The Three Monetary Systems During the Civil War

Since Paul Krugman is talking about the 150th anniversary of the U.S. Civil War outbreak, it is worth recalling  the great monetary experiments created by the Civil War.   This great event resulted in the establishment of  three monetary regions in the United States: the Greenback monetary system, the Yellowback monetary system, and the Confederate monetary system.

The Greenback monetary system emerged in the East when the gold standard was suspended so fiat currency could be introduced in 1862.  There was no central bank at the time, so the new fiat money   popularly known as the greenback was introduced by the U.S. Treasury.  Ironically, the Treasury Secretary who introduced the Greenbacks, Salmon Chase, would later become Chief Justice of the Supreme Court and rule that the fiat currency was unconstitutional.  The Greenbacks were highly inflationary as seen in the figure below:

Between 1862 and 1865, the price level rose about 60% because of excessive issuance of greenbacks.  Over the next thirty years, the price level decline by almost 50% due in part to a desire to return to the gold standard by 1879.  Doing so required either retiring the greenbacks (done initially) or freezing the stock of greenbacks (done later) and allowing the economy to grow into them. Once the gold standard was resumed, the price level continued to fall as the growth in gold was slower than the growth of the economy.   Eventually, the price level was about where it was prior to the Civil War.  Fortunately, this 30 year run of falling prices was associated with on average rapid real growth, rising real wages, and increasing financial intermediation as noted here. 

The Yellowback monetary system emerged in California during the Civil War.  California never left the gold standard and it dollars remained gold-backed.  These so called yellowbacks floated against the greenbacks until resumption of the gold standard in 1879.  Greenbacks did find their way to California, but were quickly returned to the East as payment.  No greenback banks every took hold in California. Because the Yellowback monetary system continued until 1879, the United States truly was a dual currency nation during this time.  Hugh Rockoff marvels at this dual monetary experiment:

[F]rom 1865 to 1879, when the greenback currency became convertible into gold we have a monetary rarity: a strong political union, untouched by war, with two currencies, greenbacks and yellowbacks, circulating at a floating exchange rate. 

[Update: Here is another Hugh Rockoff paper on the Yellowbacks.]

The Confederate monetary system emerged in the South as a way for the South to gain autonomy and finance the war effort.  The confederate dollar was a fiat money like the greenback and its value ultimately rested on the outcome of the war.  Thus, whenever the South was winning victories the confederate dollar appreciated and when the North was winning it depreciated.  Here is a picture from Feenstra and Taylor International Economics textbook that captures these developments:

Though there were other important monetary changes during Civil War like the introduction of the flawed National Banking System, the three monetary system that emerged during the Civil War was truly a remarkable development.

About That 'Long Depression' of the 1870s

Over at Angry Bear, Spencer asks a question:

[W]hat about the recent argument by Bryan Caplan... that the decade of 1870's was the peak for Libertarian freedom and economics[?] Maybe, but I wonder if he is even aware that economic historians label the 1870's as the "Long Depression". I find it really amusing that he so proud of what others call a depression.

I cannot speak to the historical peak of the libertarian movement, but I do want to address the claim that "economic historians label the 1870's as the Long Depression." That may have been the case in the past, but recent scholarship completely refutes this notion. According to a number of studies there simply is no evidence for a prolonged recession in the 1870s. I have covered this issue before and have the reposted that discussion below. Before turning to this discussion let me point out that Joseph H. Davis in his Journal of Economic History paper notes that the cycle dates set by the NBER in 19th century, which do show a prolonged recession in the 1870s, are flawed because they relied heavily on (1) qualitative information which tended to notice downturns more than upturns and on (2) nominal measures rather than real ones. Therefore, the NBER cycle dates for the 19th century are not reliable. Now here is my previous discussion:

About that Great Recession of 1873...it did not last until 1879 and it is not the longest U.S. economic contraction on record. One would not know this, though, by looking at the NBER's business cycle dates. These dates show this economic downturn lasted a record 65 months from October 1873 through May 1879. Therefore, it is understandable why observers like Paul Krugman, Matthew Yglesias, and Robert Shiller continue to invoke this period in their discussions of the current economic crisis. These dates, however, are wrong according to a series of papers published by Joseph H. Davis ( 2004, 2006 ). Using a new and more robust measure of industrial production for the Postbellum period, Davis shows most of the NBER recessions during this time are overstated. In the case of the 1873 downturn it only lasted 2 years. The popular Balke and Gordon (1989) real GNP series for this period similarly shows only a 2-year recession following the 1873 economic downturn while the famous Romer (1989) real GNP series shows no recession at all during this time. Unfortunately, the NBER has not revised these dates and, as a result, it continues to add confusion.

The figure below shows the log version of these three series for the Postbellum period. Nowhere in this figure is there 5 year + economic downturn in the 1870s. (Click on figure to enlarge.)

Update: Commentator ECB points us to this interesting NY Times piece on the 1870s.

Revving Up the Great Depression Debate, Once Again

What ended the Great Depression? Christian Romer made the case in a famous article that it was FDR's unconventional monetary policy--not sterilizing the gold inflows from Europe and devaluing the dollar in terms of gold--and not fiscal policy that ended the Great Depression. More recently, Gauti Eggertsson argued it was not unconventional monetary policy itself but rather a change in expectations from a number of policies that ended the Great Depression. His view is that FDR's monetary and fiscal policies changed deflationary expectations to inflationary ones and in so doing got nominal spending going again. While Eggertson's explanation is intuitive, it goes against Romer in arguing fiscal policy mattered too. It also makes a provocative claim that the National Industrial Recover Act (NIRA) played an important part in ending the deflationary expectations. The implication, then, is that any immediate output loss generated by NIRA cartel and monopoly-like policies was more than offset by the increase in output generated by the change in inflation expectations the NIRA helped create.

Eggertson's paper provides a clever but controversial interpretation of this period. And Steven Horwitz is not buying it one bit. He has a new article in Econ Journal Watch that questions Eggertson's paper. He specifically says Eggertson has his basic history wrong for this period and thus his DSGE model--the source of the paper's findings--has little merit. Horwitz paper is interesting and is sure to rev up the Great Depression debate once again. In case you missed this long-running debate in the blogosphere here was my past attempt to summarize it. (Click on picture to enlarge.):

Is This Economic Crisis a Key Turning Point in History?

Like other observers, Niall Ferguson says maybe:

Could this be one of those great turning points in history, when the balance of power tilts decisively away from an established power and towards a rising challenger? It is possible. Financial crises often accelerate the gradual shifting of the geopolitical tectonic plates; they are to history what earthquakes are to geology.

It was inflation that undermined the foundations of Habsburg power and opened the way for the Dutch Republic. It was the disastrous Mississippi Bubble of 1718-19 that fatally weakened ancien régime France, while Britain survived the contemporaneous South Sea Bubble with its fiscal system intact. For most of the nineteenth century, financial crises in the United States had only marginal effects on the City of London. By 1907, however, a Wall Street crash could send a shockwave across the entire British Empire, a harbinger of a new era of American power.

Something similar may be happening as a consequence of the American financial crisis that began nearly two years ago. The flapping of a butterfly's wings may trigger a hurricane in the Home Counties; in much the same way, a crisis in the market for subprime mortgages could signal the waning of US hegemony and the advent of a Chinese century.

About That Economic Downturn of 1873...

It did not last until 1879 and it is not the longest U.S. economic contraction on record. One would not know this, though, by looking at the NBER's business cycle dates. These dates show this economic downturn lasted a record 65 months from October 1873 through May 1879. Therefore, it is understandable why observers like Paul Krugman, Matthew Yglesias, and Robert Shiller continue to invoke this period in their discussions of the current economic crisis. These dates, however, are wrong according to a series of papers published by Joseph H. Davis ( 2004, 2006 ). Using a new and more robust measure of industrial production for the Postbellum period, Davis shows most of the NBER recessions during this time are overstated. In the case of the 1873 downturn it only lasted 2 years. The popular Balke and Gordon (1989) real GNP series for this period similarly shows only a 2-year recession following the 1873 economic downturn while the famous Romer (1989) real GNP series shows no recession at all during this time. Unfortunately, the NBER has not revised these dates and, as a result, it continues to add confusion.

The figure below shows the log version of these three series for the Postbellum period. Nowhere in this figure is there 5 year + economic downturn in the 1870s. (Click on figure to enlarge.)

The Latest Installment in the New Deal Debate

The latest installment in the ongoing New Deal debate comes from Harold Cole and Lee Ohanian. Writing in today's WSJ they move beyond the unemployment numbers discussion and present data on hours worked, consumption per capita, and nonresidential investment:

The goal of the New Deal was to get Americans back to work. But the New Deal didn't restore employment. In fact, there was even less work on average during the New Deal than before FDR took office. Total hours worked per adult, including government employees, were 18% below their 1929 level between 1930-32, but were 23% lower on average during the New Deal (1933-39). Private hours worked were even lower after FDR took office, averaging 27% below their 1929 level, compared to 18% lower between in 1930-32.

Even comparing hours worked at the end of 1930s to those at the beginning of FDR's presidency doesn't paint a picture of recovery. Total hours worked per adult in 1939 remained about 21% below their 1929 level, compared to a decline of 27% in 1933. And it wasn't just work that remained scarce during the New Deal. Per capita consumption did not recover at all, remaining 25% below its trend level throughout the New Deal, and per-capita nonresidential investment averaged about 60% below trend. The Great Depression clearly continued long after FDR took office.

The rest of their article explains how the New Deal created the above numbers. There is nothing new in their story, but their numbers certainly are interesting. I am looking forward to reading what Eric Rauchway, Brad DeLong, Paul Krugman and others have to say in response to this piece. Please guys, don't dissapoint me.

If you are interested, the Ohanian and Lee data can be found here.

Update: Eric Rauchway replies here. Among other things, he notes Ohanian and Lee's critique is narrowly focused on the NRA and ignores New Deal policies that did work (e.g. devaluing the dollar, not sterilizing gold inflows, and shoring up banks).

Update II: Brad DeLong provides a great response here.

The Great Depression Debate in One Picture (Part II)

Over at his blog, Eric Rauchway takes note of my attempt to summarize the Great Depression debate in one picture. He asked me what years I used to make the trend. The answer is I used the entire 20th century to estimate the fitted linear trend. The figure below shows log real GDP and trend log real GDP for this time. This figure also make clear why constructing the trend this way is a reasonable approach: it shows a persistent pattern of growth for the entire period, except for the 1930s. (Click on figure to enlarge.)

Eric also notes that my original graph only speaks to one of the three Rs--relief, recovery, and reform-- of of the the New Deal, the recovery. I am not sure there is a good way to summarize the other Rs, but the figure below which similarly graphs per capita log real GDP and its trend may provide some perspective on the relief front. (Click on figure to enlarge.)

All data comes from the historical GDP database at EH.Net

The Great Depression Debate in One Picture

The debate on whether the New Deal ended or prolonged the Great Depression of the 1930s continues with the latest installments coming from David Sirota of Slate and Jason Bean of The Beacon (hat tip Alex Tabarrok). This debate has been an ongoing one in the blogosphere with notable discussions in the past coming from Brad DeLong, James Hamilton, and Arnold Kling. Lately, though, this debate has taken on an increased intensity as many observers have been using the Great Depression experience to make sense of the current economic downturn. Among others, recent contributors to this debate include Paul Krugman, Alex Tabarrok, Eric Rauchway, Robert Higgs, and Amity Shlaes. With apologies to the contributors for oversimplifying, here is my attempt to summarize and capture the essence of this debate in one picture (click on figure to enlarge):

The Consequences of Paying Interest on Excess Reserves

Jeffrey Hummel has an interesting piece on the Federal Reserve paying interest on excess reserves and its unintended consequences (ht Tyler Cowen):

So again, the accumulation of excess reserves may reflect the perverse impact of central banks paying interest on them... I predict that future economic historians will look back on this change as a major blunder during the current credit tightening, making traditional monetary policy less effective.

If this policy turns out to be a major blunder, future economic historians will probably compare it to the one the Fed made in 1936-1937.

The Real Balance Effect During the Great Depression

Okay, one more posting on the real balance effect and the vertical AD curve during the Great Depression. Yesterday, Paul Krugman set out to demonstrate why the real balance effect did not matter during the Great Depression. His main point was that the impact from even a sharp fall in the price level would not be that consequential for aggregate demand since the monetary base itself is not that large and the wealth effect is similarly modest in size. His post, however, only raises more questions:

(1) Krugman doesn't actually look at 1930s data--which was the original point of contention--but at current data. One, therefore, cannot easily draw conclusions about the real balance effect during the Great Depression based on his posting.

(2) Why look only at the monetary base? Real money balances would at least include M1, if not M2. Since these monetary aggregates are notably larger than the monetary base, the real balance effect would be larger than Krugman shows with the monetary base.

(3) Krugman assumes a standard wealth effect elasticity of 0.05%. This estimate is usually associated with a wealth effect from stocks during normal times, but it is not clear it would be the same for real money balances during periods of intense economic distress. Consumption smoothing is the reason the the wealth effect number is less than one in normal times--individuals would not want to consume all their wealth gains presently but spread it out over time to smooth consumption--but when one's world is collapsing around them, as it was during the Great Depression, are individuals really thinking about consumption smoothing over their lifetime? During such times, individuals get myopic and think more about just making it through the day. This would imply a higher wealth effect elasticity for real money balances. A paper by Karl Case, John Quiqley, and Robert Shiller shows that wealth effects do change based on the the type of wealth. In this paper, the authors discuss some interesting findings on various wealth effects:

Differential impacts of various forms of wealth on consumption have already been demonstrated in a quasi-experimental setting. For example, increases in unexpected wealth in the form of large lottery winnings lead to large effects on short-run consumption (see Imbens, Rubin, and Sacerdote, 1999). Responses to surveys about the uses put to different forms of wealth imply strikingly different “wealth effects” (Shefrin and Thaler, 1988).

The bottom line is that not all wealth effects are the same, even in good economic times. Throw in bad economic conditions and all bets are off on the 0.05% wealth effect number used by Krugman.

So let's put points (1) - (3) to use and construct the real balance effect in 1933--the last year of the Great Contractions--following Krugman's method. First, take a look at M2, real M2, and nominal GDP for this period in the figure below: (Click on the figure to enlarge.)


Real M2 is constructed by deflating M2 with the GDP deflator. All data come from here and here. Using 1929 as the base year, real money balance wealth gains were $11.26 billion in 1933. Using Krugman's 0.05% wealth effect number times the $11.26 billion, we get $0.563 billion which is about 1% of nominal GDP ($56.4 billion) in 1933. If we assume a multiplier of 2, as did Krugman, then the real balance effect raises GDP by about $2 billion or about 2%. This non-trivial increase suggests there was at least some downward slope to the AD curve.

But wait, what if my contention that Krugman's 0.05 wealth effect elasticity is on the low side is correct? Then there would be even a larger gain to GDP. Using the same approach as above, here are some possible scenarios using slightly higher wealth effect numbers:


Again, when people are living day-to-day they are probably not thinking about consumption smoothing, but rather are spending any by any means possible, including their wealth gains. Consequently, if anything these numbers are probably on the low side. Now, this analysis, is far from complete, but at a minimum it shows that a meaningful real balance effect was possible during the 1929-1933 downturn. These results, in conjunction with Tyler Cowen's point that an infinite liquidity preference is needed here, make it hard for me to believe there was a vertical AD curve during the Great Contraction.

Update 1: ECB in the comments notes a flaw in my analysis: the real balance effect should only apply to outside money since it only--and not inside money like M2--is a net asset to the private sector. This means my analysis overstates the real balance effect. It also means Krugman was correct to use the monetary base. See here for more on this point.

Update 2: Based on the flaw mentioned in update 1, I redid the analysis using Friedman & Schwartz's monetary base numbers. Using 1929 as the base year, one finds a real money balance gain of $2.85 billion by 1933. Again, using Krugman's multiplier of 2 and allowing for different wealth effect elasticities, here are some scenarios:
To get a meaningful real balance effect then, one must allow for higher wealth effect elasticities. As argued above, such high wealth effect elasticities are entirely reasonable during times of severe economic distress.

Paul Krugman and the Vertical Aggregate Demand Curve

Paul Krugman is all over Amity Shales's argument that the New Deal's high wage doctrine reduced employment and ultimately output. He blasts her here, here, and here. His main beef with Shales is that her argument assumes an downward slopping aggregate demand (AD) curve which he asserts was not possible during the early-to-mid 1930s. In his words:

[I]n normal times the AD curve slopes down, we think, because other things equal a higher price level increases the demand for money, which drives up interest rates, which reduces desired spending. (In terms of IS-LM analysis, higher P leads to lower M/P which shifts LM left.)

But in liquidity trap conditions, the interest rate isn’t affected at the margin by either the supply or the demand for money – it’s hard up against the zero bound. And as a result the usual explanation for the downward slope of the AD curve doesn’t work.

As a result, Krugman claims that instead of a downward slopping AD curve there was a vertical slopping AD curve. This, in turn, means any leftward shift of the AS curve from the high nominal wages should have no effect on output. Here is his money graph:There is a problem, however, with Krugman's story. It assumes there is no real balance (or pigou) effect and if there is one Krugman claims it is swamped by the impotency of the interest rate channel effect and the effect of debt deflation. This assumption is highly controversial. I can buy that there was some steeping of the AD curve, but to forcefully conclude that it was perfectly vertical and, thus, high nominal wages had no effect on employment and output seems too extreme. Where is the conclusive evidence?

What is really remarkable is that despite this empirically-unsupported assumption, Krugman concludes as if it is truth and, therefore, claims that those observers who think otherwise are not "thinking it through":

The key point, then, is that the reality of a liquidity trap in the 1930s has crucial implications for what we think about the effects of policies like the NIRA. People who assert that New Deal support for wages made the Depression much worse aren’t thinking it through. They’re implicitly assuming – not demonstrating – that the AD curve had a “normal” slope, even in the depths of the Depression. But it didn’t.

Krugman may be correct in his assumption about the real balance effect, but I think one can reasonably disagree with him on this point until there is conclusive evidence.

Update: Tyler Cowen also questions Krugman's vertical AD curve.

Update II: Paul Krugman explains why he dismisses the real balance effect.

Historian Eric Rauchway on the Great Depression

The latest podcast EconTalk:

Eric Rauchway of the University of California at Davis and the author of The Great Depression and the New Deal: A Very Short Introduction, talks with EconTalk host Russ Roberts about the 1920s and the lead-up to the Great Depression, Hoover's policies, and the New Deal. They discuss which policies remained after the recovery and what we might learn today from the policies of the past.

Listen to the podcast here.

Was the American Revolution the Product of a Boom-Bust Cycle?

Ronald W. Michener and Robert W. Wright say yes. According to this article, these authors have "worked for several years on a manuscript arguing that the American Revolution was a direct result of the economic malaise that followed the French and Indian War." So how exactly does their story unfold? From the article:

For the colonists, as for us, first came the boom. During the height of the French and Indian War, which lasted from 1754 until 1763, money flooded into the colonies, especially New York, where the British Army was headquartered. At the same time, the New York Legislature issued large numbers of bills of credit.

All that cash sloshing around resulted in lavish displays of wealth — notably by British officers, whose opulent living was emulated by the locals, especially in New York.

Housing prices soared during the war. But when credit tightened afterward — thanks in no small part to a prohibition on the issuance of paper money by the colonies under the Currency Act of 1764 — real estate owners who could not pay their debts lost their land.

[...]

At the core of the Wright-Michener argument is that this confluence of nasty economic circumstances was what produced the anger that found expression in rebellion against the Stamp Act and other British taxes. In other words, the core economic culprit was a boom-bust cycle; convinced that their future was no longer in their hands, the colonists could summon the ghost of John Locke, setting the stage for the arguments of Tom Paine and the Declaration.

I wonder if Niall Ferguson included this story in his new book.

Paul Krugman Versus Christina Romer

Paul Krugman is questioning whether the Great Depression was truly a monetary phenomenon. He apparently missed Christina Romer's article "What Ended the Great Depression?" where she shows that monetary developments were key not only to the economic recovery of 1933-1936 but also for the post-1938 recovery. These developments were what I would call unconventional monetary policy: FDR's devaluing gold, gold inflows from abroad, and Treasury choosing not to sterilize them. See here for more discussion of her findings--including a striking figure that shows what would have happened had there not been these monetary developments--and how it raises questions for the World War II-ended-the-Great-Depression story.

Update: See Josh's comments below and Zubin Jelveh's take on the numbers.

Monetary Policy Ended the Great Depression...

and not fiscal policy, according to Christina Romer in her 1992 JEH paper. Tyler Cowen recently referenced this article--amidst the New Deal debate ragging between Alex Tabarrok, Eric Rauchway, Paul Krugman, and others--and I want to follow up by noting a few more details from its conclusions. First, Romer found that fiscal policy was inconsequential not only in the early -to-mid-1930s, but also as late as 1942. Her results call into question the traditional view that World War II-driven fiscal policy ended the Great Depression. Second, Romer shows that it was monetary developments that ended the Great Depression, both in the mid- and late-1930s. In her own words:

The money supply grew rapidly in the mid- and late 1930s because of a huge unsterilized gold inflow to the United States. Although the later gold inflow was mainly due to political developments in Europe, the largest inflow occurred immediately following the revaluation of gold mandated by the Roosevelt administration in 1934. Thus, the gold inflow was due partly to historical accident and partly to policy. The decision to let the gold inflow swell the U.S. money supply was also, at least in part, an independent policy choice. The Roosevelt administration chose not to sterilize the gold inflow because it hoped that an increase in the monetary gold stock would stimulate the depressed economy.(p. 781)

So a defacto easing of monetary policy was the source of the 1933-1937 recovery as well as the one after 1938.

To make these findings more concrete, Romer performed some counterfactuals to demonstrate what would have happened had there not been expansionary macroeconomic policies. She does this by showing the actual path of real GNP and its path under non-expansionary policies. The difference between the two series show the importance of the expansionary policy that took place during this time. First she shows the impact of fiscal policy:Note there is no meaningful difference between these series. Hence, there was no real expansionary fiscal policy, even as late as 1942. Next, she shows the effect of monetary policy:
Here there is a significant difference. Romer concludes "real GNP would have been approximately 25 percent lower in 1937 and nearly 50 percent lower in 1942 than it actually was if the money supply had continued to grow at its historical average."

So much for the World War II story. But wait, Romer does notes that World War II can still be credited in a different way for ending the Great Depression:

However, Bloomfield's and Friedman and Schwartz's analyses suggested that the U.S. money supply rose dramatically after war was declared in Europe because capital flight from countries involved in the conflict swelled the U.S. gold inflow. In this way, the war may have aided the recovery after 1938 by causing the U.S. money supply to grow rapidly. Thus, World War II may indeed have helped to end the Great Depression in the United States, but its expansionary benefits worked initially through monetary developments rather than through fiscal policy.

Once again we are reminded that monetary policy matters.

Update: To be clear, Romer does not say fiscal policy could not be effective only that it was not really tried. See Mark Thoma for more on this point.

Niall Ferguson

Niall Ferguson must never tire. He produces books so rapidly one wonders whether he ever sleeps. Ferguson's latest book is the The Ascent of Money. According to the cover, Ferguson shows that "finance is in fact the foundation of human progress. What’s more, he reveals financial history as the essential backstory behind all history." I love the implication: one cannot be a real historian unless one understands finance and economics. With such a ringing endorsement of my profession I am looking forward to getting a copy. There is also this interesting interview with Ferguson regarding his new book:



PBS will be airing a series to accompany this book in January. If you want a taste of Ferguson's writing without buying one of his books, take a look at his recent article in Vanity Fair titled "Wall Street Lays Another Egg."

George Selgin Discusses Good Money

George Selgin has been highly influential in shaping my own thinking about monetary policy. My critique of U.S. monetary policy in the early-to-mid 2000s that has been a prominent part of this blog is based on Selgin's work on deflation. Selgin, though, has other research interests. This past summer he published a book called Good Money which I posted on here. Now you can listen to Selgin discuss his new book in this podcast interview. For more commentary on this book, see Alex Tabarrok's review of the book here.

The 'Big Push' and Economic Development in the American South

One of the great stories from 20th century U.S. economic history is the great economic rebound of the American South. From the close of the Civil War up through World War II, this region’s economy had been relatively undeveloped and isolated from the rest of the country. This eighty-year period of economic backwardness in the South stood in stark contrast to the economic gains elsewhere in the country that made the United States the leading industrial power of the world by the early 20th century. Something radically changed, though, in the 1930s and 1940s that broke the South free from its poverty trap. From this period on, the South began modernizing and by 1980 it had converged with the rest of the U.S. economy. But why the sudden break in the 1930-1940 period? A new paper by Fred Bateman, Jaime Ros, and Jason E. Taylor provides a fascinating answer: the economic rebound of American South was the result of a 'Big Push' from large public capital investments during the Great Depression and World War II.

A novel contribution of this paper is that it appears to provide a real-world example of the 'Big Push' theory. Never heard of the 'Big Push' theory? Well, here is how the authors describe it:

According to the “big push” theory of economic development, publicly coordinated investment can break the underdevelopment trap by helping economies overcome deficiencies in private incentives that prevent firms from adopting modern production techniques and achieving scale economies. These scale economies, in turn, create demand spillovers, increase market size, and theoretically generate a self-sustaining growth path that allows the economy to move to a Pareto preferred Nash equilibrium where it is a mutual best response for economic actors to choose large-scale industrialization over agriculture and small-scale production. The big push literature, originated by Rosenstein-Rodan [1943, 1961], was initially motivated by the postwar reconstruction of Eastern Europe. The theory subsequently appeared to have had limited empirical application... [S]cholars have found few real-world examples of such an infusion of investment helping to “push” an economy to high-level industrialization equilibrium.

Until this paper, that is. The authors continue:

We argue here that the “Great Rebound” of the American South, which followed large public capital investments during the Great Depression and World War II, is one such application. Although 1930s New Deal programs are typically presented in the context of their attempt to bring relief and recovery to the U.S. economy through demand-stimulating public expenditures, the long-term economic effects of these and subsequent wartime expenditures were profound for the South. Specifically, and consistent with big push theoretical literature, the infusion of public capital—roads, schools, waterworks, power plants, dams, airfields, and hospitals, among other infrastructural improvements—fundamentally reshaped the Southern economy, expanded markets, generated significant external economies, increased rates of return to large scale manufacturing, and encouraged a subsequent investment stream. These improvements helped create the conditions that allowed the region to break free from its low-income, low-productivity trap and embark on its rapid postwar industrialization.

This paper deals with the break from the South's poverty trap. The sustained nature of the South's postwar economic recovery has been covered by other studies: Connolly (2004) looks to improved human capital formation, Cobb (1982) points to industrial policy, Beasley, Persson, and Sturm (2005) finger increased political competition, and Glaeser and Tobio (2008) discuss the merits of the climate or Sunbelt effect. (I will also note I have seen somewhere the advent of air conditioning did wonders for development in the South).

In short, this paper tells an interesting and under reported story of 20th century U.S. economic history. In so doing, it also provides what appears to be a good example of the 'Big Push'. Read the rest of the paper here.

A Good Hyperinflation?

I see Bryan Caplan is questioning again the necessity of the American Revolution. His views on the American Revolution reminded me of an experience I had in grad school with one of my monetary economics professors.

Somehow, I had picked up J.K. Galbraith's Money: Whence It Came, Where It Went and read his account of how fiat money was used by the Continental Congress to finance the Revolutionary War. The excessive creation and uncertainty surrounding the Continentals, as the fiat currency was known, created an hyperinflation-like environment. Galbraith, unlike Caplan, valued the American Revolution and concluded that "the U.S. rode the wave of hyperinflation into existence." The implication was clear: hyperinflation was needed to win U.S. independence. Feeling all smug about having in hand what seemed to be a hard-to-refute example of high inflation actually being a good thing, I visited my monetary economics professor. Now I am not an advocate for hyperinflation--far from it--but I could not resist the chance to throw a monetary curve ball at my professor. So I did and expected him to strike out. Instead, he hit took my pitch and hit a home run off of it with these sharp words:"David, history is written by the victors!" I left his office humbled once again.

Debunking the 'Liquidationist' Myth

Lawrence H. White has a forthcoming article in the JMCB where he debunks several important myths about the 'liquidationist' view (or what Paul Krugman calls the "hangover theory") during the Great Depression era.

First, he shows that Treasury Secretary Andrew Mellon was not an advocate of the liquidationist view, but actually supported stabilization policies. This may come as a surprise to you, as it did to me, given Mellon's famous liquidationist line: "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate." White shows, however, that these words were attributed to him by Herbert Hoover in an attempt to salvage his own reputation by making Mellon appear as an indifferent "leave-it-alone-liquidationist." Moreover, White shows that Mellon actually called for monetary easing and some expansionary fiscal policy to stimulate the depressed economy.

Second, and more importantly, White shows that F.A. Hayek and Lionel Robbins were not the ardent liquidationists during this time that they are made out be by many contemporary observers. In White's own words:

The Hayek-Robbins (“Austrian”) theory of the business cycle did not in fact prescribe a monetary policy of “liquidationism” in the sense of doing nothing to prevent a sharp deflation. Hayek and Robbins did question the wisdom of re-inflating the price level after it had fallen from what they regarded as anunsustainable level (given a fixed gold parity) to a sustainable level. They did denounce, as counterproductive, attempts to bring prosperity through cheap credit. But such warnings against what they regarded as monetary over-expansion did not imply indifference to severe income contraction driven by a shrinking money stock and falling velocity. Hayek’s theory viewed the recession as an unavoidable period of allocative corrections, following an unsustainable boom period driven by credit expansion and characterized by distorted relative prices. General price and income deflation driven by monetary contraction was neither necessary nor desirable for those corrections. Hayek’s monetary policy norm in fact prescribed stabilization of nominal income rather than passivity in the face of its contraction.

This was interesting to learn because my understanding had been that Austrians love deflation no matter what form it takes (i.e. negative aggregate demand shock-driven or the 'malign' form versus the positive aggregate supply shock-driven or 'benign' form). That Hayek and Robbins believed in a monetary policy that aimed to stabilize nominal income means that they did differentiate between types of deflation. However, with that said White also reports

[t]he germ of truth in [Milton] Friedman’s and [Brad] DeLong’s indictment [of Hayek and Robbins as liquiditationists]... is that Hayek and Robbins themselves failed to push this prescription in the early 1930s when it mattered most.

So Hayek and Robbins should have pushed their nominal income stabilization views more forcefully during the Great Depression. However, even had they been more vocal they would have run up against the influential real bills doctrine that did not stabilize nominal income. So how the outcome would have differed is any one's guess.

Check out the entire article and the related post by Lawrence H. White.