Prices During the Great Depression: Was the Deflation of 1930-32 Really Unanticipated?

Working Paper: NBER ID: w3174

Authors: Stephen G. Cecchetti

Abstract: Several explanations for the depth of the Great Depression presume that the -30% deflation of 1930-32 was unanticipated. For example, the debt-deflation hypothesis originally put forth by Irving Fisher is based on the notion that unanticipated deflation increases the burden of nominal debt, adversely affecting the banking system and the aggregate economy. Other theories imply on ex ante real interest rates being low during the period, and so it is essential that the deflation was unanticipated. This paper measures inflationary expectations from data on prices, interest rates and money growth in order to investigate whether the deflation could have been anticipated. Current econometric techniques are used to compute expectations implied both by the univariate time series properties of the price level, and by the information contained in nominal interest rates. The major conclusion is that price changes were substantially serially correlated, and so once the deflation began, people expected it to continue. This implies both that the deflation was anticipated, and that real interest rates were very high during the initial phases of the Great Depression. These results call into question the validity of theories that rely on contemporary agents' belief in reflation during the early 1930s, and provide further support for the proposition that monetary contraction was the driving force behind the economic decline.

Keywords: deflation; Great Depression; inflationary expectations; monetary policy

JEL Codes: E31; E32

Causal Claims

Cause	Effect
prior experiences of deflation (E31)	anticipated deflation (E31)
persistence of inflation expectations (E31)	anticipated deflation (E31)
anticipated deflation (E31)	increased real interest rates (E43)
increased real interest rates (E43)	economic behavior (investment and consumption decisions) (E20)