Lecture 8 - Recovery from the Great Depression Flashcards
Recovery in the US
Recovery to pre-late depression growth in late 1930s, early 1940s
Monetary Policy (US)
March 1933: devalued US currency to dollar
Devaluation expanded monetary base
Led to Gold inflows into the US
=> No further devaluation expected (safe haven)
=> Capital flight from Europe after election of Hitler
US Problem 1933 (Monetary Policy)
US economy was in liquidity trap
=> ST bond yields were alrady near zero
=> Monetary supply expansion ineffective at ZLB
Solution: monetary expansion was part of a credible regime change that increased inflation expectations
1) Reflationary policies lowers real interest rate
2) Lower interest rate increased AD
==> Prices, investment, output increase
Fiscal Policy (US)
Fiscal deficits although modest, were very effective (but barely used)
Did not crowd out private investment, had multiplier effect
New deal = variety of spending and lending programs
1) Relief for unemployed and poor
2) Recovery of economy (reflation commitment)
3) Return of economic system (deposit insurance, investment vs retail banking)
National Recovery Administration (US)
Goals:
1) Fight cutthroat competition
- Suspend antitrust laws, promote cartelisation
2) Promote fair prices
- Minimum wages, collective bargaining, max working hours
Goal was to achieve negative supply shocks => increased inflation expectations
Example: payed farmers to leave land uncultivated
=> Contested results: Positive inflation effect vs Negative firm investment
Recovery in Germany
Rapid after 1933
Even by international comparison
Monetary Policy (Germany)
Modest money growth until late 1930s
Since 1923: expansionary economic policies hard to sell
Middle of Great Depression: Newspapers just as worried about inflation as deflation
=> Thus, no German reflationary strategy
Fiscal Policy (Germany)
Many regional work programs and stimulus packages
Re-armament = big fiscal expansion
Financed through:
1) Unilateral default on foreign debt
2) Monetary financing
3) Financial repression (forced banks to buy gvt bonds,
=> Financed through deficit
Contested results: fiscal expansion accelerated recovery vs recovery already underway
Fiscal Policy (International)
Until 1939: modest budget deficits
=> Automatic stabilizers
=> Fed broke balanced budget orthodoxy
From 1939: Gvt spending and budget skyrocketed
=> Pre WW1: deficits only during war time
=> WW2: traditional justification for deficits appears
Monetary Policy (International)
Economic recovery tended to follow exit from gold (higher inflation expectations)
Reasons:
1) Expansionary monetary policies
2) Rising inflation expectations
3) Newly gained competitiveness (devaluation boosted NX)
Reflation: ended Great Depression by lowering real wages
=> Wages more rigid than goods prices
=> Firms hired more workers and produced more goods
However fiscal policy not important until 1939 (except for Germany)
Bretton Woods System
1944: Bretton Woods agreement
=> Free monetary policy
=> Prevent currency crisis
After WW2: US has majority of global gold reserves
Fixed exchange rate regimes based on Gold
=> USD fixed in Gold
=> Other currencies fixed exchange rate and held USD reserves
=> FX rate adjustment in case of fundamental disequilibrium (to facilitate external adjustment)
Stable FX Rate & Capital Mobility => Stable FX Rate & Independent Monetary Policy
- Encouraged International goods trade
- General agreement on tariff and lower trade barriers
- Currency convertible for current account transactions
- Fixed FX rate to facilitate goods trade
End of Bretton Woods
1950s & 1960s: US gold coverage ration falls
1) Party monetized US budget deficit
- Vietnam war & Great Society Spending
- More USD thus in circulation
2) US gold outflows
- Smaller gold reserves
- Backing of USD becomes less credible
=>France wants to convert USD to gold
=> Gold convertibility suspended (1968)
=> Other CB no longer willing to purchase USD to stabilize USD exchange rate
=> Transition to flexible exchange rate system with w/o backing
=> Capital controls no longer needed, financial markets reglobalize
