ECON 4580 FINAL REVIEW NOTE 10-15-09

Brittan and the Global Downturn- Why did we do the US and then Brittan?

o Aren’t the economies doing the same things from the 20s and 30s?o The Answer: NO! They are very differento In the US

Economy is booming in the 20s, growth is relatively fast, housing, durables increase

Then, 1929, great stock market bubble crashes, bank failures, etc 1929 was a very bad year, we don’t get back to 1929 GNP until 1937, we

don’t get out of recession until after the waro In Brittan

The unemployment rate after WWI was high from 1921-1929 Years of double-digit unemployment Slugging throughout inter-war period Brittan’s economy is two parts:

One part is sluggish One part grows quickly

Because Brittan grows sluggishly, downturn from 1929-1932 is not big GDP fall 5%, much less than in US Brittan gets out in 1932, gets back to 1929 level in 1934 and grows

rapidly Brittan is off the gold standard in the interwar period, and it goes back to

its old exchange rate- The British Economy

o Peter Temin and many other economic historians, when asked what is the cuase of the depression, say it’s the ramifactions of WWI

o First World War is incredibly distuptive for Brittan Leads to collapse of british trade in other economies Internal problems: rapidly rising prices, significant inflation, large buildup

in national debt Its forced off the gold standard, and its national debt balloons

o Three Consequences for British Post-War Economy During the war, Brittan becomes heavily reliant on US for goods, both

domestic and war goods, Becomes decreasingly able to pay for these goods through their

own exportso Reasons:

Brittan goes to total war economy German U-Boat blockade

o Because of this, Brittan runs huge trade deficits with the US

o This eventually forces Brittan to go off the gold standard, otherwise, US would have taken ALL of brittan’s gold

Brittan inflation issues paying for WWI

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Brittan, during the war runs massive deficits, billion dollar deficits Tax rate is going up, Brittan is trying to pay for war by increase

taxes, but it can’t simply keep up, its too expensive Brittan is running these deficits, and to pay for them, they are

printing money This leads to rapid inflation By 1920, prices are 150% above where they were in 1913 Prices going up 2.5x is chicken feed compared to most of Europe Most of Europe experienced inflation rates far higher than this British inflation was MUCH higher than US inflation

o War does not affect US like it affects Europe This will become important because if you want to stay at your old

gold standard exchange rate, all other countries need to inflate at the same exact level

o However, the correct exchange rate, should not be the old gold standard

o Once Brittan is ready to go back on exchange rate, Brittan wants to go back on old rate

o One of three things need to happen to successfully go back to old rate

Need Miracle: US would need to inflate like crazy Brittan will need to deflate on purpose

Brittan will need to drive its prices down, but it is a very dumb policy, according to Keynes

Brittan does this Go back to 4.86, even though it is not the correct

exchange rate, overvaluing currency You are making your goods, by the stroke of

a pen, more expensive This is very dumb

o Thus, fixation on Gold Standard and fixation on pegging at 4.86

British treasury were horrified at size of deficits Debt grows from 754 million to 6.1 billion from 1914 to 1919

o It essentially grows by a factor of 8 in 6 yearso Tax revenue goes up, but not nearly enough

Much of the debt was financed by 5% war loans Government needs to pay a lot of money to service its national

debt Debt interest grows form 41 milion/year to 345 million/year In the interwar period, ¼ of government expenditures was

servicing debt British government’s desire to pay off the debt and keeping

country on gold standard at old rate meant they would sacrifice the domestic economy

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o Herbert hoover’s policy on sterioids Brittan, during the 1920s had policy of surpluses and high interest

rates, culminating in massive unemployment and sluggish growtho Brittan is an economy based on exports

Exports, as a share of income, 1913: 29.9% of world manufacturing exports

o Biggest trading nation in the worldo 23.2% of national income comes from exports abroad

This number is enormous 1929: 23.6 of world manufacturing exports

o 17.6% of national income 1938: 22.4% of world’s manufacturing exports

o 9.8% of national income 1913 to 1938 is a massive drop Brittan was the wealthiest country in Europe

Coal, Cotton, Wool and Ships are what made up the british economy

Every one of the se sectors goes into freefall in the interwar period British exports simply dry up, and go from being almost a quarter

to more like 1/10th of income Why do these exports go down?

Their markets are cut offo British sold to Asia and Latin Americao US takes over Latin Americao Japan takes over Asiao It proves very difficult for the british to break back into

these markets, these markets are lost forever Furthermore, many of these countries begins to supply themselves

o Neutral parties in war begin to manufacture their own goods

o To protect these new industries, tariffs are put up to block foreign goods

o Brittan’s decision to go back on the gold standard at $4.86 will cause british goods to become overly expensive

o In 1932, when british bank slashes interest rates and institutes cheep money, minor housing boom

o Colapse of export industries and rise of industries to british Collapsing industries are in northern England New industries are in midlands and south of England

10-20-09The Stupidest of Stupid Government Policiesb

- Industrial growth in interwar Brittan o In Brittan, there are failing industries

Old staple industries: coal, cotton, steel, shipbuilding These are the ones that made Brittan great

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Export orientedo They built ships for the world…

These industries are all located in the north of England, in scoltland, south wales, etc

“The Celtic Fringe” Losing 1 million jobs

o Growing industries New, consumer oriented Mainly domestic consumption These gained slightly over 1 million jobs in the same period they are located in the south and midlands

- The main source of power, in the 18th and 19th centuries was coalo Industries had to locate near coal fields, there is no coal near Londono Electricity changes everything in the 20th century

It allows for industries to locate near the greater consumer market, London- What does it mean?

o When you go to look at inter-war bittan, we find it is a massive regional problemo We have a complete flip in where unemployment is o Why? Because of weird reactions to WWI and the collapse of british export

industries o What should be happening?

Migration, and they do From 1923-1936, London and the south attract 1.1 million migrants. The

Celtic fringe loses 1.2 million migrants Who migrates?

The people who migrate are young (15-29) and skilled (has some amount of training or can take a fresh apprenticeship)

The problem is among older workers in the celtic fringeo If you look at the NE of England, 17% of those

unemployment aged 45-64 had been unemployed for at least 5 years

o There were absolutely no jobs, and they were not re-trainable

o If you take all ages for NE, and figure out how long they’ve been unemployed on average, 71 weeks

The Return to gold- By 1914, its been on the gold standard for 90 something years. Its willing to purchase

gold at 4.25 pounds. - Brittan is the virtual center of financial markets

o US is buying gold at $20.67o Therefore, one pound=$4.86

- For countries like Brittan and US that stay on gold standard for decades, there is a beautiful fixed exchange rate

- The existence of stable exchange rates greatly facilitates international tradeo Everyone benefits from this, great growth 1870-1914

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- After WWI, this international system collapseso Exchange rate stability collapseso During the war, there’s massive inflationo There would have been exchange rate stability if every group had the same rate of

inflationo In 1920, the relative price would have been the same

What happens during and after the war is that country after country is forced off the gold standard and their countries just collapse

US prices go up less than everyone else’s Prices in Brittan go up 150%

But, in comparison, is really nothingo Hungary, prices from 1913-20s, went up 23000%o Russia, 1913-20s, prices up 4 BILLION%o Germany, 1913-20s, prices up 1 TRILLION%

Prices were going up in germany 600% week Surpisingly, germany has a stable economy by 25-

26 Good News: US

o Look at Brittan and compare then with US rates In august, 1915, when war was exactly one year old, Brittan decides to

devalue slightly Aug ’15, $4.76

Stays pegged until 1919 when Brittan’s central bank goes off gold standard

April 1st, 1919, goes off gold Act of pariliemnt that took Brittan off gold standard has clause,

saying “our disallowing of the exports of gold will expire on Dec 31st, 1925 unless renewed”

If parliament didn’t do anything, Brittan would be forced back on Jan 1926

As of april 1st, 1919, Brittan is off gold and bank of England has stopped pegging pound

Pound falls through floor Feb ’20, pound down to $3.20

Brittan starts deflating like crazy in 1920 Early deflation is caused by recession, caused by the collapse of

government spending and demobilizationo Jan 1918, Cunliffe Committee

Consider currency problems in the post-war period Clear Brittan will win Clear that will need to go off gold

Reaches one conclusion with two parts: Return to gold as quickly possible Should return to gold at ONE exchange rate $4.86

o It should NOT consider returning to any exchange rate at any other price

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o Cunliffe committee wants to re-create the pre WWI economy

Bank of England needs to drive down prices to get back to good exchange rate but we can do it

Bank of England does this, and by mid 1924, pound back to $4.40 British prices are falling, US prices going up Pound on Intl exchange rates getting more valuable

o 1924, Bradbury Committee Advise chancellor of Exchequer, Churchill, what to do in order to

implement the recommendation of Cunliffe committee, in light of the fact the pound is up to $4.40

Bradbury committee rejects going back on $4.40, we need to go back on $4.86

Two ways to do this: o Go back immediately and suffer consequences by

overvaluing currencyo Hope that british bank and US bank continue policies that

drive prices back to $4.86o $4.40 is about 10% off from taget

1924, election conservatives go back to power, pound shoots up By late fall, 1924, exchange is $4.79

o Discrepancy of 1.5% Feb 1925, Bradbury committee recommends going back on gold standard,

noticing the small parity April 28, 1925, Winston Churchill, announced Brittan was going back on

gold at $4.86 Off gold for slightly more than 6 weeks

o Why did they do it? Why was everyone obsessed with going back onto gold at 4.86 All believed there were advantages of being on gold, and being on gold at

4.86 Exchange stability

o A nation built on exports, due to the stability, should be back on gold

o However, that doesn’t mean you should go back on gold at $4.86

The idea of reconstructing pre-war international economyo Brittan’s golden age

Exports 4% growth year Low unemployment Brittan was center of economic universe

Belief, if we return to gold, since we’re number 1 in euroupe, France, Germany, Italy, belgans, etc, will go back onto gold exchange rate at old levels

o Trade will increase sharply

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o Export industries will boom like mad, and our unemployment rate will go down

This is a huge gambleo Though, the city fathers think this is a sure-beto We think we will shoot back to great times, high export low

unemployment World trade is screwed up since no one is on gold standard

o Once we go back on, everything will be fine This is the theory, but mostly wishful thinking

o There were a lot of problems with this Lost export markets

Latin America and Asia They thought once back on gold, these groups would buy british

This didn’t happen Returning to gold standard was not good enough, we have to return to gold

standard on old exchange rate In theory, since all you need are stable exchanges, you can go back

on any level You can go back on whatever, but you DON’T need to go back on

$4.86- Sayers and other defenders of Churchill said that it was a gamble, but it was a good

gamble and should have worked, except for three thingso First Lesson:

Never trust the French France and Belgium don’t play by british rules

Remember, if british do the sacrificing, all the European countires will go back to exchange rates

They don’t go back at old exchange rates, they go back at far far lower levels

Go back at 1/5 of what the franc was when it went off British: this is unfair. They are undervaluing their currency

Their goods, as it looks to foreigners, looks cheep British goods look expensive

Brittan should have followed France and devalued its currency However, Churchill defenders got an unfair trading advantage over Brittan Sayers: If Brittan had gotten back at $4.40, Sayers says French would have

pegged their currency lower. Nothing Brittan could doo Second lesson:

Never underestimate germans After war, British thought that germany was not an economic competitor

anymore Economy, post WWI was a basket case 1926, new regime, new currency, and put their house in order, and they

began to export British never thought they were going to compete with the germans

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No one thought that Germany was going to be an economic power anymore

o Third Lesson: Americans will not save you economically British thought that US were going to inflate currency to make it easier to

go back to old exchange rates US did not do that and british were upset over it

o Resetting to $4.86 thought it would create some economic nirvana, and create WWI, but it didn’t happen

- J.M. Keyneso When the armistice was signed, the allies did not know how terrible shape they

were ino Versallies treaty writing takes a nasty turn, allies try to stick it to germans

Keynes resignes over this Keynes: Its idiotic economically what they are doing

Writes brilliant book “The Economic Consequences of the Peace” Treaty will be disasterous for Europe WWI had irrevolably changed the economic balance of power Predicts that European powers will try and recreate/reconstruct

pre-WWI economy Its not desirable to do that Things have changed

o US more powerfulo Europe weakero Hard to go back to the way things were

1923: 186-219, Essays in persuation knows that Brittan and France are looking to get back on gold they have to decide between deflation/Devaluation Their currencies have gone down in value,

o If you want to go to the Pre WWI-Exchange rate, you need to deflate, since US’s value went up during war

o Devaluing, weaker currency due to appreciated US currency

Which is worse: deflation, driving down prices, is associated with unemployment

o When prices fall, debt goes up Its much less costly to go back on gold standard level you are

currentlyo Those countries that have had stable inflation since 1913

should stabilize them at domestic prices levelo Feb 1925, Exchange rate back to $4.79

Bradbury committee says go back immediately Kenyes: don’t do it! This is a false exchange rate, this is speculation

Currency traders are tyring to take advantage of the conservative policies

Real exchange rate is still about $4.40

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If you go back to 4.86 with the stroke of the pen, you have overvalued currency by 10%

o You would have raised your commodity prices by 10%, and you are going to destroy your export industries

o Churchill does it anyway Keynes responds with scathing attack: “The economic consequences of

Mr. Churchill” Winston Churchill has just overvalued the pound by 10% while

leaving domestic prices unchanged How do you go back, drive down prices 10% Firms will break union contracts and cut 10% of wages, leads to

general strike 1926, all hell breaks loose in Brittan 10-22-09

Brittan and The Gold Standard- John Maynard Keynes

o It is impossible to recreate the pre-WWI economyo Do not go back on 4.86o Churchill’s Dinner Party

Invited bankers and Keynes to discuss gold standard Keynes kept his mouth shut,

o He had already conceded defeato April 1925, Brittan back on gold standardo July, 1925, Keynes publishes the economic consequences of Mr. Churchill

Gold was at 4.79, but it did not represent the real exchange rate The real exchange rate was 4.40, since the 4.79 was more of a spectulative

rate based on the conservatives taking power Since the real exchange rate, based on imports/exports was 4.40, Churchill

had overvalued the currency at 10% This makes the goods more expensive abroad

Internal prices/costs are the same What does this mean if foreign prices go up?

Either foreigners say they’re going to swallow the cost increase, and pay more

Or…foreigners will not buy the british goodso British goods are not competitiveo The only way for them to become competitive again is if

exporters lower their prices by 10% So, firms go to their workers, break contracts and cut wages by 10%

o Wages are the main cost of productiono The reason they do this is because they need to be competitive

on world markets Churchill has committed to drive down wages by 10% Churchill: we will let the market drive down prices

The market will not do it rapidly and will not do it at the same time Left to market adjustments, there is nothing that says that the

adjustments will occur fairly

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What chruchill has done is made british goods look uncompeitive in foreign markets

He has also made foreign goods more attractively priced Churchill has thrown the country into a balance of payments crisis

“The president of the board of trade has asserted in the house…has asserted it has been all to the good. The chancellor of the exquecker has expressed the opinion that the gold standard’s effect on the coal industry has no more effect on the industry than the gulfstream…this is of the featherbrained variety”

So, if you’re back on gold and you have a balance of trade deficit, you’re going to raise interest rates to attempt to get people to invest in local markets

To correct deficit and outflow of gold, in the long run is to lower domestic prices Keynes,

o draconian way to get wage cut: Give workers the following option;

Starvation through unemployment Submission through wage cut

o Keynes: we just have to drive down prices like crazy Fixates on cold miners

June 1924, British coal sold for 45 cents less on world markets than US

o Brittan is exporting coal like crazy June 1925, US coal is now cheaper by 63

cents/ton British exports of coal collapse, British coal-mining firms, who are unionized,

and have a contract, say we need to break the contract and we need to cut your wages by 10%

Coal miners are pissed But, the short run solution is to raise interest rates

Keynes: the market isn’t fair The end of lassiez faire: we have been taught that there is a fair and

natural law in the marketplaceo That may have worked up to WWI, but no one really believes

that anymore, its not trueo The market is one way to distribute goods, but its not the only

way Coal miners are first victim of economic juggernaut

o Coal is a very competitive industry on world marketso Government has wrecked coal industryo Mine-owners have to do the only thing, and cut wageso Coal miners are not happy but don’t understand what’s going

on, but why should they, Churchill doesn’t understando Keynes thinks there’s going to be mass unrest

The strategy is flawed and not well thought outo Keynes solution:

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Government should offer unions a deal: Negotiate an across-the-board wage cut of 5% Subject to a promise that the government would do everything in its

power to lower consumer price index by 5%o Purchasing power doesn’t budge, workers are the same off

But what about middle class? Government should implement a 5% increase in income tax

Workers don’t pay income tax As workers accept wage cut, and middle and upper class sacrifice

equally o No one was listening to Keynes in 1925o The policy of the bank of England was explicit:

Set the bank rate higher, between ½ and 1% higher than US discount rate We want to people to put their short-term money into pounds instead of gold

o This is what a country should not do The country is giving priority to a maintanece of a stable exchange rate to

sacrifice prices Government is forced to jack up interest rates, stilfiling investment and

slowing economic growth The bank of England is forced to sacrifice the exchange rate Instead of giving easy money to help the unemployment rate, Brittan deflates rather than devaluing

They did this because the city fathers thought it would be easy/short term

o British Exports go up 9% from 1924-1939, imports go up 13% However, the world exports go up 32% There is world trade picking up, but Brittan is not participating

o World trade has gone up, but Brittan is not sharing in the gains. o In fact, its worse than that

Export industries decliningo Keynes predicted industrial conflict:

Occurs in 1926 Mine owners were losing money 1926, they decide to break the union contract To support strike by miners, trade union congress calls for a general strike.

2.5 million workers go on strike General strike lasts for 9 days. Miners strike for 7 months. Workers

capitulate Mine owners get wage cut and increase of work hours. Real purchasing power of mine owners go down 5%

o Government basically has two policy tools: monetary and fiscal policy Monetary policy: changing interest rates Fiscal policy is government spending During recession: cut interest rates and increase government spending

During this recession, Brittan uses the monetary policy perversely Furthermore, they use the fiscal policy perversely

o They are obsessed with getting rid of the WWI debt

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o These are current account surpluses, not full unemployment surpluses

The government is doing everything wrong in domestic policies10-27-09

British Government Policy Objectives

- First policy objective: Stable exchange rateo Go back on gold on $4.86/pound

- Second objective: retire/reduce national debto National debt gone way up due to WWIo These were both attempts to go back to pre-WWI economy

- Reduce Unemployment rateo Get back to “normal levels” of 5%

- Policy toolso Monetary policyo Fiscal policy

Can you fix three problems with two tools? If two work on oneo Monetary policy is not used right, interest rates are raised, raising inflation and

even worse for job creation. Unemployment rate riseso Fiscal policy is also not used right

The british government runs current account NOT full employment surpluses, meaning that there is massive unemployment

- Unemployment is 10-14%, what does the government do? Very little!o British government decided to deal with unemployment back in the way it did in

the 1880s, through public works policieso British localities had set up public works projects during periods of high

unemploymento Public works policies should be undertaken by local authoritieso However, central government will set up unemployment grants committee that

will help subsidize some projects. At least 50% of funding has to come from locality How does localities pay for it? The localities raise taxes The whole point is crazy: CITIES CAN’T RUN DEFICITS, so you’re

raising taxes on those unemployed- 1886, Joseph Chamberlin- Public works: Unemployment tax money,

o Dec 1920-June 1929, would have created 42,000 jobs year This is a tiny number The avg unemployment rate was 1.2 million. For every hundred

unemployed workers, 3.5 of them could be employed with public works jobs

o Rationale: 1: Public works jobs merely alter the time-distribution of unemployment

You build something today, you can’t do it tomorrow Public works is robbing the future of jobs

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2: Any work on public works projects must inevitably be subtracted from private sector today

This is crowing out with gusto Productivity can also be lowered with public works jobs

So, you are not creating jobs in the future, but you are not creating any jobs today

o In the 1920s, the conservative and labour party both say public works won’t worko However, the liberals take a different tack

During the 1920s, the liberal party, under David Llyod George, was a staunch supporter of public works to stem unemployment

Party put out book in 1928 called brittan’s industrial future Election in 1929 where conservatives in power run against labour and

liberals, is that parties put out manefestos Liberal manifesto: “We can conquer unemployment”

Lloyd george’s pledge: We are ready with schemes of work which we will put into operation. It will reduce the unemployment. This will not add one penny to national or local taxation

What does he pledge to do: Spend 125 million pounds/year on public works

o Telephone developmento Electrical developmento Land drainageo Extending London undergroundo Roads/bridgeso Public housing

Will put hundreds of thousands to work each year There will also be indirect effects

o Increased purchasing power, the workers will spend the money,

o thus they will increase purchasing power on food, clothing, entertainment, etc

Lloyd George: I will get unemployment rate down to normal proporations

There were about 1.5 million unemployed workers in 1929o Normal proportions is around 500,000 workers

I will spend 125 million/yr for two yearso That will create 600,000 jobs, but it will in total create 1

million jobso Indirectly, it will create 400,000 jobso This is the keynsian multiplier

o Gets battered by both labour and conservativeo Lloyd George is saved by Keynes

Essays of persuasion 118-34: A program for expansion Real title: Can Lloyd George do it?

Can Lloyd George get unemployment back to real levels?

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o There’s work to be done Theres 1.5 million people unemployed

o Usually the market solves these issues, but for whatever reason the market is not fixing the issue

Stanley Baldwin: it is financially sound to keep 10% of population unemployed

Keyens and Hend: this is sheer nonsenseo The major objective is crowing out/limiting capital

The government could spend more money but the total government expenditures could not increase

LG, K (money multiplier)=1.67 SB , T, K=0

o Keynes sand Hend say the idea that the money multiplier is wrong Argument is the capital stock is fixed and is insufficient to employ

workers Thus, it is now natural to have a 14% of unemployment If the capital stock is fixed, if one firm gets more capital, one firm gets

less capital Thus, it is impossible to raise number of jobs Not only can government not do it, but the private sector can’t do it either

o Keynes and Hend reject this They believe Lloyd George can do this, and the money can come from

three sources: First: Unemployment insurance funds

o What Keynes and Hend say is that the government is not employing workers, but the government is still spending money on unemployed workers

o The government has spend 500 million pounds on insurance

o Its giving workers to do nothing instead of workingo Why not give the 50 million pounds that are being used in

unemployment and transform it into wages Second: Savings are going to waste

o Its going to waste because its not being demanded by entrepreneurs

o Treasury makes an assumption that every pound saved by the public is turned around and invested by industry, none is horded

o Untrue. During downturns, money is saved that is not invested,

o During downturns, private savings S > Io There is money out there ripe for the taking

S-I is a positive number Why can’t the government use it to put people to

work?

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o Money saved that is not being used to put people to work in the private sector

Third source: reduction in foreign lendingo Divert savings being used abroad to USo The idea that foreign investment will be reinvested in

Brittan doesn’t work Keynes & Hend, the multiplier is at least K=2. For each one million

dollars spent, it will create 600,000 jobs directly. However, there is also the indirect purchasing power, and indirect costs related to these public works

You will stimulate all industries if you put all this together. You will create at least as many jobs indirectly as you will directly

So, Lloyd George doesn’t need to create 600,000 jobs, he only needs to create 500,000 jobs

- Could Lloyd George really have done it?o Glynn and Howells (1980)

They believe multiplier is much lower, 1.26 K=1/1-mpc In reality: 1/1-(MPC-MPI)

MPI=marginal propsnsity to import Glynn and Howells, its quite high For every 100 pounds, that worker will spend 35.5 pounds on

foreign goodso Glynn and Howells are cheating: they don’t do the calculations for 1929, they do

it in 1932 In 1932, it’s the peek of the depression in Brittan, there are 3.2

unemployed workers To get it down to 5%, would need to create 2.8 million jobs

o What would it have cost to create 5% conclusion: if you believe the multiplier is 1.26, required government

expenditures is 537 million pounds that is an enormous number 70% of what government planned to spend in 1932

o Problems: This is a bait and switch Multiplier is way too low Also, bizarre assumption that government spending means deficit

They don’t understand that people pay taxes if employed

10-29-09

Glynn and Howells

- Conclude that Keynes and Lloyd George are wrong- Glynn and Howells attempt to discover how many jobs do you want to create through

public works

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- Glynn and Howells are cheating, getting unemployment rates back to normal rates in 1932, which was nearly triple what it should have been

o 1929: when Lloyd George is proposing public works, 1.5 million unemployed (500,000 jobs need to be created)

o 1932, time which Glynn and Howells use for calculation 3.4 millon unemployed 2.8 million jobs need to be created)

- P=Marginal product of laboro Glynn and Howells: increase in GNP to get up to full employment=676 million o Government spending needs to go up Y/ multiplier

If multiplier is one, G and Y are the same Government spending does not need to go up as much as GNP, it only

needs to go up by the multiplier When you put these together, G=E*P/K, that is what you need to increase

government spending byo Glynn and howells say that that Lloyd George and Keynes forgot an important

point British workers will spend a lot of their new income on foreign goods

o Glynn and Howells estimate marginal propensity to import is .355 Because of the high marginal propsneity to import, you get a low

multiplier, 1.26o To create 2.8 million jobs, you will need to raise 537 million pounds.

This is a huge number This is almost 14% of GNP Government spending would have had to increase to a massive number to

get unemployment down You would have to increase the Government expenditure by 70% to get

the jobs needed This could not have possibly have happened, the government could

not just go out and borrow 14% of GDP This is both politically and economically unfeasible during

peacetime It would have created massive crowding out

o The conclusion: Its impossible, the program would have not worked using Glynn and Howells calculations

The government could not get us out of the depression Bizare Problem: Why would you attack Lloyd George for a problem he is

working to fix in 1929 by looking in 1932 They’ve invented a straw man

- Hatton o Redoes Glynn and Howell

Recalculates the multiplier Does it by making different assumptions about the marginal propensity to

importo Assumption 1: How big is the multiplier due to the marginal propensity to import

Glynn and Howells: K=1.26, MPI=.355 Hatton: K=2, MPI=.21

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The number Hatton thus generates for government spending 338 million, 45% more than what government wants to spend

What does this do to the deficit? People getting jobs will get money and will pay taxes Furthermore, government social service spending will go down

Tax revenue will go up How do we calculate how much does the deficit go up when spending

goes up by 100 pounds Roger Middleton

o For Brittan in 1930s, effects of increased taxes and social spending changes, means the deficit goes up 56

If multiplier is 2, you can increase jobs by 2.8 million by increasing deficit by 41 million,

o Tax revenue increases and social spending decreases If the multiplier is 1.26, deficit will be much higher

o Robert Lucas, K=0. you can spend until the cows come home, and you will create no jobs

o It really matters what the multiplier is to know what to spend- Looking at Lloyd George’s policy in 1929: could he have done it?

o Glynn and Howells’s multiplier, K=1.26 Cost 192 million pounds to put people to work Deficit would have gone up by 86 million

o If multiplier is 2: to create 1 million jobs, cost 125 million/yro Lloyd George has his number almost perfect if the multiplier is 2o Lloyd George says something dumb

I can do this without increasing the deficit by one penny Its wrong, but not completely wrong

o If you believe middleton and hatton, deficit would increase by only 15 milliono Under these assumptions, Lloyd George was right, unemployment could have

been reduced to normal levels with a minimal increase in the deficit

The Depression

- The Moralso The what doesn’t go up, doesn’t need to come downo The smaller they are, the softer they fall

- The depression that starts is not all that bad in Brittan,o But Brittan has had unemployment rates of 10-15% in the 1920so The british economy does not have a domestic boom in the 1920s, there is no

roaring 20so We have the farmers in the early 20s going into debt like crazy, we have the huge

increase in durables spendingo We have this huge increase in bubble spendingo This does not happen in Brittano By overvaluing their currency, they make their growth even more sluggish

17

o Thus, the depression looks MUCH less severe in Brittan than it does in the rest of the world

o What drives downturn is a collapse in exports From 1929-1932, GDP only goes down by 4.8%, so this is nothing But exports go down 37.5% Whats driving the british downturn is not a domestic problem, but it’s a

collapse in exports The US Sneezed and the world got the flu

o The US bought enormous amounts of primary products from third world country Third world countries spent a lot of money buying british goods When the US economy collapses, US stops buying primary products,

meaning British exports collapseso The depression in Brittan is very regional

The parts of Brittan doing badly in the 20s does even worse in the 30s 1929: Wales unemployment 18.8%, 1932, 31% Coal fields and shipbuilders regions, up 18% Scotland, unemployment up 17.8% London, much less, up 8%

o British call this the slump of 1929 Affects some part of Brittan much worse than others Mainly the export areas Again, Brittan has no housing boom in the 1920s, no motor vehicle boom

in the 1920s, no agricultural boom in the 1920s, no bank failures, and no stock market crashes

o Brittan does have one thing: unemployment gets a lot worseo Unemployment gets up to 22.1% in 1932

This is primarily concentrated in the Celtic fringe- British policy during the depression

o The good : Cheep Moneyo The bad: Tariff Protectiono The really bad/stupid: Balanced Budgetso Cheep Money

British monetary policy in the 1920s was governed by the gold standard Pre 1925: we need to drive down prices to get back on gold

standard in 4.86 Post 1925, we need to maintain our currency at 4.86

It was governed by the exchange rate British raise interest rates to high levels to prevent gold outflow However, this slows down the british economy

High investment means slow economic growth The belief: saving the gold standard would have created a huge

burst in economic growth/long-run nirvana Once the US collapses, everything gets much, much worse The bank of England has been fighting like crazy to keep gold high Exports collapse even worse

Balance of trade is much worse, gold standard is much worse

18

It gets much worse in 1931 when Credit Aunstalt in Vienna fails With the huge trade deficits the british are running, speculators begin to

think that Brittan is going to go off gold Speculators begin to withdraw from the pound before the currency

is devalued They need to jack up rates even higher to protect gold, but this is

insane The only thing to do is go off the gold standard. September 21st,

1931, Brittan goes back off gold, allowing the pound to float/depreciate

o The pound plummets March, 1932, value of pound is down to 3.40

Remember, US is still on gold standard Treasury begins to do the opposite of what it did before

Treasury likes the low exchange rate because it makes british goods cheep on foreign markets

1932, exchange equalization account Allows british treasury to manage pound to make it cheep This is a complete about-face in policy, and it works until april

1933 The policy of cheep currency doesn’t work after US drops gold standard

When US goes off gold, dollar collapses, but that makes value of pound go up

By end of 1933, the exchange rate is back to about $5.00, and remains above 4.86 until WWII starts

Irony: Brittan the US fought like crazy to keep on gold standard, and on 4.86, and destroyed the economy to do it. after markets were completely open, the exchange rate got to 4.86

o Brittan goes off gold, and all of a sudden, the british treasury were no longer slaves to the exchange rate

This leads to a massive policy shift The bank of England is forced to keep exchange rates high The bank rate is kept between 4.5 & 5.5 percent At the end the bank rate is up to 6%, stays at 6% until feburary 1932 From 1925 to 1932, Brittan has very high interest rates, and very slow

growth of the money stock The money stock grows about 2%/yr

From 1929-1931 money stock grows slightly If you look at british high powered money, it is slightly more than

1931o

11-3-09

British Policy in the 1930s

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- Three Partso Cheep Moneyo Tariffs (revenue)

Not draconian, protective tariffso Balanced budgets (surpluses)

- Cheep Moneyo 1925-1931, Brittan has very restrive monetary policy because they are desperately

attempting to stay on gold standard Back on at 4.86,

o It gets much worse, 1929 after US market collapses, Brittan’s exports collapseso To counteract balance of trade deificts, to stay on gold standard, Brittan would

need to raise interest rated 1925-1932, Bank of England kept their discount rate above discount rates

above everyone else This was to attract London money in the short term They are keeping inerest rates high, but this is choking off investment

o Everything changes in September 21st, 1931o In feburary, 1932, complete about-face in monetary policy, cheep money

From februrary to june 1932, the discount rate is cut from 6% to 2% in a series of steps

o British treasury is throwing a lot of money into moneystock Growing at rate of 2%/yr

It had declined slightly because of bank failures 1930, high powered money was less than it was in 1921 British monetary policy had been contractionary throughout 20s

o However, complete about-face by the 1930s 1932-1936, money stock growing at 6%/yr

o Once gold is gone, british go to extremely expansionary monetary policy to jumpstart domestic economy

It works brilliantly Pent up for domestic housing in Brittan

Completely opposite of US From 1929-1932, expenditures on residential construction go down

1.5%, but goes down by an astronomical number in US From 1928-1932, hosuing has actually gone up,

1933, expenditure goes from 131 million pounds to 172 million pounds 1932-1933, goes up by 3.3%, increase is a lot less than 31% Gross domestic fixed capital formation has actually fallen by 28 million

pounds Spending on plant and equipment goes down 1932-1933

Not working everywhereo Therefore, the domestic housing market is single-handedly pulling Brittan out of

recession Housing is basically saving Brittan Housing boom is driven by cheep money

o Why did Brittan get out of depression

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Got off gold standard Turnaround in Brittan is going off gold standard You can’t do cheep money on gold Expansionary monetary policy

Depression in Brittan is largely an exogenous event It is not something that occurs in british economy Collapse in exports

- Tariffso Brittan was the bastion of free trade in the worldo When Brittan went free-trade in 1846, much of Europe cut tariffs sharplyo However, in the 1870s, most of Europe threw up nasty tariffs, in 1890s tariffs got

even biggero Brittan remains free-trade throughout all thiso When your economy is running balance of trade deficits, you need to figure out a

way to balance again If you can’t increase exports, you can cut imports The most simple way: pass a tariff

These rumblings for tariff gets much louder during US economy collapse

o Keynes is in favor of a revenue tariff There was unbearable pressure on English pound Bank of England could not continue to raise interest rates The government put on a tariff to ease balance of trade deficit

Its not a protective tariff It is a revenue tariff, make some money, cut imports

Use money to ease budget problems Keynes says this in march, 1931, when Brittan is on gold standard In September 1931, Keynes makes a huge about face

Everything is different, because now that we’ve gone off gold, the value of the pound is falling like crazy

This is doing the tariff’s job for us British goods become cheeper to foreigners Balance of trade problems fixes itself Pound is depreciating by 25%

o Imports will go down naturallyo Tariff, however, does nothing to help exports, and may hurt

exports The value of the pound dropping will lead to huge boom in exports

10% duty on imports Revenue tariff excludes commonwealth areas, Canada, Australia, etc Tariff’s effect on economic recovery:

Overall the contribution to the economy was a wash, it was very modest

It helps some industries, it hurts otherso Helps: iron/steep & cotton

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10% duty leads to much higher domestic production of these goods

o Hurts: Shipbuilding & housing Shipbuilding hurt because material prices go up

Shipbuilding already the most depressed industry in the country, this is just making it even worse

Housing boom: iron and steel is important in housing

o When you add all this together, there’s not much of an effect

- Balanced budgeto Labour and conservatives think that a balanced budget was important to economic

recoveryo Argument: business confidence is key to economic growth

One of the keys to business confidence is confidence in the economy, confidence that the budget is under control and ready

o The current account budget from 1929-1930 are deficits not run by choice They are deficits that occur by accident Tax revenue falls automatically, spending on government insurance

automatically goes up British government responds to these deficits much like hoover does in the

US We need to do something, and what we’re going to do

o Avg Inc Tax Rate: 1929-1930 20% 30/31 22.5% 31-33: 25% 34/35: 22.5%

o Government did not expect that there would be so many bad years in a row, unemployment insurance is supposed to balloon up and down to counteract good/bad years

o That changed in 1934, unemployment insurance needed to pay for itself Workers were taxed more, companies were taxed more

o Late 1930s, shift in fiscal policy, increase in government spending Fear of Hitler

Churchill was the one pushing this 1930s, british defense spending goes way up

While defense spending goes up by four fold in 10 years, however, spending in other sectors goes down

This is not keynsian policy, this is a fear of hitler policy o Roger Middleton

Constant employment budget We can’t look at the full employment because Brittan never came

close to full employment

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However, I’ll look at 1929 and 1937, the closest Brittan came to full employment (that was not even close)

The budget is contractionary, and gets even more contracionary as the slump gets worse, 1929, contractionary, 1934, even more contractionary

This is because government is trying to balance its current account budget British fiscal policy is very contractioanry

It turns around in 1933-1934, but only because of defense spendingo Defense jobs: 1935: 445,000 to 1938: 1,482,000

80% of the jobs created in Brittan from 1935-1938 were created in defense industry: that may include linkages

It is a great way to get people back to work, and it breaks the budget issue- Brittan is getting out of depression because it goes off gold and it is helped by a shift

out of contractionary budgets through rearmament- Say’s law

o The lowest unemployment before the rearmament was 9%o If you asked economists as to why, economists would point to Say’s Layo Jean Baptist Say

Supply creates its own demand There’s always enough money in the economy to buy all the goods

produced There are downturns, but this is from misallocation

If you let the market alone, money will flow from glut sectors to underutilized sectors

o Its very hard to reconcile say’s law Why was the unemployment rate so high for so long If you believe in say’s law, you have to believe wages are flexible So…why are wages sticky?

o Keynes came up with theory that Say’s Law is Hogwash There is a possibility that economy can get stuck in liquidity trap

o Trade unions keep firms from being flexible; Trade unions refuse to negotiate wage contracts Unions are willing to accept reverse seniority layoffs to keep downturns

o If you’re a worker that isn’t getting laid off, your wages go up, due to deflationo Other story: british unemployment insurance system was uniquely generous

between the wars If unemployment insurance is generous, the cost to be unemployment has

gone down, and the cost of leisure has gone down, A lot of this unemployment is voluntary, these people are not actively

searching for new jobso The market works fine, but is being screwed by UI and trade unionso

11-5-09

Unemployment in Inter-war Brittan

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- unemployment between 1924-1937 is very higho yet, 1951-1973, unemployment rate 2.1%

- It is no surprise that keynsian economics was invented during the interwar period- Benjamin and Kochin, (JPE, 1979)

o When it came out, Paul Craig Roberts wrote a response in the wall street journal: Phantom Unemployment

o Benjamin and Kochin say Keynes is nutso Unemployment in brittan is insanely high: 1921-38, Average=14.2%, o There is a paradox: respectable growth rates, very high unemploymento The reason for this is not because the market “failed”o The reason is, according to Benjamin and Kochin, is the national system of

unemployment insurance, with “uniquely generous aspects”o Their story is going to be UI is uniquely generous, because of this, there is high

unemployment, and much of this unemployment is thus voluntaryo The benefit/wage ratios is hovering around 50%

The benefit wage ratio in 1913, is 27% The B/w (1921-1938) about 50% If brittan had stayed with a b/w ratio of 27%, unemployment would have

been much lower Once you take out the voluntary unemployment: 5.3% unemployment in

1927. Unemployment (minus voluntary) rate would have eventually hit a low

number, if not for the fact Brittan got back on gold in 1925, sending unemployment rate back up

o The Benjamin and Kochin story is one where the economy works but it keeps getting hit by bad shocks

Big Shocks WWI, Great Depression Smaller Shocks: Gold Standard

o National unemployment insurance established in 1911, only covers 15% of workers and can only receive for a small amount of weeks, benefit wage ratio is very low

UI in 1911 is an alright systemo 1920, unemployment insurance has changed, benefits are extended to workers age

16 and older. Also increases benefits A LOT Remember, students left school at 14 Excludes agriculture and domestic servants

o Liberalized during the 1920s, getting the B/W ratio to 50%- Why is the benefit wage ratio so high?

o No experience rating: You can experience rate firms and workers Experience rating: the more you lay off workers, the more UI tax you

should pay The worker who is laid off a lot should be taxed higher (Ignore)

Firms that lay off workers more pay higher UI taxes

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In great Brittan, there is zero experience rating. They pay taxes based on their workforce.

In Brittan, there is no cost for laying off more workers, the marginal cost is zero

o Beneifts are not tied to wages Wages are tied to benefits, so that if two workers are laid off, the worker

making 40,000 year will get higher benefits than the worker making 20,000 year

In Brittan, based on worker’s age, whether they are male/female, and children

30 year old male with wife and children will get more than 30 year old single man

Regardless of what they made on the job Five workers with identical wages can get seriously differnelevens

of wages depending on family situation They will have a high benefit, but a low wage, some individuals

will have benefit/wage rations close to 100%o Waiting period

UI has very short, almost non-existent waiting period When you’re laid off, you won’t get a job on Monday, in Brittan, the

waiting period was one week before they can get benefits You can merge every other day as continuious days, and then merge non-

working days within 10 weeks As long as there is a bridge of no wages, you are immediately eligible This is called the OXO system

o OXO is a boullion cube company OXO system is an organized short time People were sharing jobs:

o If you work more than 50%, you are not elgible for UIo If you work exactly 50% of the time, you are elgible for the

UI People will get 75% pay for 50% work, this is a very attractive

option When you put the oxo system on top of it, this will lead to more

unemployment- What’s going on here:

o Generous UI should raise unemployment in two ways:o Unemployment insurance will lead to creation of sticky wages

Workers don’t like having wage cuts UI, along with trade unions, lead to a system without wage cuts We don’t have a perfect world where the markets are flexible, wage is

now set at old wage Workers will not accept wage cuts

o Benjamin and Kochen, since they don’t like wage cuts, say workers will favor sticky wages and layoffs over market economy wage rate

This will lead to higher unemployment

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o Average duration of a spell of unemployment will rise The more wages you get, the lower the cost of foregone wages are, and the

logner you can search for a jobo If you set a reservation wage higher, the odds you will get the wage you demand

is high Good news, when you get a job, you will be getting a job that’s higher

than you would have if you set a lower eageo The cheeper it is to search, and with generious UI it is, the longer you will search

for a higher reservation wageo Problems

During their regression, they bias their W up by using the average weekly earnings of all FT employees.

They get the coefficient on benefit. There is large, positive impact on the ratio

They oly use 18 data points for the regressiono Result: UI is sucking people into unemployment due to overgenerosity of

unemployment insurance- Juveniles

o Look at three catagories: people aged 16-17, 18-20, & 21-24 16-17 unemployment 5% 18-20 unemployment 10% 21-24 unemployment 15%

o UI goes up as you get oldero Wages go up too, but not as fast as benefitso Turns out that if you look at b/w replacement rates

B/W (16-17) < B/W (18-20) < B/W (21-24)o This is consistent with a story that says the B/W ratio really matterso They regressed Juvenile unemployment rate on the average wage ratio: it had no

effect- Married Women

o Fact 1: the unemployment rate for married women was above that for single women from 24-28, but the difference was much smaller after 1931

o Fact 2: Unemployment for females is less than for Males, but the gap gets bigger after 1931

o Why? The unemployment insurance system is changed in 1931 The anomalies regulation

Married unemployed women don’t want to work, they want to use the UI to supplement their husband’s income

Makes it much more difficult to get unemployment benefits if married woman

1931-1932: Unemployment rate for men: 21% to 25.4%, Unemployemnt rate for women 18 to 13%

This proves married women are abusing the system, and that its UI that is jacking up unemployment rates

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Boyer: I don’t think this is true. All it proves is that if you refuse people benefits, they’re not unemployed

o It’s a counting phenomenono I don’t think it has anything to do with women’s motives

11-10-09

Unemployment in Inter-War Brittan

- Benjamin and Kochin (1979, Journal of Political Economy)o Considered a brilliant write-up of the post war British economy o Basically says Keynes is wrong and that the market clears itself

- Regressiono Unemployment is the function of the benefit/wage ratio plus the function of total

output minus some trend output How much is output below trend And given the benefit wage ratio, does that matter

They will fixate on the coefficient on the benefit wage ratio As it gets higher,

o 16-17 year olds has low unemployment rates, but it kept going up from 18-20 and from 21-24 year olds

Benefit/wage go up in each groupo Women and married women

If you look at female unemployment after 1931, it goes down Reason: anomalies reg (1931)

Married women didn’t want jobs but they wanted unemployment benefits

What the law did was it made it significantly harder for single men and women to get benfits

This doesn’t mean anything If you’re disallowed from unemployment insurance, you will not

be counted in the unemployment rate- At the end of their paper, a brief discussion on the regional unemployment problem

o The big problem in inter-war Brittan was the regional and structural nature of ito Its much higher in some areas and some sectorso How do you explain this?

Admit that unemployment in export industries Also admit that these industries were concentrated in the north of Brittan Finally, the collapse of export industries led for them to decline

o They move onto asking why these individuals remain unemployed for so long?o Their answer: these regional/industrial concentrations of unemployment were

because of cross-regional variations in wage rates o Benefits are not tied to wages

Low-wage areas will have high benefit wage ratios on average High-wage areas will have low benefit wage ratios on average

o Oh brother moment:

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The decline in the demand for labor is whats causing all this If the demand for labor goes down, it will raise unemployment, and drive

down wages This will drive down the benefit wage ratio coefficient and have

nothing to do with the benefit wage ratio Its simple supply and demand

o What would the unemployment rate look like in post-war Brittan had there been no generous UI

Experiment: we now know the impact on the replacement rate of the coefficient

We can use that coefficient and what happens to the benefit wage ratio to reconstruct the unemployment had there been a small benefit/wage ratio

What if B/W had stayed at its 1913 level in inter-war Brittano Instead of being 50% as it was in inter-war Brittan, what if

it was at 27% If no unemployment The unemployment rate would be moving downward had it not been for

the gold standard back on in 1925 Unemployment rate jumps up again in 1930, but it’s a huge shock to the

british economy, US’s fault, but not the markets, 1932, the invisible hand comes to the fore, and 1937 everything is back to

normal You have to subtract in about 5%, about 1/3 of the unemployed

These are those who do it voluntarily Once in unemployment, they will search longer and enjoy their

leisure, because it drops sharply If you’re Benjamin and Kockin, you believe the labor market works

- Criticisms of Benjamin and Kochino Points covered

Was the UI system uniquely generous? Can it discuss regional issues? Does that regression really make sense?

Is the regression result robust?o Metcalf, Nickell, and Flores

The b/w is very high There is no experience rating Benefits are not tied to wages B/W Argument: The post war period in terms of b/w wage ratios is more

generous than in the inter-war period Experience rating: there was no experience rating in post war Brittan

either, so that doesn’t make sense Benefits tied to wages: still not tied in post war Waiting period: even more easy to get unemployment benefits

28

It seems like B & K are comparing inter-war Brittan to post-war US, since US has everything Brittan does not (expeirnece and benefits to wages)

Thus, in none of these regards the UI system is not too generous in inter-war Brittan

However, it looks very generous compared to US Yet, it does not look as good compared to post-war Brittan

o Collins Regions argument The Benjamin and Kochin story are telling an aggregate story, but we all

know the unemployment issue is regional and structural The B & K story will only work if high wage industries have low

unemployment, and if low wage industries have relatively high unemployment

Works some of the time Doesn’t work in Coal mining:

o Its high wage and high unemploymento B&K: High wage means low B/W ratio meaning U is low,

but that’s not the case Works in Cotton Really doesn’t work in shipbuilding

o High wage sector and very high unemployment Works in Gas distribution

B&K works in some sectors and not in others In more than half the time, it doesn’t work

In some cases, he gets a negative coefficient benefit/wage ratioo Omrerod and Warsick

They plot the unemployment data against the benefit wage ratio 1921-1929, negative slope

o High b/w ratios lower unemployment and visa versa 1930s,

o unemployment rate bouncing all over the place and b/w stay stable

What the heck is going on in 1920?o 19 data points, and you have an outlier, that’s bado And if you have a time series, that’s really bad

This picture isn’t fair because its not taking into account output 1920-1938, coefficient of 18.3 1921-1938, , coefficient becomes 12.6

1/3 of impact goes away If you rerun regression, and add a time trend coefficient falls to 5.6

and is no longer significantly different than zero This huge coefficnet on B is very robust

- Eichengreeno Dataset: from new survey of London life and labor (1929-1931)

An attempt to estimate household poverty in London

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It’s a 1-in-50 household survey It has all the data so you can construct a B/W ratio for every worker

surveyed

11-12-09

Barry Eichengreen

- Issues with b/w ratio o The aggregated numbers does not effectively convey the general state of british

unemployed as used by Benjamin and Kochin- Barry Eichengreen found the NSLLL

o Surveyed 1 in 50 households in londoino Eichengreen has dataset with 2,440 males aged 18 and over

Knows their age, knows their wage He can construct their precise b/w ratio, even if they’re not unemployed If you know their household, you can know their b/w ratio

o Problem: survey done over three years In October 1930, the UI/benefit system was changed Eichengreen cannot figure out when an individual house was surveyed Thus, for each house, he needs to calculate two different b/w ratios, pre-

1930 and post-1930 b/w ratio- Eichengreen calculates the replacement rate, the b/w ratio

o The unemployment rate decreased as the replcmacement rate increased This was against what Benjamin and Kochin predicted in their levels

o This suggests the Benjamin and Kochin story is too simple Ignore the Replacement rate below 20%

o Looking at non-household heads, get a different result using either pre or post 1930 replacement rates

There is a significant effect on unemployment benefits for non-household heads

Goes away in post 1930s numbers, 1930 UI change: 20% increase in benefits

- Assuming Benjamin and Kochin are correct pre 1930 data is correcto Divide adult males into two groups: household heads and non-household heads\o Why would this matter for household heads vs non-household heads

Household heads need to work, this money is needed. Household had income is needed, and they’re not willing to stay unempoloyed to have less income, they’re simply not responsive to this incentives

Cost of leisure isn’t zeroo Secondary wage earners had the leisure to take a look and find better paying jobs

that may suit their skill set more properly o Benjamin and Kockin: If B/w ratio calculation was between 50-52%, looking at if

1913 b/w ratio existed, u 1/3 more lowero Eichengreen: b/w ratio 39-42%, b/w 1913 b/w u 1/7 to 1/5 lower

- Crafts: Long-Term unemployment

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o A problem for older workers Short term is less than 3 months Long term greater than 12 months Normal unemployment term: 3 and 12 months

o Sept 1929 10.7% of unemployed long-termo June 1937, 27.5% of unemployed long termo London Umeployed

0.2% have been unemployed for five years Average unemployment duration 15.3 weeks

o Northern Unemployed 30% unemployed for 1 year 10% unemployed for five years 72 week unemployment spell These jobs are not coming back: these are huge differences

o Age categories Wales, 45-64, average unemployment two years

o Interesting fact from data, Huge gaps in any region older you are, longer unemployed

o Unemployment inflows and outflows Odds you will remain unemployed based on how long you have been

unemployed befor Interesting notes:

Take any region, any age group, and go from left to right Always get the same result, no matter where you live, no matter

what the age category, it becomes harder and harder to find a job Significance

Heterogeneous workerso Good workers and bad workers who both lose their jobso Good worker has the same probability of finding a job

every periodo Bad worker has same probability

Good workers find jobs and share of workforce gets bad

Duration dependenceo Your skills atrophy over timeo It gives the longer you are unemployed, the longer the

adverse signal you will be unemployed for Cost of unemployment Unemployemnt forecast- U Rate * duration 1929: Unemployment 10.4, Average Spell: 22.3 weeks, index 100 1933: Unemploynment 19.9, spell: 39, 333.4 1937: Unemployment 10.8, spell 41.6, index,, 193.6 Cost for unemployment 30x higher for older Welshmen than middle-aged

Londoners

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o You need to look at how long you are unemployed

11-17-09

Crafts: Long Term Unemployment

- Lots of long term unemployment in interwar Brittan- Crafts ask the question: can UI be the reason that unemployment is so high in interwar

Brittan?o Crafts runs a regression from 1932-1939, has quarterly data

Does not have output data, so for his measure of his output data, he had quarterly data on bankruptcies

o Short-term unemployment rate Here we get a positive impact on the b/w ratio There’s a big positive effect: That’s support for the Benjamin and Kochin

Oxo system, leading to organized short term and employmento However, Crafts is looking at long-term unemployment

If you run that on the b/w ratio on bankruptcies Young workers can migrate can retrain and start oer If you’re over 45, the odds you’re willing to migrate at age 45 are quite

low The other thing: even if you want to be trained to do something

else, who is going train youo Who will hire a 50 year old coal worker and get retrained in

automobile manufacturing is ludacriso If you’re Benjamin and Kochin, you believe that these people like being

unemployedo However, various publications suggest that these unemployed workers would go

back to their old job, at their old wage, or even a pay cuto Simply reducing the B/w ratio back to the 1913 level is ludacris

- Other noteso A lot of workers have stopped looking for work because they have become

depressedo This type of behavior is encouraged to some degree by unemployment insuranceo If you are a skilled worker and take an unskilled labor, you will be reclassified as

an unskilled worker, and you will not be able to refuse an unskilled jobo The UI system makes people less desperate,

Post WWII Economy

- William Beveridgeo Head of LSEo Beveridge in 1942 issued a report which became the foundation of the british

welfare state The Beveridge report

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o 1944, month before invasion of Normandy, government issued a white paper on employment policy

British government begins to talk about employment policy in peacetime British and US have great fear what peace will mean

Both US and Brittan had high unemployment rates during interwar period

There was a fear that something was wrong with capitalism Once war ended, and government spending went down again, and

soldiers sink back into unemployment, and goes back into depression

o British government decides to make a statement that it will do whatever it can to stop high unemployment

Brittan commits itself to high and stable level of employment Commits to doing this with Keynsian style policies

British still has some anti-Keynsians, but has some young, trained Keynsians, who want to use these policies to fight unemployment

o Beveridge, in 1944, publishes a book called: “Full employment in Free society” British government should strive to maintain unemployment level at no

higher than 3% Even Keynes thinks this is crazy

Election in Brittan in 1945, Churchill, the conservative, is running for re-election, of course,

the great man who has saved Brittan, gets slaughtered in the election

Labour party says it will give british the welfare state and to maintain unemployment at around 3%

o The british are optimistic and thinking what it will do in peacetime- US:

o When war ends in 1946, congress passes its version of the white paper that comes out in Brittan in 1944

Employment act of 1946 Incorrectly regarded as a Full Employment act, but it is not

The government must promote maximum employment, production, and purchasing power

Government does not define targeto Bill was greatly watered down in congress

Original bill did pledge full employment, pledged government spending, that it would generate a full employment level of production

The law does two other things: The bill sets up the economic report of the president

o Set forth conditions for which there will be useful employment for those able and willing to seek work

o Signal for government to keep unemployment low Sets up council of economic advisors

o It is the council of economic advisors that publishes the report

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This bill is opposed in congress by those who consider it liberal spending Truman and Eisenhower do not do much with the council of economic

advisors Both appointed businessmen as the chairman

o Truman and Eisenhower 1948-1960, economy does well,

Average unemployment 5%, Unemployment highest in 1958 Inflation is bad in 48 and 51 Running small surpluses and deficits except in 1959 Inflation rate below 3% Mind recessions in a few years

Ignoring Europe, japan, and soviet union, the US economy appeared to be performing well

However, comparing the rest of the economies around the world, US looks sluggish

What kind of economic policies did Truman and Eisenhower follow?

Eisenhower and Truman’s budgetary policies: adopt a budget that’s balanced at a high level of unemployment, but let it go into deficit or surplus based on busts and booms through automatic stabilizers

Automatic stabilizers G=T G=tY, you can set tax rates to balance the budget at full

employment if you know what level full employment GNP spending is

If you’re not at full employment, if Y is less than FE, given the tax rates you’ve set, you will automatically go into deficits

If the economy is overheating, government spending falls, budget goes into surplus, dragging down economy slightly and economy goes back to full employment

These will not work if the government budget is only a small share of GNP

The larger government spending is as a share of GNP, the larger the effects of automatic stabalizers

o 1920s, Government share of GNP: 3%o 1950s, 15-18%o 1990s, 21.8%o 2000, 18.4%o 2060 est: 31%

o 1960: JFK is running for president against VP Richard Nixon What does Kennedy criticize Eisenhower?

Economic growth under Eisenhower is relatively slow In the last three years (1958-1960), the economy seems to be

slowing down even faster Under Eisenhower, GDP was growing 2-2.5% yr.

o Kennedy says this is nowhere near our potential

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o Our potential is 3.5% year Giving compound interest, Labor force is growing 1.5% year Labor productivity is growing at 2%/yr Adding these together, this is how fast we should be

growing, This is on the low end, compared to the rest

of the industrialized world A 3.5% rate of growth is compatable with the economy operating

at full employment Kennedy essentially gives a number for full employment: 4%

o We’ve slid into a gap from 1954-1960s 1958-1960, it just keeps getting bigger

o This is through Arthur Ochun & Ochun’s law: Determined the correlation between unemployment

and the gap When the economy was basically sitting at 4%, the

unemployment rate goes up We’re growing too slow

What worries Eisenhower: Inflation rate 1959, the deficit explodes to 12.8 billion, 2.6% of GNP In 1958-1959, Eisenhower decides he needs to turn to active policy

o Argues at end of 1958 that he will set a new high priority for the administration, which is a budget surplus

o We have been told in the past that republicans have been worried more about inflation/unemployment

Eisenhower: If the government runs a surpluso Slows down inflationo Also, if we run a surplus, the government can use the

money its taking in to buy part of the national debt, held by Americans

People who were holding debt will invest it in firms it will finance public investment if you’re holding onto government debt, you will

not hold onto public sector investment, the public will still want to get a rate of return, and that will sprun on economic growth, he doesn’t say what this will do to unemployment

o what it seems to do in the short run is it slows down an economy with high unemployment

the government remains sluggish in 1960, economy’s sluggishness can be blamed on eisenhower’s move to balance the budget/run a surplus

Kennedy wins the election, he takes office, and he starts our being like Eisenhower and Truman, with one exception

35

Kennedy, as an economic objective, sets 4% unemployment Defines full employment Also wants more rapid economic growth As the president to officially express a goal, its still the case that he

tries to achieve objectives using orthodox economic principles, like Truman and Eisenhower, maintains that he wants to balance the budget

The economy begins to grow, like under Roosevelt, However, it slows in the summer of 1962,

Kennedy is told that economy will go into recession in 1963 Kennedy proposes a tax cut for 63

11-19-09

Kennedy-Johnson Tax Cuts

- 1959, US goes into recession badly under Eisenhowero Run a 12.8 billion deficit, unemployment close to 7%, inflation close to 3%

o Eisenhower believes there has to be something behind this, by buying debt,

Americans will get money back and invest in economyo Also raises taxes, to some extent.,

- Eisenhower wants to have a budget at full employmento Budget passed in 1959 according to kennedy’s economic advisors, would

have been at surplus at full employment- Kenney increases spending by 6.5 billion, from 1961 to 1962

o Economy starts growing, unemployment gets down to 5.5%

o Kennedy, at the moment, is not making any drastic changes in policy

Inflation is down Deficit goes up a bit, 7.1 in 1962

Debt 1.3% of GDP- Summer of 1962, Kennedy calls for active policy that will jumpstart economy

o Jan 1963, in state of union message, and in other budget speeches, called for

congress to pass a very large tax cuto “it has become increasingly clear that the largest single full employment of

our manpower and resources is the unrealistically heavy drag on federal income taxes on purchasing power and incentives”

This sounds like Regan, but it aint The thing that’s killing us is the unrealistic purchasing power and

incentives Saying this in Jan, 1963

Budget deficit in 1962, was 7.1 billion Considered, at the time, rather large People do not want a bigger deficit

36

How do you cut taxes and not have taxes go up? Kennedy’s economic advisors came up with an argument to reduce

anxiety that tax cut would reduce deficit, E Carry Brown, Full employment budget

At full employment, this budget would be at surplus The concept of the full employment budget was invented by E.

Carry brown Kennedy’s economic team uses it to explain what they will do Once the economy hits the breakeven point: the economy is

now hampered by the governmento Government will put a drag on economic growth and

surplus if the budget reaches to breakeven Kennedy’s team calls the difference between the breakeven

point and full employment “fiscal drag” Fiscal drag will never result in economy growing quickly

Fiscal drag was the result of Eisenhower in 1959o Kennedy’s plan: will have across the board tax cut, will shift tax revenue

down at any level of GNP In short run, drop of tax revenue We will not balance the budget until we hit full employment, we will

have a massive stimulus on the economy from Ya to Yfe They have cut tax rates, but increased tax revenue

This works because there is a massive stimulus in the economy- This sounds like supply side economics, Jack Kemp, Regan, and Laffer

o But walter Heller says you need to increase aggregate demand

A tax cut balanced by a cut in government spending will not lead to any rapid growth, it will not eliminate fiscal drag

As a result, reganonomics would not work because it would not deal with the issue

o Regan: The problem with the economy is the government itself

The government’s taxes have lead to problems with saving and investing

- This is not the kennedy programo A stimulus program, generated by a big tax cut, would generate an increase in

demand, which will jumpstart the economy- Did it work?

o US Tax rate: 20%-91% 1963

Dropped to 14%-65% in 1964o The economy was not in bad shape, but this was a big stimulus

37

o This is instituted immediately, people instatenously see more money in their

paycheckso At 1964 income levels, tax liabilities were cut by 14 billion, 11 billion went

to this in tax cuts and 3 billion went to corporations This is a huge stimulus package

o It looks like it worked very nicely

The deficit in 1963 was 4.8 billion, but then it shoots down, the deficit in 1965 is down to 4.8 billion

Essentially, would have had a 14 billion dollar tax cut, and the dficit in the first year its in effect would have gone up by 1.1 billion

Spending would have gone up in 1964, and would have had a 14 billion tax cut, but the deficit would have only gone up by 1.1 billion

Its clear that the economy was strongly stimulated by government policy

- Milton Friedmano Money stock has grown from 1959-1960 had grown 5.6%

o Friedman believes the reason or the slowdown in growth was not caused by

the fiscal drag, but was caused by the fact the money supply was growing so slowly

o Slow rates of money stock and slow rates in growth of economy

o From 1961 to 1966, Money stock grew more than triple rate, 19.7%

o Keynsian policy does not work, according to Friedman

- Unemployment rate keeps falling in 1968, due to Vietnam waro Inflation begins to grow, up to 4.2% in 1968, budget deficit balloons to 4.2

billion, making it the biggest peacetime deficit in percentage termso Johnson, is in some ways like Hoover, and had some extraordinarily bad luck

Johnson’s great dream was the “Great Society” Bad news: Johnson was obsessed with the not being the president that

would lose southeast asia- Johnson’s spending

o Social programming goes up 41%,

o Defense spending goes up 30%

o Government spending goes up rapidly, and there is no increase in tax revenue

o This causes the economy to overheat in 1966, and its causing inflationary

problems- The council of economic advisors is telling Johnson, you can’t keep this up without

raising taxeso You need to increase taxes or you are going to cause serious inflationary

pressures

38

o They are not willing to increase taxes for those reasons, but Congress will

look at Johnson’s budget and say that you will lose the Great Societyo You will need to cut spending on the war, and doesn’t want to be the people

who will lose indo-china to the waro Finally, in the summer of 1967, Johnson makes a proposal to congress for

what he calls a “Tax Surcharge” a 10% short term increase in taxes to try and make up for the deficitis at the moment,

By june, 1968, Johnson is not out of the race, Hubert Humprey is running against Nixon

o This generates, for the Nixon Administration, a small budget surplus in 1969

From 1969 until Clinton, no president ran a budget surpluso The problem: its too little too late

o Oil Shock, inflation hits 11% 1974,

But unemployment is not going down- The beginning of Stagflation

o The idea that unemployment and inflation would not go up at the same time

o It was believed because of the Phillips curve, there would be a consistent

trade-off It does not hold beginning in 1973, unemployment and inflation go up

at the same timeo 1974: Nixon Resigns, Gerald Ford takes over

Johnson “He played too much football without a helmet”o 1976: End of Ford Administration

Unemployment 7.6% Inflation rate is not good, but down from 11% Deficit, 73 billion, 4.2% of GNP Highest unemployment and deficit, but he almost beat carter

- Carter Erao Deficit kept going up: but we have the second oil crisis/shock in 1979

o 1980 is the last year of Carter’s presidency

o 1980 horrific year: 7.1% unemployment, 13.1% inflation rate, deficit of 73.1

billion, o Carter challenged by Kennedy in his own party, and gets Slaughtered in

general election against Regan- What we see from 1973-1980 is everything going to hell

o Unemployment, inflation, and deficit is going up

o Keynsian economics is not working

We’re running big deficits but we are not growingo This was considered the Death of Keynsianism, and demand side

39

o caused the rise of supply side economics

- Supply side economicso Arthur Laffer:

The laffer curve: If the tax rate is zero, tax revenue will be If the tax rate is 100%, you will have no revenue, people will

stop working At the top of the curve, there is a breakeven point

Laffer’s assumption: if you’re to the left of Point B, if you increase tax rates, you will get more money

If you’re to the right of the breakeven point, you will get a perverse result,

If you cut tax rates, you increase incentives for working, saving, and investing, and that is what will stimulate the ecnonomy

The laffer curve does not justify the kennedy tax cut Laffer Curve: Incentives are the key to growth and the economy has

completely screwed up incentiveso Regan latches onto Laffer

Regan: Cut tax rates 10% year for three straight years Regan’s six proposals: wins an electoral landslide

Sharp reduction in non-defense spending, other than safety nets

Slower and stedier monetary growth for reducing inflation Substantial reduction in government regulations of economy Large increase in defense spending Bringing federal budget back into a few years (fiscal ’84)

Put out by regan’s chief economic advisor, Murray Weitenbaum, puts out document: america’s new beginning

Contends the following: the most important cause of the economic problems has been the government itself, excessive government spending, high marginal tax rates, and inefficient regulation of the economy

The new economic program will reverse the debilitating combination of sustained economic distress that faces the econbomy, reduce negative expectations, and rekindle entrepenruail activity

11-24-09Reganomics- Key Points

o 10% Tax cut/year for three years Kemp/Roth Tax Plan

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High tax rates are holding down productivity If we can lower tax rates, individuals will work harder, save more, and invest

moreo Sharp reduction in funding on non-defense spending

Except safety net issueso Slower and steadier monetary growth

Problem with the economy is the government itselfo Balanced budget by fiscal 1984

- Will Rekindle nation’s entrepreneurial activity o Regan’s advisors, once they adopt the regan program, assume that within one year,

1982 growth will grow to 4.2% Compared to 1.1% growth We will exceed long-term average trend in the post-war world Very rapid economic growth

o Inflation: in three years, we will get it under 5%o Unemployment, by 1986, will be down to 5.6%, from 7.8% in 1981

- How will we do this?o Increase productivity

How to do it? Eliminate excessive government spending Decrease marginal tax rate Eliminate haphazard regulations

- Misery index: inflation and unemployment rate put togethero 1960: misery index is 7.3%o 1980: misery index is 17.2%

Been quite high since 1973o Regan: we will get it down

- How will it work?o Is it just Kennedy/Johnson tax cut? NO!

Kennedy is a demand side tax cuto Regan story is that it’s the government problem

The supply side is screwed up By cutting taxes, we’re going to create incentives for people to save more and

invest more This is the whole key to supply-side economics

o Regan knew, as all politicians knew, is that it would be political suicide to reduce spending

However, you could cut rate of growth of spending Everyone, except for the truly needy and the defense dept, would be asked to

help curb controlo Shifts in budget priorities:

More spending on defense, less on public works, and other non-defense spending

Non-defense spending goes up 25 billion over three years Increase defense spending by 92 billion

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o Balanced budget by 1984, and surplus by 1986- Supply side economics may have worked, but it was set up to fail

o It can’t possibly worko The idea is that they will massively jumpstart the economy by cutting taxes,o but the problem is that they will slash the money stock growtho They will do two things at once, slash inflation and create rapid economic growth

However, the policy to slash inflation is a contractionary policyo There was a reason: inflation was out of control

Using contradictory policies will get you in trouble If they wanted rapid economic growth, the fed needed expansionary monetary

policies- What happens

o 1981: first phase of tax cuts beginso Congress raises defense spending sharply, passes non-defense measureso The fed also slashes the growth of the money stock

What happens? Instead of a great economic spurt, US goes into major recession since world

WWII Unemployment goes up to 9.7% instead of down to 7.2%

o By the Fall of 1981: The regan administration changes its projection and says there may be deficits of over 100 billion/year

o Feb 1982, changes estimate of a balanced budget to a 80+billion deficito 1983: projecting deficits of over 200 billiono Reason is simple: tax cut didn’t generate the tax revenue they were thinking it would

It didn’t go up because the economy didn’t jump-start, it nose-dived Short term: Spending went up, but receipts went down

1981-1984: Income +tax rev up 2.4% Spending: up 25.6%

o Defense spending up 44%o Non-defense spending up 20%

o Worst record of deficits: 1983: 6.0% of GDP, Regan 1933: 5.9% of GDP, FDR 1936- 5.5% FDR 1985: 5.1% Regan 1986: 5.0% Regan 1984: 4.8% Regan 1992: 4.7% Bush I 1991: 4.5% Bush I

o 1982: Even with these loophole closings and revenue enhancements, deficit is way up

o 1985: Congress does something drastic: Gramm-Hollings-Rudman Great act that won’t work:

42

Act specified a path of deficit ceilings We need to get them down, and in five years, we need a balanced

budget If it does not get down, it will become a dreaded trainwreck

o Dreaded trainwreck: across the board cuts in federal spending, including defense (maybe not Medicare and Social security)

Belief was that if we put in the ceilings, no dreaded trainwreck would occur

What happens in 1987: The dreaded trainwreck is about to occur They rework the ceilings, it wasn’t much of a trainwreck anymore

- 1988: Regan leaves office, Bush I enters officeo Read my lips: no new taxes

Bush agrees to tax increase in 1990 Spending keeps going up faster than any tax increase Spending goes back upto 7.4%, deficit goes up to hundreds of billions

- 1992: Clinton wins officeo Taxes raised and deficit was cuto American people responded by throwing democrats out of congress

American people thus believe in free lunches- Delong and Summers

o How would you measure if the macro economy functions as well as it used to? (1988, brooking papers of economic activity )

o What Delong and Summers do is they look at two periods, 1890 to 1930, and 1950 to 1987

Compare actual output per working adult with potential Potentital is connecting economic peaks What you have is gaps: gap between actual and potential movements

per worker Gaps are bigger than they are 1950 to 1987

Average gap between average and potential output was 50% greater in 1890 to 1930 than it was 1950 to 1987

Potential is slowing down, and the gaps are getting bigger If you compare 1950 to 1970 with 1890 to 1930, the mean output gaps are

double the output from 1950 to 70 The good news: the mean output gap is only 30% greater in 1890-30 than

1970-87o Thus, the macro economy functioned much better in 1950-70 than 1970-87o Could government policy caused this?

Few aspects of post-stable world More stable financial system after the war due to federal deposit insurance

and fed acting as lender of last resort Increased use of discressionary fiscal and monetary policy Third pillar: growth of automatic stabilizers

Increase in growth of automatic progressive taxation, and increase in growth of GNP

43

Increased financial stability helps, banks are failing, but nothing like they used to

Discressioanry fiscal policy, according to DeLong and Summers has been used twice

Kennedy/Johnson Regan Do they have stabilizing effect?

o Kennedy cuts dido Regan’s policy did not, it was destabilizing

Discressionary policy does not work well because no one predicts when downturns occur

Tend to develop rapidly, these issues take a lot of timeo Delong and Summers, who are good keynsians, say discressionary policy is not the

answer In their view, the reason we had done so well is because of automatic

stabilizers Could also explain why western europe did so well in post-war

o Welfare states have huge automatic stabalizerso Delong (journal of economic policy):

1890-1916: if there was a 5% increase in unemployment, this would automatically lead the budget more towards deficit, 0.28% of GNP increase

1950-1995: 5% increase in unemp: 3.5-4.5% deficit increase as share of GNPo This, according to Delong, causes the economy to function so well after the waro Delong: there are two types of deficits:

countercyclical deficts, which are good, automatic stabalizers structural deficits, occur year after year, regardless of economy

these are bad, they are harmful to economic growth, someone needs to pay the debt sometimes, and drives down interest rates which drives down investment

deficits are NOT good all the time, and the idea of structural deficits, will be disasterous

the fact that structural deficits are bad, the idea that countercyclical deficits are not good

Keynes did not argue for structural deficits 12-1-09

FINAL EXAM WED, DEC 16TH, 2-4:30, WARREN HALL 245, 360

FORMAT IS SAME IS MIDTERM! DO ONE ESSAY AND HAVE CHOICE OF ONE OF TWO ESSAYS. FINAL WILL LOOK LIKE A MIDTERM, BUT IT SHOULD NOT BE ANY LONGER.

OFFICE HOURS: DEC 1ST 3-4:25 pm, DEC 3RD, 4-5 PM, DEC 10TH, 3:30-4:30PM, MON 14TH, 3:30-5:00, TUE 15TH, 3:30-5:00

PAPER IS DUE: 4:00PM, FRIDAY

44

Delong and Summers

- Compared potential output to actual output 1890 to 1930o The economy has functioned much better since WWII than since 1930o Gap had shrunk significantly since 1950,

1988 dollar terms, a bonus of 50 billion dollars a year, pure welfare gaino But it hasn’t been bought at the expense of inflation

If you take out the inflation peak years in 1970s, it hasn’t been all that bado Bad news: economy functioned much better from 1950 to 1970 than from 1970 to

1987o Output gap is huge in 1950-70, twice as big 1890 to 1930o But compare 1970-1987, only 30% higher than in 1890 to 1930

Something has gone wrongo Whats the hero here?: Automatic stabalizers

Government/budget is automatically shifting into deficit into downturns Bigger deficit, bigger downturns Making deficit smaller and even going into surplus during booms What makes automatic stabalizers work better than it used to? Big government

Bigger government is as a share of domestic product, the more oomph automatic stabailzers have

Gov as share of GNP Progressive taxation’

Good times, people move into higher tax brackets Bad times, people move into lower tax brackets which drive down

tax revenue Welfare state (social spending)

Goes up in downturns, down in good times- Romer

o Lets not get ahead of ourselves Delong and summers got this result, saying that the economy is better than

it used to be, but romer says theres a problem here The problem is that the data, used in the pre-1930 period, This is not government-collected data They were made up using census data and whatever output forces existed:

GNP-Simon Kuznets Unemployment: Lebergott

For decades, everyone used Kuznets and Lebergott series as gospel What Romer found out is that these series have volatility built into them

which may not, and possibly do not exist Romer reconstructed GNP numbers from 1890s and 1930s and

unemployment from period Redid Kuznets and Lebergott

45

Looked at these are measures of volatility, big is bad, small is good, the closer to zero is a better thing

Romer Compared those numbers to the volatility of business cycles Numbers from Kuznets were much higher than Romer’s According to Kuznets’s numbers, Macro economy was twice as

volatile from 1893-1927 than were from 1951 to 1980 Unemployment, Lebergott, numbers are hugely different than

Romerso Unemployment volatility 1893-1927 is three times as

volatile than 1951-1980 Romer says Leibergott and Kuznets numbers are not calculated correctly

They built in extra volatility that was not there Romer reconstructs movements in national product from 1890s to

1927 Romer’s redone numbers are much less volatile than the redone series

Romer’s series is much less volatile than both Kuznets and Leibergotts

It changes how economy looks Yeah the numbers are still worse, pre 1928 numbers are still

different, but not very big The pre-great depression economy is not nearly as volatile as we

used to believe If the pre-1930 economy is only slightly more volatile than the post war

economy, thus, despite the big government, despite automatic stabilizers, despite fine-tuning the economy, we’re doing hardly any better than if we left the economy alone

Thus, macroeconomic policy has had little effect on the stability of the American economy

She’s not challenging the post WWII numberso But we’ve been comparing the numbers with a “straw man”

something that did not exist, overly volatile conclusion Concludes: results show that the great depression was a unprecedented

collapse of a reasonably stable economy One could go beyond this is the unbelievable turmoil and say that

WWI and the collapse of the gold standard brought this on- Delong

o In a more recent paper, brad Delong has responded to Romer on unemploymento Romer’s unemployment series is right that Leibergott’s o Belief that romer and/or weir are superior to leibergott’so But adds more: extends unemployment numbers back to 1870s, using similar

adjustments to construct the numbers back to the 1870s, just for unemploymento Romers numbers are for the economy as a whole, and that includes agriculture

But the further back in time you go, the larger agriculture is as a share of the workforce

He constructs a non-farm unemployment rate There is not a lot of unemployment in agriculture

46

Agriculture is stabilizing, Malthus: industry is cyclical, agriculture is stable

o What Delong does is not look at agriculture, because the agricultural sector was quite large up to WWII

The agriculture sector would damp down unemployment, and post WWII, agricultural sector is tiny, so does it with and without agriculture

o Compare 1870 to 1910 std dev of nonfarm unemployment compared t o 1946-1975, three times less std deviation unemployment

really matters with agriculture how it works, share of agriculture is so small

o look at 1980 to 1910 compared to 1901-1930, less std deviation in unemployment 1901-1930, but higher time spent in recession

o Calculate proportion of time spent in recession Of the time spent in recession, its still twice as high

o Should the great depression be included in this calculation DeLong asks why is the great depression excluded by romer? Romer believes it is a unique occurance that could not happen at any other

time If you believe great depression was result of processes , then we should

includeo Question: is great depression something that was bound to happen under

economic structures of the time, or was it a unique occurance? If it was a unique freak occurance, it should not be included If it was not, then include it

Current Crisis

- The current recession began in December 2007- Economy began modest recovery in third quarter of 2009, but its not clear if its real, cash

for clunkers and hosuing tax credit- Unemployment hit 10.2% in October- October was the worst unemployment since 1983, worst unemployment rates were in

1982, 10.8%o There were people who are predicting 11-12% unemployment rates

- Bush policy response: o Feb 2008 passed economic stimulus plan, one time tax rebate of 300-600

dollars/person Rebates: 152 billion

o Attempt to jump-start economyo Hank Paulson: Troubled Asset Relief Program, TARP

TARP: 700 billion Also bailed out fannie mae and Freddie mac

- Obama is elected in 2008, and feburary, congress passes American Recovery and Reinvestment Act, spends 787 billion

- “That’s a lot of coin”o Obama plan has something for everyone:

47

Three main parts Federal Spending

o Infrastructure and social programs, 357 billiono 81 billion for public workso 81 billion for “protecting the vulnerable”

40 billion for extending unemplopyment insurance benefits, 19.9 billion for food stamps, etc

Tax reliefo 288 billiono 237 billion for individuals, 51 billion for companies

Money for state and local fiscal reliefo 144 billiono States and local governments cannot run deficits

- Is it gonna work?o Romer and Bernstein put out a document that it wold raise GDP by the end of

2010 and create between 3.3 and 4.1 million jobs- Response of economists:

o Reponse is decidedly mixed Supported by Joseph Stiglets, Krugman and Samuelson

o Liberal economist Robert Solo: program is too small, too late, and should have had more job creation

Infrastructe spending, 81 billion, Solo wanted moreo Conservative economist martin Feldstein supports stimulus, but on the same lines

of Robert Solo Too little job creation for such big deficit

o Stimulus is opposed by conservative and libertarian economists- This is not an ideological issue: they are very deeply divided on whether the stimulus

package can work, and will it cost too much for what its deliveringo Same argument that JM Keynes, Lloyd George, etc is: How big is the fiscal

multiplier, what effect will government spending have on the economyo Those whoa gree believe muiltiplier believe its greater than 1o Opponents believe its less than one, some believe its essentially 0o Keynes, and Henderson say, in “Can Lloyd George do it?” its essentially 2

Linkage and direct effectso No one else argues the multiplier is that high’o Congressional budget office has nine separate multipliers

For each one of the nine multipliers has two choiceso Romer and Bernstein has two multipliers: one for government spending and one

for tax cuts Their multiplier for government spending is 1.6 Tax cuts: 1.0

grounds that if the government spends money, it will spend all of it if people are given money, may save or buy imports multiplier of 1 means if government cuts taxes by 100 billion, gnp

goes up by 100 billion

48

o no free luncho Romer and Bernstein are in the administration, these are optimistic numberso Cogan et al believe the multiplier is 0.4

If government spending goes up by 100 billion dollars, GDP only goes up by 40 billion

Whats happening? Crowing out Private spending in their model, goes down by 60 billion What it means is that interest rates will be forced up, money gets

deflected, people will not borrow at higher interest rates, government is pulling money out of private sector

GNP will go up, but it will not get that much bang for buck o Robert Barro: Multiplier is essentially 0

Virtually 100% crowding out Criticizes multiplier greater than 1, free lunch that would make Charles

ponzi proud Government is somehow more able than the private sector to marshall

resources Multiplier is equal to zero Every dollar of government spending means one dollar less of

government spending, you’re no better off than befor If you believe that the private sector is better at spending, there

could be negative private sector multiplierso Economist magazine

In economy in full employment, economy close to zero However, bigger unemployment, bigger multiplier is going to be Multiplier in down economy can be greater than 1

12-3-09

Read George Orwell and E. White Bockey

Current Stimulus

- Robert Barro: how can it be possible that the government can allocate resources more efficiently

- Debate over whether stimuls policy will work/stimulate economy - Argument over fiscal multiplier: how big is it?

o Same debate over Lloyd George in Brittan in 1920s

- Romer, Bernstein: gov’t spending=1.6, Tax cut=1.0- Cogan, et al, multiplier is 0.4,

o There is crowding out, private sector spending is down when government

spending is up- Barro, multiplier is essentially zero, during large wars, multiplier is 0.8- Thus, Barro is animatedly against any government stimulus program- The size of the multiplier varies over time, varies significantly across countries as well

49

- Countries that import a lot, open economies, will have lower multipliers than countires that are more economically closed

o More closed economy, government spending will go further

o Spending money on foreign goods will do nothing to benefit, in terms of

employment- The Economist: bigger downturn, bigger multiplier

o At full employment, government spending will do nothing at all, government

spends money at full capacity, it must come from private sector, thus fiscal multipliers are near zero

o The more idol resources, its no surprise that the multipler in the 1930s is larger

than 8 or 10 years agoo Its perfectly reasonable to believe government spending will be greater than one

with idle resourceso People may react differently to government spending programs/borrowing

If spending bolsters confidence, it will lead people to spend more, which will generate economic growth

If people respond positively to stimuls program, it will work If people freak out stimulus program, if it inspires fear and anxiety, it will

not work Thus, the size of the multiplier depends on expectations

- Projected deficit in 2009, 1.7 trillion dollars, percent of GDP, 11.2% of GDPo Biggest peacetime deficit, as a share of GDP, was the regan deficit of 1983 which

was 6%, this is virtually double the peacetime deficito This is small compared to the WWII deficits

o Even without Iraq and Afghanastan, prof believes that it would be one of the

highest deficits in historyo These are still bigger than anything we had in Vietnam or Korea

o Where is money coming from? Fall of 424 billion, 20% increase in spending

133 billion of money is TARP 291 billion is bailout of fannie mae and Freddie mac In any case, these numbers are disconcerting

o Individuals worry about inflation due to low interest rates and deficits

o However, Congressional budget office estimates inflation rates of only 1.5-2%

For those who are terrified of inflation, CBO does not share fearo The deficits are very optimistic guesses of what will happen to deficit

They are assuming that government will keep spending under control

Post-War Brittan

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- In 1944, British government puts out white paper saying it is an important thing to try and keep unemployment low, because there was a fear that once the war ends and soldiers come home, that the british economy will slide once again back into depression

- 1945, after VE day, Brittan has electiono Churchill is running for reelection as a conservative

o One of the things Churchill says is that we cannot promise too much to british

people We can’t promise low unemployment and welfare state, because we do not

know if we can afford ito The labor party says they will bring in the welfare state and the beveridge plan,

and will follow white paper and pledge whatever they can to bring about full employment

- Who do you vote for?o Do you vote for the war hero or the labor party and the promise of a better future

o Both parties are accepting welfare state and keeping low

o Conservatives in Brittan were trying to get welfare state

- By 1950s, conservatives pledge they will not dismantle welfare state- Looking at statistics, Brittan is like US but only magnified

o 1946-1973, Brittan is in a golden age

o 1974 onward,

economy in Brittan has not done well- The golden age

o From 1920 on: the british government redefines what it means to be unemployed

o The unemployment rates were bad, but they were worse than the official numbers

The official numbers were a mirage by the Thatcher and Major governments

o Avg unemployment rate from 46-63: 2.0%

Between 1946-1970, unemployment rate was over 3% for 4 monthso When Beveridge claimed the government should stay below 3%, even Keynes

thought he was insane, and said they should pledge a more attainable rateo Inflation rate from 46-70 was 4.6%

High but not terribleo Main cause: wages increase because of low unemployment, the labor market is

incredibly tight When the economy is booming and there is no idle resources, wages can

increase rapidlyo Workers are doing incredibly well

Economists claim they have solved macroeconomic problems- They were in for a rude shock in the 1970s

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o 1974-1999: avg unemployment rate: 9.3%

Avg inflation: 7.4% Inflation goes up 2.8% and unemployment more than quadruples

- If you compare Britain to US, looking at unemployment rates, it looks like US is real laggard

o From 1974-99, US averaged 6.6%, much better than the 9.3

- Unemployment in 1980s in Brittan is above 10% for the majority of the decade- What jumps out is how good was the golden age was

o US is looking very bad compared to Brittan

o Question: whats wrong with American labor market at the time? Or whats right

with the british labor market?- R.C.O Matthews (EJ 1968): Why has Brittan had full employment since the war?

o Matthews: We all know what the typical explination is: the british government

has adopted a full employment policy, and that’s the cause of full unemploymento The government is increasing aggregate demand, when its quite low

o The government had made up the fiscal policy during downturn, the keynsian

revolution is a success, we’re home freeo It appears in 1968, this is all true:

o Matthews, however, says this story is not right

When you look at the data, the first thing you see is that the british government is running current account surpluses, equaling 3% of GNP

Government fiscal policy, in reality, has actually allowed government to run current account surpluses

Government is not helping the economy at all, If that’s the case, whats going on? What makes the period so much

different? Looks at consumption spending, government spending, exports, etc Peak periods of demand, looking at investment

1929: 8.8% 1937: 10.3% 1955: 15.6% 1960: 17.2% 1964: 18.6%

These numbers are not only high compared to interwar, these numbers were also high pre-1914

They are incredibly high Whats driving the post-war economy is very rates of investment in the

private sector Whats driving this investment? The reason has to be either demand or supply

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This is largely a demand story It appears that the investment demand schedule in post war Brittan has

been abnormally high This is very strange?

Why? The reason the investment demand schedule is so high because it

was so low in the previous 40 years 1908, Brittan had serious downturn, but in 1914, WWI started,

very little private investment, interwar period was very screwed up, total average investment rate was quite low,

WWII, there was massive destruction of british plant and equipment by bombing

1908-1948: domestic stock of fixed capital was growing at rate of 1% year, insanely low

Average growth rate of 1% yearo Imagine pent up demand for 40 years, 40 years of

unrealized investment opportunities All of a sudden, economy explodes with pent up demand, there is

cyclical boom of gigantic, biblical proportions This is a historical accident, the reason Brittan has this boom because of

how badly the economy performs during WWII If this is a huge historical accident, its going to end, and it will end fairly

soon The reason we’ve been doing so well is because of how badly things have

gone with the two wars and in between We will come back to earth, and will come back shortly

o When he wrote this, many people began to agree with Matthews 10 years later

Interesting thing to think about: Delong and summers: could be a big explanation that 50-70 was a good economic time is the same story

Pent up demand during the 1930s and 40so Could be the reason all of western europe did so well in post-war was because of

pent up demand that all started with WWI- However, there is one weird issue with this story:

o Why can’t the demand story tell us everything?

o If this is all pent up demand, what should be happening?

The peak investment should be going down after the middle, peak should be in the 50s and the investment should decline in the 60s

o But that doesn’t happen

o Thus, maybe there is a government stimulus story

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o One possibility is that interest rates have been historically low, but doesn’t

explain why it would go up, unless interest rates went down in the 60so Another: Tax policy is being changed in ways to benefit business

Evidence tax policy changed in the 60s Grants for distressed areas and it spears that this tax treatment gets more

generous and drives these numbers up Tax policies towards business,

o Another; change in expectations based on government policies

British business has more faith in stability of economy after WWII and that risk is going down

Business believes government rhetoric If you believe risk is down, you will make larger investments Evidence you should be seeing: profit rates should be low,

o However, possible it was an accident

o The golden age could have been the rainbow after the great flood

- Things really fell apart in the 70s and 80s- We all blame Margret thatcher, and she has a lot to be blamed for, but the prime minister

in 1976, but James Callaghan, labor prime minster said in 1976, we used to think we can spend our ways out of downturns, but this is not true anymore

o There was no reason, after Callaghan said this, that there was no reason to vote

conservative- In 1985 white paper in unemployment policy, it basically said the workers and trade

unions were to blame for unemployment, if they want to take jobs, they should accept lower wages

o Jobs will be created to the extent that they will accept that workers can afford

- Final nail in coffin for Keynsianism in 1985

E. Wight Bakke

- looked to understand the effect of the british system of unemployment insurance on the willingness and ability of the worker to support himself

- workers estimate of unemployment insuranceo workers are in favor of some unemployment insurance

o confused and frustrated at times, but in general appreciation of the security given

o to the question: should the state support us when we’re out of work is responded

to by: “the state isn’t just giving it to us, we’re paying for it”- effects of unemployment insurance

o kept workforce at minimum way of life, unrest at minimum and communist

agitation minimalo higher utilization than otherwise

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- security vs fearo the fact that the social security system provides a feeling of security, or that it

reduces the feat, may have some effect- effect on willingness to work

o worker comes to a period of unemployment with experiences and attitudes

o there are distinguishable groups of workers in the menbersip in which is

determined by life circumstances, and the folkways and attitudes which have grown of these

o many assume unemployment insurance causes individual’s willingness to work,

Bakke refuteso worker feels helpless with fate

o workers enterence into work has been early, required to contribute to the family,

cut off at 14-16o chapter on foresight: difficultires to practice of foresight when it had to be

adjusted to smaller and variable minimum wageo workers satisfaction on job is limited by monotomy of word

- difference in attitude amongst workers towards unemployment vary between conditions of life as well as skilled vs. unskilled worker

o several factors on man’s willingness to support himself

scale of wages occupational status and opportunites discipline of his training and experience the regularity of his employment length of time out of work possibility and practice of foresight group association attractiveness of home surrpounding to be preserved religious and moral influences possibility of satisfaction personal character and qualifications

o skilled worker has advantage

skilled worker has higher wages as head of household, artisans have budget surplus

occupational status is favorable for worker initial advantage of training sets of children sets one group apart from

another the unskilled laborder is more victim to severe periods of unemployment skilled laborer has better foresight artisans are more frequently members of trade unions

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home surrounding different to rents paid and space available, home ownership larger in skilled arena

church membership higher in skilled groups safasfaction of laborer at work was limited to wage, skilled worker had

more interesting work, higher wage, and better homelifeo social leglislaiton between skilled and unskilled worker

different effect on different groups basis for developing support are strong in all groups that a signle item in

the whole setting conteracts the total influence- activities when unemoployed

o found that 80% of those unemployed who found jobs did so by the efforts made

outside the exchanges, job hunting was seen to be well-developed and possible methods thoroughly exploited

o unemployment insurance served as a check so that men did not take odd jobs

o unemployment insurance also acted as a deterrant for individuals to strike out for

independent worko british labor is very immobile so far as movement between localities is concerned

unemployment roots individuals to their locality majority of those british out of work are not loafers, only single digit of

those unemployed\- pauperization

o argument that giving individuals money without adequate return will “pauperize

them”o not clear what pauperization involves

circumstances that make It necessary for a macn to make a living by sponging off the state instead of unearned fortune

o unployment benefit isn’t much but such as it is saves a man from the necessity

from sacrificing his socio-economic group o to the extent it places a barrier between him and that hopeless and discouragement

is the essential characteristics of pauperismo unemployment insurance has not made paupers, it has revealed some of them and

supported themo criticism of insurance is that it treats lives alike which are in reality, very unlike

- conclusiono fear of concerning the effect of unemployment insurance on the malingering

tendencies of human nature seems to undermine the purpose of social insuranceo there are few who work with exceeding ambition and few who are overly lazy

social insurance is not involved with them, it is involved with those who are good indiviudlas making the best of the situation presented

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o problem of social insurance is first of all to make more secure happiness or

ordinary mano it is as effective a remedy for the problems of pobery and maladjustment to stop

the movement in that direction as it is to apply remedies once an indivudla or a family has arrived

o the value is not that a system of insurance says you can’t eat if you don’t work,

but it is if you do work, you can eat.

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