The Great Crash and the Onset of the Great Depression

1. The Great Crash and the Onset of the Great Depression By: Christina D. Romer Working Paper No. 2639

2. Overview • Stock market collapse of 1929 caused uncertainty about future incomes • That uncertainty caused consumers to forego purchases of durable and semidurable goods • Evidence in decline in confidence expressed by forecasters • Evidence shown in consumer spending after the crash.

3. Introduction • Romer argues that there is an important link between the stock market crash and the decline in real output in late 1929 and throughout much of 1930 • The link is the uncertainty that consumers had about their future incomes • This uncertainty explains their spending behavior after the crash

4. Uses a model to make predictions about spending behavior • She uses monthly spending data on durable, such as automobiles • She also uses spending data on non durables, such as perishable items and semi durables which are goods that last less then 3 years • In the model, she shows that uncertainty is high when future income is unknown

5. When future income is unknown, consumers forego purchases of durable goods • Purchases of durable goods also depends on how easily that good can be resold • Also for semi durables, such as clothing, cannot be easily resold • When uncertainty about future income is high, purchases of durable and semi durables decline

6. Uncertainty also leads to a halt in investment spending • Investors wait to gather more information and wait for the uncertainty to be resolved

7. Application to 1929-30 • The stock market experience a speculative bubble that burst in October 1929 • Caused uncertainty about future incomes • People realized the crash could disrupt credit markets and reduce investments • People were hoping that the Government would step in and stabilize the economy

8. Uses sales data from two largest mail-order houses • Uses automobile registration to measure automobile sales • Uses construction contracts for residential and commercial building • Uses sales data at grocery store chains

9. Sales of durables, semi durables, and investment spending decline after the crash • Sales of non durables higher • Consistent with the uncertainty hypothesis that predicts that consumers will substitute perishable goods for durable goods in periods of uncertainty

10. More evidence • Analyzes forecasters of five contemporary business analysts furnished in Business Week, The Harvard Weekly Letters, The Magazine of Wall Street, Moody’s Investors Service, and Standard Trade and Securities Service • The all indicate uncertainty following the crash • Some were even believed to have “manufactured optimism” through the “prosperity propaganda program” under Hoover

11. The conflicting forecasts from the analysts created even more uncertainty in consumers which continued through 1930 • In conclusion “evidence suggests that uncertainty can explain not only the initial collapse of output in late 1929, but also the continued drop in consumption throughout 1930