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Coping with Financial Crisis:USA in the 1930s
Price FishbackUniversity of Arizona
2
Focus
• Long list of contributors to the Great Depression
• Contributions of Monetary and Fiscal Policy– To the U.S. Contraction 1929-1933– To The Recovery, 1933-1937– To the Second Dip of 1937-1938
3
1930s Monetary Policy Overview
• Mistake-filled Decade: Little Debate– Deflationary Policy in 1928-1929– Slow reactions to Bank Failures, 1930-33– Doubling of Reserve Requirements, 1936-37
• Why?– Too Much Emphasis on Gold Standard– Failure to Perceive Tightness of Policy
• Fed did not see impact of deflation on investors’ attitudes• Fed perceived many troubled banks to be unsound
• Shock Therapy by Leaving Gold Standard• How Much Causal Effect? 20-80%
4
Fiscal Policy Overview
• Keynesian Stimulus Never Tried– Large Rise in Government Spending
• Both Hoover and Roosevelt
– BUT Increases in Taxation to Match– Both Interested in Balanced Budgets
• Macro Discussion:– 1933 Rise in Spending part of Policy Shock in 1933: Reversing
Deflationary Expectations • Govt Spending Really more About Differences Across States• Most Successful Policies at Improving Welfare
– Public Works and Relief Spending on various Measures of Welfare– Farm Programs Did more Harm than Good.
5
Monetary Policy
• Friedman and Schwartz, Monetary History of the United States
• OMOs Too Little,• Too Late
6
Jan-30 Apr-30 Jul-30 Oct-30 Jan-31 Apr-31 Jul-31 Oct-31 Jan-32 Apr-32 Jul-32 Oct-32 Jan-33-100.0
0.0
100.0
200.0
300.0
400.0
500.0
Figure 1Change in FED Holdings of U.S. Securities, Value of Bank Deposits
Suspended, January 1929-December 1932
Mill
ions
of D
olla
rsBig Spikes in Failures FED waited until 1932 To Run Large Purchase of $1 Billion over 5 months
Value of DepositsSuspended OMO bond
Purchases
7
DISCOUNT RATE POLICY
Jan-29
Mar-29
May-29
Jul-29
Sep-29
Nov-29
Jan-30
Mar-30
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Discount Rate, 1929-1933
Fed Cut Rates Until after Britain left Gold in 9/31
8
Why so Recalcitrant?
• Emphasis on Gold Standard support– Offsetting Gold Flows and not enough attention
domestically– All Agree played significant role. – Countries Freed from Gold Standard Recovered
• Temin and Wigmore, Eichengreen, Kindleberger
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Jan-29 Apr-29 Jul-29 Oct-29 Jan-30 Apr-30 Jul-30 Oct-30 Jan-31 Apr-31 Jul-31 Oct-31 Jan-32 Apr-32 Jul-32 Oct-32 Jan-33-500
-400
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0
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1.5
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Figure 2FED Discount Rate, Value of Bank Deposits Suspended, Change in U.S.
Gold Stock, January 1929-December 1932
Change in U.S. Gold Stock New York Fed Discount Rate
Mill
ions
of D
olla
rs
Perc
ent
Raising DR to offset outflow Of Gold
10
Why Ignore Domestic Problems?
• Real Bills Doctrine– Let Commercial Activity and Banks Determine their needs– Weak Banks Failing
• Fed Did not recognize policy as tight.• Cut Nominal Discount Rate• Never Mention Deflation Effect on Real
Interest Rates in their Discussions
1921 1922 1923 1924 1925 1926 1927 1928 1929 19300.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00
% of Banks SuspendingPayments
% of Assets in Suspending Banks
% of Deposits Lost
1920s Fed was Used to Many Bank Suspensions of Small, undiversified unit banks, with Small
Deposit Losses
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121925 1926 1927 1928 1929 1930 1931 19320.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
8.00
9.00
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% Banks Suspended
% Assets Suspended
% Deposits Lost
In 1920s Fed Sees Many Bank Suspensions of Small, weak unit banks, Deposit Losses Very LowEven 1931 spike, little spike in Lost Deposits
13Jan
-29
Mar-29
May-29
Jul-29
Sep-29
Nov-29
Jan-30
Mar-30
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Discount Rate, 1929-1933Loose Policy Except for Rise to Offset Gold Outflows
What the Fed Saw
No Mention of Deflation Causing Real Rates to Be High
14
Jan-29
Mar-29
May-29
Jul-29
Sep-29
Nov-29
Jan-30
Mar-30
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Mar-33
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Jul-33
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Nov-33
0
2
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Real Discount Rate
Nominal Discount Rate
What the Borrowers FeltNearly TripleNext Highest Real RateAfter 1933
15
Second Dip Reserve Requirements
• Fed given control under Banking Act of 1935• In 1936 worried about overheated recovery• Banks holding excess reserves and worried if lent
them out, inflation would develop• Doubled Reserve Requirements in 3 steps
• 8/1/36, 3/1/37, 5/1/37
• Banks no trust for Fed as Lender of Last Resort• Continued to Hold Excess Reserves, Credit Dried Up
16
1919 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 193950
60
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100
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Figure 3Monthly Indices of the Money Supply, Industrial Production of
Consumer Goods, and the Consumer Price Index, (100=1923-1925
Money Supply Industrial Production/Consumer goods Consumer prices
Money Supply Blue strongly correlatedWith Real Output Red
17
Recent Estimates of Impact in DSGE models
• Build a Dynamic Stochastic General Equilibrium Model of Economy– Infinite-Lived Households choosing consumption
and assets – Firms maximize profits as hire household members– Capital accumulation process.– Add inefficiencies: sticky wages, credit limits– Choose parameters – Solve and do policy simulations
18
Consensus on Money Effects
• At a minimum it can account for 20 percent of the problems (Cole and Ohanian)
• Estimates range as high as 70-80 percent• (Bordo, Erceg, and Evans 2000; • Christiano, Motta, Restagno 2003)
• Many estimates in between • Bernanke• Chari, Kehoe, McGrattan 30-50
19
Microeconomic Evidence
• Tale of two Feds in Mississippi (Richardson/Troost)– St. Louis Real Bills– Atlanta Bagehot’s rule in panics– Fewer Bank failures in Atlanta district– Expanded wholesale sales.
William McChesney Martin, Sr.
20
Shock Therapy
• Eggertsson (2009) Temin and Wigmore (1990)• Roosevelt Broke Deflationary Expectations in
1933– Move off Gold Standard– Fed’s lower Discount Rate and OMOs– Spending more– Push for high prices– Eggertsson model claims explains 80 percent of
recovery
21
Fiscal Policy
• Hoover and Roosevelt Administrations Increased Outlays– Hoover the old-fashioned way
• Roads, rivers, harbors, flood control• Real spending up 88 percent 1929-32
– Roosevelt in many new ways • Relief, farm programs, new agencies• Real spending up 68 Percent 1933-1936, Adds another
6% from 1936-1939Tax Revenues Declined 31-33, Rose Afterward
22
1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939
-15.0
-10.0
-5.0
0.0
5.0
10.0
15.0
20.0
25.0
Figure 6Real Federal Government Outlays, Tax Revenues, and Surplus
in 1958 Dollars, 1929-1939
Real Deficit Real Government Expenditures Real Government Receipts
Revenues
Deficit
Outlays
23
Not Keynesian Stimulus
• Find Keynesian Misperception everywhere• Keynes, Alva Hansen, E. Cary Brown, Larry
Peppers all say it wasn’t• Essence shown in Figure 7
24
1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939-70.0
-60.0
-50.0
-40.0
-30.0
-20.0
-10.0
0.0
10.0
20.0
30.0
Figure 7GNP minus 1929 GNP, and Federal Expenditures, Tax Revenues, and
Budget Surplus in 1958 Dollars, 1929-1939
Real Deficit Real Government Expenditures Real Government Receipts Real GNP minus 1929 GNP
Real GDP in Year – 1929 GDP
Deficit
RevenuesOutlays
25
Real Action Was in States, Counties, Cities
• New Studies Show• 1) Don’t Treat Each Program Same
– Relief and Public Works (positive)– Farm Payments to Reduce Output (slight negative)
• 2) Some crowding out of private employment as move from 33-35 to 35-40
• 3) State Level multipliers– $1 of G leads to $0.8 to $1.4 in income. – 1.4 to 1.6 for Pub works and Relief. Neg. Farm
>
26
Tax Rate Infamy: Uncertainty Rules Day
• Smoot-Hawley Tariff• Income Tax Rate Increases in 1932
– Only Top 5-7 percent of HH paid Income Tax– Over $1 million 23.1 to 57 (to 68 in 35-36)– Income Tax Revenues Fell
• Introduced Excise Taxes on oil, pipelines, autos, bank checks, gasoline– 48 % of revenue by 1934– Alcohol Taxes
• Investment Tax with NRA• Undistributed Profits Tax• Uncertainty Ruled Day
27
Banking Problems
• State Deposit Insurance Unsuccessful in 1920s– Attracted weaker banks (adverse selection)– Insured banks took more risk (moral hazard)
• Unit banks– Not diversified enough to withstand local shocks– Explains bad balance sheets when suspended
• Banks, Margins, and Stock Crash– After 1927, New York Banks broker lending declined– Slow growth in lending by other American banks– Most broker loans from foreign banks, private individuals,
corporations
28
1930s Banking Reforms• Deposit Insurance• Glass-Steagall
– wall between investment banking and commercial banking– No too big to fail– separates riskier investments from traditional banking roles– BUT repeal of GS not seen by many analysts as current problem– Repeal Allowed Goldman and Morgan Stanley to become banks
• Regulation Q (ended 1978)– Not interest on checking, ceiling on savings interest– Way too Conservative
• Separation of S and L and commercial banks– 1980s problem: premiums too low, lax monitoring
29
1930s Summary
• Monetary Policy Mistakes– Fed was learning on the job– Too much focus on gold not enough on lender of last
resort– Fed not paying attention to deflation impact on real costs
of borrowing– Measured impact ranges from 20-70 percent depending
on model and scholar• Fiscal Deficit Policy Not Really Tried
– Real Action is in the Microeconomic Effects of Expanding Relief and Public Works
30
1930s Supply-Side Effects
• Tariffs a Disaster• 1932 Income Tax Increase
– affected less than 10 percent of Households– Most rate rises to levels not too high, BUT– Confiscatory for those over $1 million, 23 to 58 to 67%– Sharp drop in Income Tax Revenues resulted
• Real Tax Problem new Federal Excise Taxes on Leading new Industries
• Electricity, pipelines, autos, gasoline, etc• Alcohol Taxes Post-Prohibition
• 1930s Different Tax Mix, 48 % from excise taxes by 1934
31
Fed Policy Then and Now
• 1929-1932 Fed waited 3 years– as unemployment rose above 10%, then 16%, then 20%– before making a large open market purchase of $1B.
• In 2008 Fed ran – large open market operations and drove federal funds rate
close to zero – before the unemployment rate passed 7 percent
• 2009 Bought huge amounts of mortgage-backed securities
• To Avoid Second Dip, $600 Billion in QE2
32
To Prevent Shocks from Failures Borrowed New Deal Playbook
• Bernanke, Paulson, and Geithner propped up many large institutions – Bear Stearns– Fannie (a New Deal Legacy) with Freddie– AIG– RFC-style ownership stakes in banks– Bank Holiday-style Stress tests
33
Bailouts Seemed to Be Right Move
• Policy Makers Describe Fear that Whole System going down
• Guarantees Have not been costly – Except for Fannie and Freddie
• Deficits have been smaller than predicted (14% predicted, 10% actual) because half of TARP money not spent, money paid back by banks
34
Long Run Issues to Address
• Do we want the federal government heavily involved in financing economy
• Freddie and Fannie– supposedly private but ultimately backed by govt.– Major portion of the whole mortgage problem– now financing over 90 percent of all new home loans
• Bailouts create moral hazard– Banks take more risks because anticipate bailouts as
protection.
35
Modern Fiscal Policy
• New Deal was not Keynesian Policy – Deficits too small relative to size of problem
• New Policy is Keynesian. – Deficit rose from 3.3 % in 2008 to 9.9 in 2009 to
10.6 in 2010– Uncharted waters.
• Deficits as a share of GDP– twice the next highest peace-time deficit,– 3 and 4 and 5 times New Deal Deficits
36
2009 Deficit Response more like what Keynesian would have done in Depression1930s Deficit more like expected Response to 2007-2010 problems
WWI
WWII
37
Increasing Debt
• 1930s responding to Unemp range 10-25%– 10 years to increase Debt/GDP ratio by 28 points – 16% in 1929 to 44 % in 1939.
• 1907-1910 responding to Unemp range 5-10%– 3 years to increase Debt/GDP ratio by 28 points.– 36% in 1907 to 64 % in 2010
38
Did the Fiscal Stimulus Work?
• Most academic short run Macro spending multiplier estimates are in the 0.5 to 1 range– $1 of federal spending raises GDP by 50 cents to $1 with some
crowding out. Government replaces some private activity• My estimates for 1930s for U.S. states range from 0.8 to
1.4 for general spending– BUT. These would be highest estimates on record because
1930s had so many unemployed resources– No positive effect on private employment, some negative– Focus should be on the microeconomics of each specific
program and not on fiscal multiplier.
