Working Paper: CEPR ID: DP2547
Authors: Albrecht Ritschl; Ulrich Woitek
Abstract: This paper recasts Temin's (1976) question of whether monetary forces caused the Great Depression in a modern time series framework. We analyse money-income causalities and predict US output in a recursive Bayesian framework, allowing for information updating and time-varying coefficients. The predictive power of money aggregates and the Fed discount rate is in general very weak and collapses after the crisis of the gold standard in 1931. In contrast, non-monetary variables, particularly leading indicators of residential construction and equipment investment, have impressive forecasting power, forecasting almost half the output decline already in mid-1929. Our recursive framework also allows examination of the stability of our estimated dynamic parameters. Recursive estimates of the monetary impulse responses exhibit remarkable structural instability and strongly react to monetary regime changes during the depression. This phenomenon is discomforting in the light of the Lucas (1976) critique, as it suggests that the money/income relationship may be endogenous to policy and was not in the set of deep parameters of the US economy. Given the instability and poor predictive power of monetary instruments and the strong showing of leading indicators of real activity, we remain skeptical about a monetary interpretation of the Great Depression in the US.
Keywords: conditional forecasts; great depression; money-income causality; recursive estimates
JEL Codes: C53; E37; E47
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Monetary policy (E52) | US output during the Great Depression (N12) |
| Monetary shocks (E39) | Onset of the Great Depression (N13) |
| Leading indicators of real activity (E32) | Predictive capacity prior to the stock market crash (G17) |
| Non-monetary variables (E19) | Forecasting power for output decline by mid-1929 (E37) |
| Money-income relationship (E41) | Instability in parameters governing the relationship (C62) |
| Impulse response functions (C22) | Structural instability in relationship between monetary policy and output (E19) |