Gauti Eggertsson

1. GautiEggertsson Was the New Deal (= NIRA) Contractionary? A world of • Monopoly power • Sticky prices and wages • Deflationary shocks • Zero lower bound (ZLB) NIRA (a supply restriction) reduced “natural output” but increased actual output.

2. Borrowed Slides

3. Cole and Ohanianfind a possible answer to the weak recovery in the cartelization of the US manufacturing sector. • This arose out of the creation of the NIRA • Individual firms could not set prices below cartel established floors • If they did other cartel firms would exert pressure and the NIRA chief would publicly berate the “offending” firm • Manufacturing wages were set in the same political/administrative manner.

4. Cole and Ohanian postulate that qualitatively this shock (NIRA) seems promising in explaining why output was so much and so consistently below trend from 1934-1939. • Eggertsson berates them for ignoring the “mistake of 1937” which had nothing to do with NIRA • Eggertssonberates them for assuming 1929 output was at trend rather than 10% above trend • Cole and Ohanianconclude by stating that they are currently in the process of researching and quantifying the NIRA shock to employment, investment, consumption, output and wages.

5. Changing Expectations • After Roosevelt’s inauguration he stated that the prime goal was to reflate prices to pre- depression levels within 1-3 years • Roosevelt made it no secret what is goals were, often his quotes would show up in newspapers • Reflationary Quote from Roosevelt “We are agreed in that our primary need is to insure an increase in the general level of commodity prices. To this end simultaneous actions must be taken both in the economic and the monetary fields.”

8. Changing Expectations • Saying that inflation is going to take place and doing is two completely different things. • Roosevelt knew he had to make his reflationary talk credible • He did this by expanding the government through deficit spending.

9. Eggertsson’s Model With Distortionary “Wedges “ Representative household utility function • Dixit-Stiglitz consumption of differentiated products • Introduces monopoly power into modeled economy Labor supply by industry β = time preference discount θ = substitution elasticity between products > 1 • Intertemporal budget constraint “Complete” financial markets  no limit on borrowing Nominal interest rate links current and future periods • i >= 0 Real interest rate enters household optimization condition • Arbitrage between current and future utility

10. Eggertsson’s Model With Distortionary “Wedges “ Labor market Real Wage = (1 + ω1)(MPL/MUc) ω1= “Labor market markup”  regulations favoring labor Nominal Profits increase with “monopoly markup” = ω2 • Policies encouraging collusion between monopolistic competitors Always maximize profit

11. Solutions Flexible price solution p = [θ/(θ – 1)] [W /(1 – ω2 )] AS: (θ – 1)/θ = [(1 + ω1 )/(1 – ω2 ) ] MPL/MUc • For efficiency, set markups to eliminate distortion owing to monopoly power of firms (1 + ω1 )/(1 – ω2 ) = (θ – 1)/θ • Optimum is independent of i M-policy ineffectiveness Sticky price solution (each firm’s prices fixed for random period) π = f(πe,expected output growth, policy wedge) Policy wedge = (1 + ω1 )/(1 – ω2 ) The greater the policy wedge, the greater is πand the greater is πe • For efficiency… policy matters i = 1/β - 1

12. Eggertsson’s Insights • Policy wedges reduce output in flexible price economy … but increase it in the face of sticky prices and “emergency” conditions • “Emergency” conditions: • Zero lower bound • Grinding deflation Solution: Commit to higher inflation Conclusions • Depression was driven by high real interest rates • Dramatic recovery (1933-37) driven by New Deal • Mistake of 1937 kept economy from recovering to trend before WWII (Eggertsson’s trend treats 1929 as 10% above trend)