catastrophic collapse of investment and the great depression robert barsky miles kimball university...
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![Page 1: Catastrophic Collapse of Investment and the Great Depression Robert Barsky Miles Kimball University of Michigan and NBER Very preliminary discussion prepared](https://reader030.vdocuments.site/reader030/viewer/2022032805/56649ef15503460f94c01ce0/html5/thumbnails/1.jpg)
Catastrophic Collapse of Investment and the Great
Depression
Robert Barsky
Miles KimballUniversity of Michigan and NBER
Very preliminary discussion prepared for seminar at Michigan, April 11, 2007. Please do not circulate.
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Executive Summary: Model• Study Great Depression in standard New
Keynesian sticky price model with capital• Provides interesting synthesis of:
– Consensus monetary view of Depression emanating from Friedman and Schwartz
with– Earlier arch-Keynesian real theories based on
collapse of investment, building cycles, “floors and ceilings”, self-fulfilling prophecies, etc.
• Has elements of the nonlinear, catastrophe-theoretic development of the latter by Hicks, Kaldor, Goodwin, Kalecki, Varian, etc. but– Money remains the driving variable– Model is modern, recognizable, and totally standard
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Executive Summary, cont. Empirical Facts
• Gross Investment really did collapse essentially to zero
• Sharp drop in wage bill – Indicates sharp decline in rental rates on capital
• Strongly deflationary environment with very high real interest rates until 1933
• Then sharp turn towards inflation, low real rates• Rental rates and investment didn’t show strong
recovery until at least 1935
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Bottom Line Explanation of Depression and Recovery
• Very high real rates confronted low rental rates on capital – Former due to tight money and deflation– Latter due both to low output and possibly high
inherited capital stock
• This lead to complete investment collapse, apparently hitting between 1931 and 1932
• Turn toward inflation in 1933 plus depreciation of capital eventually reignites investment, but wasn’t enough to do it quickly
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Elements
• NRR curve – net rental rate on capital
• MP curve – real interest rate as function of output– Easiest case: LM curve from constant
elasticity money demand function
• Phase diagram to endogenize inflation
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When and Why Did Investment Leave Great Depression Models?
• Friedman and Schwartz– Persuasive – Highly aggregative; no discussion of components of
GNP– Emphasis on why money stock collapsed, not how it
caused fall in output
• Temin– Pointed out drop of gross investment to near-zero in
1932 but– Found autonomous fall in consumption, not
investment (don’t confuse impulse with propagation!)
• Bernanke a partial exception– But emphasis is on financing, not implications of
investment per se
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The Net Rental Rate
•r=R-δ •N=Y1/γ(1-α)K-α/(1-α)Z-1 (IRTS Cobb Douglas production function)•RK/WN=α/(1-α) (constant cost shares )•W=–UN/UC = W(N(Y,K,Z),λ) (labor
supply)
•Rental Market for Capital (no adjustment costs, investment smoothing)•Rental rate R = “marginal cost product of capital” (sticky prices, demand-constrained
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Y
r
The Net Rental Rate Curve
r=0–
NRR
Ymin
(I=Imin)
Note: Curve would be steeper if elasticity of substitution between K and L were less than unity
•Recall that both N and W are increasing in Y
Here gross investment is zero (or at some fixed minimum)
•Low Y → low of Investment
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Wage Bill
700
750
800
850
900
950
1000
1925 1930 1935 1940 1945
TOTWAGESAL/DEFLATOR
Total Real Wage and Salary Payments
•Capital essentially fixed over short period•Indicator of Net Rental Rate
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Gross Investment CollapseGross Investment Collapse
0
5
10
15
20
25
30
35
24 26 28 30 32 34 36 38 40 42 44 46
GROSSCAPFORM_REAL
-8
-4
0
4
8
12
24 26 28 30 32 34 36 38 40 42 44 46
NETCAPFORM_REAL
2
4
6
8
10
12
14
24 26 28 30 32 34 36 38 40 42 44 46
New Manufacturing Capital Expenditure, Real
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Gross Investment Collapse: Building Index and Building Permits
0
50
100
150
200
250
300
1925 1930 1935 1940 1945
BUILDING_TOT_INDEX
0
100
200
300
400
1925 1930 1935 1940 1945
Building Permits, Chicago
0
40
80
120
160
200
1925 1930 1935 1940 1945
BUILDPERM_SC_IND
0
40
80
120
160
200
1925 1930 1935 1940 1945
BUILDPERMIT_REAL
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Y
r Multiple Short Run Equilibria
MP
–πe
r=0–
Ymin
(I=Imin)
Ynatural
NRR
Selection Criterion: Stay put unless the equilibrium you are at disappears
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Depression: Predisposing Factors From 1920s
• Low inflation or deflation (Makes MP curve high)
• Technology revolution• “Overbuilding”? (Makes NRR curve low)
-“liquidationist" viewpoint– Long expansionary period– Easy money?
– Over-optimism about growth rates?
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Y
r Unexpected Monetary Contraction
MP
–πr=0–
Ymin
(I=Imin)
NRR
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Y
r Expected DeflationMP
–πr=0–
Ymin
(I=Imin)
Ynatural
NRR
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Y
r Hysteresis: A Monetary Restoration May Not Restore the Original Equilibrium
MP
–πr=0–
Ymin
(I=Imin)
Ynatural
NRR
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Y
r Further, Modest Monetary or Fiscal Expansions Provide No Escape
Ymin
(I=Imin)
MP
–πr=0–
Monetary Expansion Shifts MP Right or Down
Fiscal Expansion Shifts Ymin Right
NRR
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Y
r An Escape by Monetary Policy Alone Can Cause a Jump Above the Natural Level of Output
MP
–πr=0–
Ymin
(I=Imin)
Ynatural
NRR
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Y
r The Skillful Way Out Involves a Monetary Restoration Plus a Fiscal Expansion
MP
–πr=0–
Ymin’=C+Imin+G’ Ynatural
NRR
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Endogenizing Inflation: The Phase Diagram in the Neighborhood of the Steady State in the Absence of an Investment Collapse
x (real moneybalances)
steady-stateinflation
dx/dt =0
dπ/dt =0 π=0(different positions possible)
π
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The Phase Diagram with Coexisting Blue (Normal) and Red (Depression) Dynamics Shown
x (real moneybalances)
steady-stateinflation
dx/dt =0
dπ/dt =0 π=0(different positions possible)
Collapse Boundary
π
ReignitionBoundary
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The Phase Diagram with Only the Blue (Normal) and Red (Depression) Saddle Paths Shown
x (real moneybalances)
steady-stateinflation
dx/dt =0
dπ/dt =0 π=0(different positions possible)
Collapse Boundary
π
collapse values of x
ReignitionBoundary
Assume log money follows random walk with constant drift
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Lessons From Phase Diagram• Nonlinearity
– Need sufficiently large monetary expansion to get to the reignition boundary
– Nothing happens to investment and output until then
• Hysteresis – Dynamics depend on where you start from – Probably need inflationary boom to reach reignition
region
• Mundell and Keynes effects – Keynes effect will restore full-employment in long run– Low but rising inflation means Mundell will eventually
switch from harmful to helpful
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Using a Fiscal Expansion to Shift the Reignition Boundary
x (real moneybalances)
steady-stateinflation
dx/dt =0
dπ/dt =0 π=0(different positions possible)
Collapse Boundary
π
collapse values of x
ReignitionBoundary
•Moves boundary to left of of p-dot=0 locus
•Avoids need for inflationary boom