Revving Up the Great Depression Debate, Once Again

What ended the Great Depression? Christian Romer made the case in a famous article that it was FDR's unconventional monetary policy--not sterilizing the gold inflows from Europe and devaluing the dollar in terms of gold--and not fiscal policy that ended the Great Depression. More recently, Gauti Eggertsson argued it was not unconventional monetary policy itself but rather a change in expectations from a number of policies that ended the Great Depression. His view is that FDR's monetary and fiscal policies changed deflationary expectations to inflationary ones and in so doing got nominal spending going again. While Eggertson's explanation is intuitive, it goes against Romer in arguing fiscal policy mattered too. It also makes a provocative claim that the National Industrial Recover Act (NIRA) played an important part in ending the deflationary expectations. The implication, then, is that any immediate output loss generated by NIRA cartel and monopoly-like policies was more than offset by the increase in output generated by the change in inflation expectations the NIRA helped create.

Eggertson's paper provides a clever but controversial interpretation of this period. And Steven Horwitz is not buying it one bit. He has a new article in Econ Journal Watch that questions Eggertson's paper. He specifically says Eggertson has his basic history wrong for this period and thus his DSGE model--the source of the paper's findings--has little merit. Horwitz paper is interesting and is sure to rev up the Great Depression debate once again. In case you missed this long-running debate in the blogosphere here was my past attempt to summarize it. (Click on picture to enlarge.):

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Is This Economic Crisis a Key Turning Point in History?

Like other observers, Niall Ferguson says maybe:

Could this be one of those great turning points in history, when the balance of power tilts decisively away from an established power and towards a rising challenger? It is possible. Financial crises often accelerate the gradual shifting of the geopolitical tectonic plates; they are to history what earthquakes are to geology.

It was inflation that undermined the foundations of Habsburg power and opened the way for the Dutch Republic. It was the disastrous Mississippi Bubble of 1718-19 that fatally weakened ancien régime France, while Britain survived the contemporaneous South Sea Bubble with its fiscal system intact. For most of the nineteenth century, financial crises in the United States had only marginal effects on the City of London. By 1907, however, a Wall Street crash could send a shockwave across the entire British Empire, a harbinger of a new era of American power.

Something similar may be happening as a consequence of the American financial crisis that began nearly two years ago. The flapping of a butterfly's wings may trigger a hurricane in the Home Counties; in much the same way, a crisis in the market for subprime mortgages could signal the waning of US hegemony and the advent of a Chinese century.

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About That 'Long Depression' of the 1870s

Over at Angry Bear, Spencer asks a question:

[W]hat about the recent argument by Bryan Caplan... that the decade of 1870's was the peak for Libertarian freedom and economics[?] Maybe, but I wonder if he is even aware that economic historians label the 1870's as the "Long Depression". I find it really amusing that he so proud of what others call a depression.

I cannot speak to the historical peak of the libertarian movement, but I do want to address the claim that "economic historians label the 1870's as the Long Depression." That may have been the case in the past, but recent scholarship completely refutes this notion. According to a number of studies there simply is no evidence for a prolonged recession in the 1870s. I have covered this issue before and have the reposted that discussion below. Before turning to this discussion let me point out that Joseph H. Davis in his Journal of Economic History paper notes that the cycle dates set by the NBER in 19th century, which do show a prolonged recession in the 1870s, are flawed because they relied heavily on (1) qualitative information which tended to notice downturns more than upturns and on (2) nominal measures rather than real ones. Therefore, the NBER cycle dates for the 19th century are not reliable. Now here is my previous discussion:

About that Great Recession of 1873...it did not last until 1879 and it is not the longest U.S. economic contraction on record. One would not know this, though, by looking at the NBER's business cycle dates. These dates show this economic downturn lasted a record 65 months from October 1873 through May 1879. Therefore, it is understandable why observers like Paul Krugman, Matthew Yglesias, and Robert Shiller continue to invoke this period in their discussions of the current economic crisis. These dates, however, are wrong according to a series of papers published by Joseph H. Davis ( 2004, 2006 ). Using a new and more robust measure of industrial production for the Postbellum period, Davis shows most of the NBER recessions during this time are overstated. In the case of the 1873 downturn it only lasted 2 years. The popular Balke and Gordon (1989) real GNP series for this period similarly shows only a 2-year recession following the 1873 economic downturn while the famous Romer (1989) real GNP series shows no recession at all during this time. Unfortunately, the NBER has not revised these dates and, as a result, it continues to add confusion.

The figure below shows the log version of these three series for the Postbellum period. Nowhere in this figure is there 5 year + economic downturn in the 1870s. (Click on figure to enlarge.)

Update: Commentator ECB points us to this interesting NY Times piece on the 1870s.

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The Three Monetary Systems During the Civil War

Since Paul Krugman is talking about the 150th anniversary of the U.S. Civil War outbreak, it is worth recalling  the great monetary experiments created by the Civil War.   This great event resulted in the establishment of  three monetary regions in the United States: the Greenback monetary system, the Yellowback monetary system, and the Confederate monetary system.

The Greenback monetary system emerged in the East when the gold standard was suspended so fiat currency could be introduced in 1862.  There was no central bank at the time, so the new fiat money   popularly known as the greenback was introduced by the U.S. Treasury.  Ironically, the Treasury Secretary who introduced the Greenbacks, Salmon Chase, would later become Chief Justice of the Supreme Court and rule that the fiat currency was unconstitutional.  The Greenbacks were highly inflationary as seen in the figure below:

Between 1862 and 1865, the price level rose about 60% because of excessive issuance of greenbacks.  Over the next thirty years, the price level decline by almost 50% due in part to a desire to return to the gold standard by 1879.  Doing so required either retiring the greenbacks (done initially) or freezing the stock of greenbacks (done later) and allowing the economy to grow into them. Once the gold standard was resumed, the price level continued to fall as the growth in gold was slower than the growth of the economy.   Eventually, the price level was about where it was prior to the Civil War.  Fortunately, this 30 year run of falling prices was associated with on average rapid real growth, rising real wages, and increasing financial intermediation as noted here. 

The Yellowback monetary system emerged in California during the Civil War.  California never left the gold standard and it dollars remained gold-backed.  These so called yellowbacks floated against the greenbacks until resumption of the gold standard in 1879.  Greenbacks did find their way to California, but were quickly returned to the East as payment.  No greenback banks every took hold in California. Because the Yellowback monetary system continued until 1879, the United States truly was a dual currency nation during this time.  Hugh Rockoff marvels at this dual monetary experiment:

[F]rom 1865 to 1879, when the greenback currency became convertible into gold we have a monetary rarity: a strong political union, untouched by war, with two currencies, greenbacks and yellowbacks, circulating at a floating exchange rate. 

[Update: Here is another Hugh Rockoff paper on the Yellowbacks.]

The Confederate monetary system emerged in the South as a way for the South to gain autonomy and finance the war effort.  The confederate dollar was a fiat money like the greenback and its value ultimately rested on the outcome of the war.  Thus, whenever the South was winning victories the confederate dollar appreciated and when the North was winning it depreciated.  Here is a picture from Feenstra and Taylor International Economics textbook that captures these developments:

Though there were other important monetary changes during Civil War like the introduction of the flawed National Banking System, the three monetary system that emerged during the Civil War was truly a remarkable development.

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