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The Mistake of 1937: A General Equilibrium Analysis

The Mistake of 1937: A General Equilibrium Analysis. Gauti B. Eggertsson and Benjamin Pugsley. Poor communication reversed the tide of the recovery from the Great Depression

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The Mistake of 1937: A General Equilibrium Analysis

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  1. The Mistake of 1937: A General Equilibrium Analysis Gauti B. Eggertsson and Benjamin Pugsley

  2. Poor communication reversed the tide of the recovery from the Great Depression • Small changes in the public’s beliefs about the future inflation target of the government can lead to large swings in inflation and output • Importance of effective communication at zero interest rates

  3. Confusing Communication by • U.S. Federal Reserve • President of the United States • Key administration officials About future price objectives were responsible for the sharp recession, 1937-38

  4. Leave door open to whether ineffective communication policy was due to deliberate change in policy or due to confusing signals • ULTIMATE EFFECT – a shift in policy beliefs about future nominal rigidities helped propagate the shift in beliefs into an output contraction and collapse in prices

  5. Contractionary Spirals • Do not occur at positive interest rates because central banks can cut interest rates • When interest rate is zero, we have contractionary spirals, vicious feedback effect • “The evolution of monetary aggregates is completely irrelevant at zero interest rates, except in their role in influencing the expectations about future money supply at the time at which the interest rates are expected to be positive”

  6. Actions including fiscal policy, gold interventions and NIRA had an effect on economy due to their effect on expectations

  7. Credits strong recovery to a shift in expectations about future policy 30% output collapses 39% output expansion • FDR’s commitment to inflate price level triggered recovery

  8. Commitment was made credible by • Vigorous fiscal expansion • End to gold standard • Large purchases of gold abroad Our primary need to insure an increase in the general level of commodity prices. To end this simultaneous actions must be taken both in the economic and the monetary fields

  9. Fear of excessive inflation • Increase reserve requirements Fear started influencing how government officials communicated policy • Change in communication Policy • People expect deflation

  10. Conclusions • Further study of the period is necessary

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