112-129 is not listed on IDEAS
    19. Satyajit Chatterjee & Dean Corbae, 2006. "Monetary and financial forces in the Great Depression," Working Papers 06-12, Federal Reserve Bank of Philadelphia.

    More about this item

    JEL classification:

    • E0 - Macroeconomics and Monetary Economics - - General
    • N1 - Economic History - - Macroeconomics and Monetary Economics; Industrial Structure; Growth; Fluctuations

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