Kiel Working Papers, Kiel Institute for World Economics
No 1543:
Expectations, Monetary Policy, and Labor Markets: Lessons from the Great Depression
Christopher P. Reicher
Abstract: This paper estimates a series of shocks to hit the US
economy during the Great Depression, using a New Keynesian model with
unemployment and bargaining frictions. Shocks to long-run inflation
expectations appear to account for much of the cyclical behavior of
employment, while an increase in labor’s bargaining power also played an
important role in deepening and lengthening the Depression. Government
spending played very little role during the Hoover Administration and New
Deal, until the rise in military spending effectively brought an end to the
Depression in 1941. With the economy at or near the zero interest rate
bound, interest rates and monetary aggregates provided a misleading
indicator as to the true stance of inflation expectations; in fact,
conditions were deflationary all throughout the 1930s in spite of high
money growth and low interest rates. The experience of the 1930s offers
lessons to modern policymakers who find themselves in a similar
situation
Keywords: Great Depression, expectations, deflation, zero bound, liquidity trap; (follow links to similar papers)
JEL-Codes: E24,; E31,; E52,; E65; (follow links to similar papers)
55 pages, August 2009
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