Hayek Explains Why He Did Not Challenge Keynes’ General Theory
03 Sep 2014 Leave a comment
in Austrian economics, business cycles, F.A. Hayek, fiscal policy, great depression, macroeconomics Tags: FA Hayek, General Theory, Keynes
Eugene Fama and the simulative effects of fiscal policy
31 Jul 2014 6 Comments
in budget deficits, fiscal policy, great depression, great recession, macroeconomics Tags: crowding out, Eugene Fama, fiscal policy, Treasury view of fiscal policy
Eugene Fama argues that government bailouts and stimulus plans seem attractive when there are idle resources – when there is unemployment such as in a recession or depression including in the 1930s.
Fama counters that:
1. Bailouts and stimulus plans must be financed.
2. If the financing takes the form of additional government debt, the added debt displaces other uses of the funds.
3. Thus, stimulus plans only enhance incomes when they move resources from less productive to more productive uses.
In the end, despite the existence of idle resources, bailouts and stimulus plans do not add to current resources in use. They just move resources from one use to another.
Fama noted that there was just one valid negative comment in response to this argument that appears to be valid which was made by Brad DeLong.
Fama thinks Delong’s point about involuntary inventory accumulation is consistent with Fama’s initial arguments about the need for the stimulus to work through moving resources to higher value uses.
For me, the notion that a fiscal stimulus is a negative productivity shock is a good starting point for analysis. The method of financing the stimulus is important too.
Economic agents know that a temporary expenditure program has no lasting effect on employment but has lasting effect on disposable income and taxes. Indeed, massive public interventions to maintain employment and investment during a financial crisis can, if they distort incentives enough, lead to a depression.
In Australia, there was a massive fiscal contraction from late 1930 onwards called the Premiers’ Plan. In 1931, unemployment rates was 25% or more.
- The Premiers’ Plan required the federal and state governments to cut spending by 20%, including cuts to wages and pensions and was to be accompanied by tax increases, reductions in interest on bank deposits and a 22.5% reduction in the interest the government paid on internal loans.
- The Premiers’ Plan was complementary to the Arbitration Court’s 10 per cent nominal wage cut in January 1931 and the devaluation of the Australian pound. Most countries had abandoned the gold standard by 1931 and 1932 and devalued by about 10% including the UK. These competitive devaluations were called currency wars. Most countries below started to recovery before they left the gold standard, a year or two before they left the cross of gold.
Maclaren (1936) dated the Australian economic recovery from the last months of 1932. It was to take another three years before unemployment rates fell below 10 per cent — the rate it had been during most of the 1920s.
The June 1931 Premiers’ Plan of fiscal consolidation had time by late 1932 to become credible and take hold given the usual leads and lag on fiscal policy. Unemployment data for the time show a rapid fall in the high twenties unemployment rate in 1932 to be below 10 per cent by 1937.
Milton Friedman on the onset of the Great Depression from the standpoint of 1930s macroeconomics
11 Jul 2014 Leave a comment
A different view of the start of Great Depression | Lee Ohanian
19 Jun 2014 Leave a comment
in great depression, macroeconomics Tags: great depression, Lee Ohanian, Milton Friedman
Friedman and Schwartz argue that the great depression was caused by a collapse of the money supply due to the negligence of the Fed that turned what should have been a garden-variety recession that started in late 1929.
Lee Ohanian argues that there was a steep industrial decline in the USA in 1929 began before monetary contractions or banking panics in 1930 and 1933. The figure below shows manufacturing industry hours worked between January 1929 and September 1930, and measures of the money stock from Friedman and Schwartz corresponding to M1 and M2. Manufacturing industry hours decline substantially and abruptly in late 1929 while money supply fall only about 4% and 1%, respectively.
This sharp decline in the manufacturing sector (a decline of nearly 30% by the fall of 1930 )began before monetary contraction or banking panics – the conventional culprits:
- There are no significant banking panics in 1929 and 1930. The banking panics in the great depression were mostly in 1933 and in 1934.
- Manufacturing hours worked had already fallen by 30% against trend by the time of the first banking panics in 1931, and these first banking panics had minor macroeconomic effects.
The data in the above figure shows that a factor other than monetary contractions or bank runs were central to the onset of the Great Depression.
Nominal wages declined by little during the early stages of the Depression. in September 1931 nominal wage rates were 92 per cent of their level two years earlier. Since a significant price deflation had occurred during these two years, real wages rose by 10 per cent during the same period, while gross domestic product fell by 27 per cent.
With a substantial depression in employment mostly in the manufacturing sector, any explanation of the onset of the great depression in the United States must start with an explanation of why the labour market failed to clear in that sector, why manufacturing decline was so immediately severe before significant monetary contraction and banking panics, why the Depression was so asymmetric across sectors, and provide a theory for why industrial sector wages were persistently well above their market-clearing level.
Just to make it harder for you,nominal wages in the agricultural sector will fell by 40% over the same period in which wages in the manufacturing sector did not fall to all. As Ohanian notes:
The Depression was the first time in the history of the US that wages did not fall during a period of significant deflation.”
Any explanation based on wage rigidity or sluggish wage adjustment or employee resistance to wage cuts must explain why this resistance was so effective in the manufacturing sector but so ineffective in the agricultural sector. Ohanian concluded that:
…the Depression is the consequence of government programs and policies, including those of Hoover, that increased labour’s ability to raise wages above their competitive levels.
Lee Ohanian: Hoover, Roosevelt and the Great Depression
03 Apr 2014 Leave a comment
in global financial crisis (GFC), great depression, regulation
Lessons from how Australia came out of the Great Depression-updated
31 Mar 2014 Leave a comment
in great depression, macroeconomics, politics - Australia, politics - New Zealand Tags: fiscal austerity, great recession, New Deal, Premiers' Plan
How Australia got out of the Great Depression in the 1930s could have lessons for today, for the global financial crisis and the Great Recession. In Australia, the massive fiscal contraction from late 1930 onwards was called the Premiers’ Plan. In 1931, unemployment rates was 25% or more.
The Premiers’ Plan required the federal and state governments to cut spending by 20%, including cuts to wages and pensions and was to be accompanied by tax increases, reductions in interest on bank deposits and a 22.5% reduction in the interest the government paid on internal loans.
The Premiers’ Plan was complementary to the Arbitration Court’s 10 per cent nominal wage cut in January 1931 and the devaluation of the Australian pound. Most countries had abandoned the gold standard by 1931 and 1932 and devalued by about 10% including the UK. These competitive devaluations were called currency wars. Most countries below started to recovery before they left the gold standard, a year or two before they left the cross of gold.
Real GDP and dates of exit from gold standard
Sources: GGDC‑Maddison International Historical Database (http://www.ggdc.net/Maddison/), Bernanke et al. 1990; Gruen and Clark 2009.
The New Zealand Government also cut everything that could be cut by 20% in 1931.
Maclaren (1936) dated the Australian economic recovery from the last months of 1932. It was to take another three years before unemployment rates fell below 10 per cent — the rate it had been during most of the 1920s.
The June 1931 Premiers’ Plan of fiscal consolidation had time by late 1932 to become credible and take hold given the usual leads and lag on fiscal policy.
Unemployment data in the 2001 Australian yearbook of the Australian Bureau of Statistics graphed below shows a rapid fall in the high twenties unemployment rate in 1932 to be below 10 per cent by 1937. This fall started just after the 1931 Premiers’ Plan of fiscal consolidation.
Australian unemployment was 7.5 per cent in 1938, which is the long-term average for the period 1906 to 1929. The USA had an unemployment rate twice that in 1938 and was coming out of a double dip great depression.
Australia and New Zealand came out of the Depression earlier than most other countries because of the fiscal austerity under the Premiers’ Plan. The New Deal prolonged the great depression in the USA.
For those that doubt, how much lower would have been the Australian unemployment rate between 1932 and 1937 but for the fiscal contraction? What is your counter-factual? The role of fiscal policy in Australia in the 1930s is rather under-studied in Keynesian macroeconomics. Why?
The fiscal consolidation in the Premiers’ Plan removed fears of even harsher future taxes, stabilised expectations, increased consumers’ expected disposable incomes, and increased investor confidence and therefore stimulated private investment. See Keynes’ 1932 letter where he says
I am sure the Premiers’ Plan last year saved the economic structure of Australia.
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