1920-21 Recession Flashcards
1
Q
Speculative boom (1918-20) (6)
A
- Huge speculative boom in 1918-20 (big domestic inflationary pressures)
o Consumption increased rapidly – pent-up demand, end of rationing & end of price controls – 46% over the 1918-20 period (15% in real terms)
o Supply contracting at the same time – collapse of military orders & firms unable to retool from military to civilian production
o As a result, prices rose by 42% (Thomas, 1994) - Boom facilitated by
o Extremely liquid state of firms as a result of high war-time profits
o Relatively easy money – M3 surged by 37% between 1918 and 1920 - Asset bubble created in 1919-20, focused on the old staples (Thomas, 1994)
o Cotton – 80% of productive capacity was bought/sold at 8x paid-up capital
o Shipbuilding – asset values decreased by 75% after inflationary expectations fell
o Iron/steel – 30% overcapacity persisted even through the best of the 1920s
o ‘Expectations were considerably overinflated’ (due to profits) - Howson (1975) – boom involved ‘much speculative buying’, especially in old industries
- Thomas (1994) – ‘a slump was inevitable’ due to ‘unreal, speculative and brittle’ boom
o Expectations were slipping even before the end of the boom in mid 1920
o Share prices peaked in Jan 1920, raw material imports fell in Feb 1920 & new capital issues in London peaked in March – slowdown in production/profits was anticipated - Bubble burst in summer 1920
o Spring 1920 saw monetary contraction to reduce inflation
o Wholesale prices peaked in May & business activity peaked in August
o Thomas (1994) – ‘monetary policy triggered the downturn, but did not decree it’
2
Q
Decision to Return to Gold (2)
A
- Clear from the First Interim Report of the Cunliffe Committee in August 1918 that Britain will return to gold at the pre-war parity of £1 = $4.86 (Broadberry, 1986)
- Policy announcement for returning to gold at pre-war parity is made in November 1919
o During the war, GB inflation had outstripped US inflation (20% p.a. ct 5-10% avg.)
o Hence equivalent to announcement of contractionary MP to deflate the price level, according to PPP theory
3
Q
Effects of 1920-21 Recession (4)
A
- GDP down 10%
- Volume of exports down 30%
- Industrial production down 20%
- u/e up from 2% in 1920 to 11% in 1921 (Thomas, 1994)
4
Q
Causes of 1920-21 Recession (7)
A
- Return to Gold
- Monetary Policy
- Fiscal Policy
- End of Boom
- Supply Side
- Exports collapse
- Coal strike
5
Q
Causes of Recession - Return to Gold (2)
A
- Solomou (1996) – returning to gold = announcement of contractionary monetary stance
o Under flexible ER, meant ER increased due to expected lower price level/higher r
o Encouraged consumers to have inelastic inflationary expectations (low πe) lower consumption and higher money demand - Anticipations of contractionary policy led to the downturn
6
Q
Causes of Recession - Monetary Policy (7)
A
- MP was particularly restrictive to facilitate the return to gold – inflation was at 20% p.a.
- Much of this was anticipated at the time of announcement of return to gold at 1913 parity
- Bank Rate increased to 7% in April 1920, up from 5% in 1918 – contractionary policy
- May not have been key
o Solomou (1996) – increase in r in 1920 not key, but merely a symbol of recessionary forces under way since 1919 (deflationary MP & “wage gap”)
o Howson (1975) – increase in r too small to have a significant effect - However, Dow (1998) argues it was ‘potent’ by triggering a change in confidence
- Broadberry (1986) – evaluates effectiveness of MP
o LM steep (interest elasticity of money demand ≈-0.2) MP effective
o IS steep (interest elasticity of non-housing I ≈-0.1, housing I ≈-1.1) ineffective
o Interest elasticity of consumption low (≈0.05) ineffective (real balance effect)
o Therefore main effects are via external sector, through the ER (high r → ↑ ER)
o Early 20s also saw decline in velocity of money, reinforcing contractionary policy - Contraction contributed to deflation, increasing real wages & reducing X competitiveness
7
Q
Causes of Recession - Fiscal Policy (7)
A
- Government expenditure fell by 75% (1918-20) due to demobilisation
o Dow (1998) – fiscal impact is -9.2% of GDP in 1920
o In 1918, taxation was just 50% of govt expenditure; budget balanced by 1922
o Initially, fiscal consolidation surpassed by boom, but filtered through by 1920-21 - Broadberry (1986) concludes that the overall fiscal stance is moderately deflationary
o Nominal budget surplus is largest in 1920
o CEBS (given rise in u/e 1920-21) is strongly deflationary
o Lower prices increase real interest payments, offsetting some of the contraction
balanced budget orthodoxy led to higher taxation 🡪 AD contraction - Ellison et al (2019) – after WW1, government debt over 175% of GDP, classical belief in balanced budgets to pay back debt during peacetime 🡪 increase in taxation from 20% of GDP to 30% 1920-21, debt interest payments reached 7% of GDP. Also fall in defence expenditure post-war
o Resulted in a surplus of 5% of GDP by 1921 - Cloyne et al (2023) - tax multiplier of about 2 in interwar years, very large -> this contraction had a large effect
8
Q
Causes of Recession - End of Boom (4)
A
- The reconstruction period after the war generated both demand pull and cost push
inflationary pressures:
o Demand pull: economy operated at full employment from 1918-20, rapid growth of demand for consumer and investment goods at home and abroad.
o Cost-push: stronger unions, work week slashed from 54 to 47 hours in 1919 (Dowie, 1975). - Pigou (1947) – post-war demand was worked off by 1921, meaning ‘there was nothing obvious to take their place’ 1920-1 recession
- Thomas (1994) – ‘a slump was inevitable’ due to ‘unreal, speculative and brittle’ boom
o Expectations were slipping even before the end of the boom in mid 1920
o Share prices peaked in Jan 1920, raw material imports fell in Feb 1920 & new capital issues in London peaked in March – slowdown in production/profits was anticipated - Dow (1998) – this doesn’t fit with the evidence
o Cumulative disinvestment of WWI not reversed until 1926
o Negative saving continued until 1923
9
Q
Causes of Recession - Supply-Side (3)
A
- Broadberry (1986,1990)
During WWI, consumers saved (C down 14% due to diversion of resources), increasing their purchasing power, so demanded more leisure, so less hours (normal good)
1919 – average working week fell from 54 hours to 47 hours (8hr day) (Dowie, 1975)
Therefore, real hourly wage rate rose 13% on average (nominal wage rigidity)
Not helped by restrictive MP to raise ER putting downward pressure on prices
Created a “wage gap” (gap between labour productivity & real wages)
Unit labour costs, ULC= W/P ÷ Y/L; wage gap raised ULCs via real wages
Higher ULCs makes GB less competitive, reducing exports and hence AD - Scott & Spadavetcchia (2011)
Majority of lost weekly output was made up in increased hourly productivity
Reflects improvements in speed/quality of work, abolition of in-work rest breaks/periods of idleness due to bottlenecks & reductions in sickness/accidents
Reduction in working hours occurred in almost all other industrialised countries
GB had lowest proportional reduction in hours over 1913-1920, except France
GB real wage growth 1913-1920 was 6.9%, slightly above Australia/US, but lower than Europeans – relative competitiveness should not have suffered
Major “social multiplier” effects associated with reduction in hours – e.g. growth of industries associated with working-class leisure - Cole & Ohanian (2002)
Construct a DSGE model to analyse a 15% reduction in the hours worked
Assuming constant MC of labour, leads to reduction in steady state output of 3%, not big enough to explain recession (predicts 20% increase in steady-state employment)
Assuming rising MC of labour, leads to reduction in output of 10% (20-21), which could explain the recession (predicts 10% increase in steady-state employment) - UK employment should have increased during IW
Problem with model is that it assumes wage flexibility, which completely misses the point of the literature on the working hours shock
10
Q
Causes of Recession - Exports (6)
A
- Exports collapse (Thomas, 1994)
o Export volumes decrease by 30% between 1920 and 1921
o Even more severely, exporters saw prices collapse by 45% between 1920 and 1922 - Dow (1998) – exports collapse for three reasons
o Competing supplies as countries recovered from war (unlikely because exports recovered in 1922 to only 4% below their 1920 level)
o Speculative element to exports on expectation of further demand
o Strikes, especially in 1921 (textiles/coal mining), reduced supply - Other reasons seem to be more important
o Rise in unit labour costs (ULCs) due to the fall in the working week
o ER appreciates due to expectation of return to gold - However, Thomas (1994) – most of real appreciation in 1919-20 was due to rapid nominal depreciation of European & Asian currencies after the Armistice (around 35%)
- ER appreciation appears to be key here
o Solomou & Vartis (2005) calculate that RER appreciated by around 10% between 1920 and 1921 – significant appreciation
o Solomou (1996) – ER appreciation can’t be seen as an exogenous cause, because it resulted from the expectation (& reality) of contractionary policy - ER appreciation explained in “exchange rate overshooting” framework (Dornbusch, 1976)
o Asset market adapts quickly to news, but goods market is more sluggish (due to sticky prices)
o Via uncovered interest parity, nominal exchange rate appreciates significantly in order to capitalise on higher interest rates (for deflationary policy)
o In goods market, prices are slow to adjust, so change little in the SR
o Therefore, the real exchange rate overshoots its LR PPP equilibrium, returning slowly
11
Q
Causes of Recession - Coal Strike (2)
A
- Mitchell, Solomou & Weale (2012) – construct monthly GDP data
o Turning points are August 1920 (peak) and May 1921 (trough)
o Decline evident from August 1920 to March 1921, then decline steepens, followed by recovery in May
o This pattern is due to the coal strike (31st March 1921 to 28th June 1921), which leads to coal rationing and significant reductions in industrial production (little evidence)
o Therefore, the 1921 coal strike causes part of the severity of the 1920-21 recession - Eichengreen & Temin (2000) – strike ∵ reluctance to accept lower wages due to deflation
12
Q
Causes of Recession - Overall (2)
A
- Eichengreen (lecture) – to evaluate which is key we need to look at inflation – decreased rapidly over 1920-21, so the recession was caused mainly by a negative demand shock
- Dow (1998) – MP/fiscal ‘greatly intensified’ by ‘speculative conditions’ with which they interacted, but the collapse of the bubble ‘is at some point inevitable’
13
Q
Persistence Effects of 1920-21 Recession (6)
A
- Hours shock – Broadberry (1986, 1990)
- Real indebtedness – Solomou (1996)
- Trade hysteresis – Solomou (1996)
- Labour market hysteresis
- Exchange rate effect
- Regional issues
14
Q
Persistence Effects of 1920-21 Recession - Hours shock Broadberry (1986, 1990) (2)
A
- “Wage gap” is sustained until 1940, causing a one-off shift in the SRAS (left), permanently reducing output for given level of aggregate demand
- Solomou (1996)
o Broadberry deflates the nominal wage series with the RPI
Key to hiring is product real wage, not consumption real wage
Therefore, should deflate with the price of final output, i.e. GDP deflator
o Doing this, wage gap is eliminated by 1922 – only a transitory effect
o Any persistent effect must occur via a version of hysteresis (trade etc.)
15
Q
Persistence Effects of 1920-21 Recession - Real indebtedness – Solomou (1996) (4)
A
- During 1918-20 boom, staple industries increased debt to finance investment (optimistic at end of war and in absence of German competition)
- Permanent deflation (return to gold) meant that real debt burdens increased substantially
- As a result, new investment was held back as they struggled to meet large debt repayments alongside poor export performance and rising import penetration
o Private sector investment rate = 6% of GDP in 1920s (lower than GFC) - Goldsmith (1984) UK debt/income ratio increased from 1.55 in 1913 to 2.76 in 1929, whereas these ratios fell in France/Belgium – supports this view