The End of One Big Deflation

1. The End of One Big Deflation Peter Temin and Barrie A. Wigmore

2. Introduction • Explanation for the US recovery from the Great Depression in the second quarter of 1933 • Explanation relies on Sargent’s (1983) model of changes in policy regimes • Friedman and Schwartz claim “the reopening of the banks was followed by a rapid spurt in personal income and industrial production” • This was not cause for recovery…

3. National Industrial Recovery act anticipated higher costs and prices which led to a rise in the money supply • Temin and Wigmore argue that the supply of money did not rise at the turning point of the Depression. • Devaluation of the currency was key to the turning point leading to recovery • More importantly, a change in expectations brought about recovery, but how?

4. Sargent’s explanation • “the key to a costless stabilization was the establishment of a new policy regime” • “immediate effects were through rapidly revised expectations” • “changing expectations were the key to stabilization”

5. 1933 • Hoover supported the gold standard—devaluation was not an option • Roosevelt devalued the dollar within 6 weeks of inauguration • Devaluation had effects on prices and production throughout the economy

6. Theory Before FDR • Economic actors expected continued contraction • People expected continued deflation because of government’s monetary and fiscal policies warranted those expectations • Required a change in the policy regime--taking action FDR • That action was devaluation • Signaled the abandonment of the gold standard • It had expansionary effects on American industry

7. Historical Narrative • Hoover Administration • Supported Gold Standard • Focused on efforts to bolster credit markets rather than the economy directly • RFC • Relief of financial institutions to promote investment

8. Tests • Stock market a good index of expectations • Value of stock prices rise because of expected inflation • “change in expectations, therefore, stimulated business investment and expenditures on consumer durables, not consumption”

9. $/pound Producer Price Index

10. Devaluation • Roosevelt restricted gold transactions in March 1933 • Grain and cotton prices rose as the value of the dollar fell, farmers had higher incomes • Rise in the demand for automobiles encouraged a rise in auto production, steel production, and industrial production • Inflationary expectations caused a shift in asset holding

11. Conclusion • Successful “reflationary” policy • “A dramatic shift in the policy regime had dramatic effects on the economy” • Temin and Wigmore suggest that if Hoover would have done what FDR did, the economy would have recovered earlier