EC104 Topic 7 (2)

amarjotsidhu's version from 2015-06-06 16:23

Policy response to Great Depression

Question Answer
Perceptions of role of government during GDrole of govt. seen as limited
Policy during GDMonetary Policy (going on/off standard) , fiscal policy (public works, rearmament), regulatory policy (tariffs, labour rleations)
Monetary policy initiallydominated by gold standard = "golden fetters"; once countries left this, they could use independent monetary policy = lower interest rates to stimulate economic growth
Fiscal policy usageproposed during GD by Keynes but not used in most countries; exception = Germany which used central planning and military production to generate full unemployment by 1936
Changes in regulatory policy during the 1930sbanking policy (commercial and investment banks split), labour relations systems, trade and tariff barriers, social services (welfare, UI, retirement)
Policy response in US: Hoover administration (1928-32)very passive = Hoover unpopular due to high unemployment; supported gold standard; no major spending programs or regulatory changes; allows Smoot Hawley to pass
Policy response in US: FDR (1933-)"New Deal"; leaves g old standard
New Deal (1933-1938)employment programs; labour law reform; banking reform; Social Security Act; agricultural subsidies -> New Deal provides social reform but NOT 'keynesian' demand side stimulus (budges remained balanced) , largely regulation
Romer (1992) on US recoveryrecovery based almost entirely on reflation after leaving GS, not rearmament
Impact of GD on UKReal GDP/capita drops 7% , unemployment increases to 22%
1920s experience in UKMuch worse than US; returned to GS at pre-war value (high), labour unrest and high unemployment, General strike of (1926)
Policy response of UKleft GS, low interest rates, General Tariff, effect of automatic stabilizers, budgetary balance
UK leaves gold standardBoE forced to abandon gold standard following German default (1931); banking system stable afte r leaving gold, allows domestic reflation (increased investment and lower unemployment); housing boom (cheap finance + supply side reform)
Broadberry/Middleton debate over UK budget policyUK govt. kept policy of balanced budgets; Middleton claims this was a contractionary policy, Broadberry = expansionary
Fiscal policy in UKKeynesian spending not used; only major fiscal program in UK = rearmament (1935-); increase in military spending = new govt. investment (threat from Hitler than policy choice)
Crafts and Mills (2012) on UK military spendingmilitary spending did stimulate recovery but only after govt. credibly committed to long-run increses in spending
Germany = worse hit country in GD (other than US)Severe unemployment; large drop in industrial output; severe deflation; restrictive fiscal policy to manage debt; financial collapse ("dual crisis") in 1931
Germany and debt problemswar reparations and domestic debt incurred during 1920s; Chancellor Bruning tried to maintain debt service via a deflationary policy = unpopular, reduces consumption, increase in unemployment = unpopular + political unrest and extremism = Nazis
Nazi economic policycentrally planned economic policy based on 4 year plans; targeted full employment, military production (rearmament after 1936), public works = autarkic policies based on rearmament nad self sufficiency
Why did Germany recover so quickly from GD?Fiscal expansion boosts AD; extremism - Nazis didn't care about international cooperation, foreign debt repayment and were hostile to organised labour ; consumptions goods suppressed in favour of industrial output;
Was fiscal policy effective in GD?Not tried so difficult to say (Germany provides possible case)

Learning from Great Depression

Question Answer
2008 crisisbiggest financial crisis and economic “depression” since the Great Depression
Prior to the 2008 crisis, there was a consensus about the major lessons of the DepressionThe Gold Standard is a terrible idea; Don’t let the banking system collapse; Use monetary stimulus to prevent deflation; Fiscal policy might be helpful, but probably not necessary
Friedman and Schwartzsuggest central bankers could have stopped the crisis (monetary policy = powerful)
Policy response to 2008aggressively with monetary policy = Monetary expansion to lower interest rates ; When that ran out, Quantitative Easing; Generous bailouts with few strings attached
Did policies of 2008 work?not in another GD but The global macroeconomy did not recover as hoped ; GDP stagnation at low interest rates ; Lingering problems with unemployment; Looming debt crisis in Europe
Banking collapseif the banking system collapses, it takes the rest of the economy along with it = too interconnected to fail; one failure triggers a chain reaction; where banks survived, recovery was faster e.g. Britain vs. where collapsed (US, etc. )
Lender of Last ResortCentral banks must act as a lender of last resort to resolve a liquidity crisis
Bagehot’s Rulein a crisis, central banks should: Lend freely…at a penalty rate, on good collateral , to illiquid but solvent institutions (not to banks whose liabilities greater than their assets)
Potential problems with Bagehot's RuleMoral Hazard - If banks know they’ll be saved, increases risk-taking, Privatizing gains, socializing losses ; Shadow Banking - Not everything financially important is a bank e.g. do insurance companies get same treatment
Saving the financial system in 2008Saving banks (and quasi-banks) is still contentious l US: Fed tries to save Bear, lets Lehman collapse, saves AIG, etc…; UK: Northern Rock is nationalized ; Worries about moral hazard are still very relevant
Monetary policy lessonsMonetary policy is a tremendously powerful tool ; “Hard” monetary policy can exacerbate a crisis ; “Easy” money can soften the crash, stimulate recovery
How central bank policy should be usedshould be rapidly and forcefully deployed to counteract crisis ; Most countries did this in 2008, and it worked; It worked better in areas that were forceful and proactive (US) and worse in areas that weren’t (Eurozone)
limits to monetary policyThe Central Bank only provides the monetary base and loans to banks, it doesn’t control the entire credit system , Zero Lower Nominal Bound;
Lessons about Fixed Exchange Rate RegimesFixed Exchange Rates are hazardous ; Domestic adjustment comes into conflict with international commitments ; System can collapse catastrophically if cooperation breaks down; The alternative to exchange rate devaluation is “internal devaluation” = Wage cuts, austerity, unemployment
Eurozone is not entirely unlike the Gold StandardSame arms of the Trilemma: Free capital and fixed exchange rate (within the zone) ; Interest rate can move, but only if the rich countries accept inflation
Currency union makes the dangers greater, not lessbreakdown in cooperation e.g. between wealthy and poorer countries
Capital flows and GDLarge capital flows from the US in the 1920s, and the “sudden stop” in 1929, set the stage for the Depression ; The large debt overhang from WWI made the global financial crisis worse by making fiscal and monetary systems more fragile
effectiveness of fiscal multipliersestimate of Keynesian multipliers between 0-2; mulitiplier higher in times of slack capacity; rearmament shows that governments can credibly commit to long run investment spending (lowers unemployment and raises output) e.g. Germany
problem of hysteresisi workers unemployed for too long, unemployment becomes long term and structural = demoralisation, skills deterioration = good case for forceful employment policy
evaluation of policy of balanced budgetsrapid repayment of debts to prevent future crises = not good in short run -> lowers AD, hinders recovery, puts restraints on political response e.g. Bruning in Germany (1930-32)
Debate today over fiscal stimulussome argue that mulitiplier is low, policy increases debt = could trigger another crisis yet bond yields have been at record lowest since crisis in safe countries despite stimulus spending
Globally optimal policies vs national concernsdemocracy awkward for technocrats; France forced to push for German reparations; Germany may have repaid its debts to France with enough taxation but that would have led to political unpopularity; nationally optimal policies can be blocked by interest groups; crises can provide opportunities for reform e.g. FDR
Danger of extremismfailure of moderate parties to address crisis = xenophobia, autarky, breakdown of international cooperation, rejection of democracy, violence e.g. Nazis
Danger of extremism todayUKIP in UK, National Front in France
Feinstein et al. on characteristics of 1930sde-globalised world; lack of economic cooperation e.g. rivalry between Europe and US over different economic aims; world economy broke off into separate trading areas -> sterling area (fared best as a result of Britain's devaluation) - ending of gold convertibility = lowering of interest rates = stimulation of exports = substitution to domestic products,=. this included colonial empire and a few others (denmark, sweden, etc. ); gold bloc - fared worst. led by france but no cohesion or organisation. included most of continental Europe. still had to follow deflationary policies = slow recovery + high unemployment. trade discouraged between members due to overvalued gold parities; US focused on agricultural reform (restriction of production and devaluation = aim to increase prices); industrialisation drive by Stalin in Russia (forced transfer of labour); Latin American countries did quite well as they defaulted = room for expansionary policies e.g. Brazil recovered by 1932 their 1929 gdp level; nazi trading area - inward looking policies e.g. subsidies to export markets = effective, aim = autarky
Hirschmann on ISI in countries that industrialised latee.g. Germany, italy and russia. they experienced a sudden growth spurt and placed big emphasis on large plants. emphasis on producers' goods. agriculture does not play role
Hirschmann on ISI problems in Latin AmericaISI gets stuck after first successes due to exhaustion of easy import substitution opportunities; import substituting industry finds it difficult to move into export markets; new industries do not make significant contribution to unemployment problem
Hirschmann on ISI benefits in LAhas allowed LA to industrialise without requiring fundamental social and political changes which were required in pioneer industrial changes
Eichengreen on failure of countries to agree on exchange rate stabilisationFrench, British and Americans could not disagree as they perceived the nature of the economic crisis in radically different ways
Eichengreen and Irwin on choices available to countries in face of economic collapsecountries either faced deflation under gold standard, currency depreciation or had to impose controls of trade and payments to maintain gold reserves; most countries rejected deflation. Countries that stayed on the gold standard tended to restrict trade more than those that allowed their currencies to depreciate
Bernanke on causes of GDcaused by monetary contraction and poor institutions. lack of international cooperation, sticky wages and debt induced financial crisis = high unemployment
Crafts and Fearon on uncoordinated return to gold standardFrance and Belgium adopted low new exchange rates; UK returned to gold with higher exchange rate (exports disadvantage); uneven distribution of gold stocks (US and France had 60% of the world's gold and sterilised most of it to prevent inflation of their money supply = deflationary impact on other countries

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