A few days ago I had the opportunity to comment on an old VoxEu piece by Ohanian. Now he´s made a presentation at the Hoover Fed Conference – Monetary Policy in the Midst of Big Shocks – that is dismaying in its conclusions. From the abstract:
This paper studies the impact of the largest deviations from price stability during the Fed´s first 100 years, with a focus on understanding the Fed´s role in impacting the economy during the post-World War I period, the Great Depression, World War II, and the Staglfation of the 1970s. I find that deflation was very depressing in the 1930s, but because of cartel and wage setting policies, and that there is no presumption that deflation is as destructive as commonly believed. In particular, the similar deflation in the early 1920s did not depress the economy nearly as much as in the 1930s. I find that the biggest impact of monetary policy during World War II was in debasing debt through inflation, which was achieved without much impact to Fed credibility. I find that the main drivers of the 1970s economy were long-run changes in productivity and the labor market, and that there may have been little that the Fed could have done at this time.
In other words, deflation per se is not too bad and usually there is little the Fed can do; that being because recessions, according to intransigent RBC theorists, are always a real phenomenon.
The “Great Depression” chart is revealing of the monetary nature of the depression. I stop in mid-1937 to avoid being caught by the 1937-08 recession within the depression, once again the result of Fed/Treasury bungling. While the former raised required reserves (minor effect) the later began to sterilize gold inflows (major effect. See Douglas Irwin´s “The policy mistake of 1937”).
There´s no escaping a “Great Depression” if a steep fall in velocity is accompanied by a significant drop in money supply. And that was the major reason for the string of bank failures which began in late 1930, more than one year after the recession began.
NIRA, which contemplated the cartel and wage setting policies, was a recovery stopper, but was not related to what gave the recession its moniker “Great”. That was the exclusive responsibility of the Fed and monetary policy. In fact as soon as NIRA is declared unconstitutional in May 1935, the trends pick up again!
Why didn´t the economy reverse when NIRA was implemented? Ohanian in his VoxEU piece argues that the Great Depression was due to Hoover´s labor policies, which were very similar to the ones in NIRA. This time around, however, FDR´s “good monetary policy”, which entailed devaluing the dollar (delinking from gold) and establishing a commodity prices target were sufficient to avoid the worst!