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.

What Corporate Bond Yield Spreads Tell Us

Recently, a number of concerned observers took note of the rising cost of corporate borrowing by looking at real interest rates on AAA-rated and BAA-rated bonds. Let me add to their concern by looking at the BAA yield minus AAA yield spread. Whenever the spread between these two securities increases the market believes there to be a higher probability of default for the riskier BAA rated bonds. The spread may also increase as a result of the BAA securities becoming less liquid, either as a result of their increased riskiness or because of stress in financial markets. Since there are a large number of firms in these measures, the spread provides a good indicator of economy-wide stress facing firms. The spread, therefore, provide some insights into the overall state of the economy. The figure below graphs the spread and the officially dated NBER recession with gray bars. The data comes from the St. Louis Fed, has a monthly frequency, and runs through 11/24/08. (click on figure to enlarge.)

The figure shows that spread is now notably higher than it was during the 1973-1975 and early 1980s recessions. Moreover, the spread indicates corporate borrowing is now as stressed as it was during the second half of the Great Depression. So what does this mean for the real economy? To answer that question I took spread data for the entire period and plugged it along with the Fed's monthly industrial production series (also from St. Louis Fed) into a Vector Autoregression (VAR) with 13 lags (enough to eliminate serial correlation). Using the estimates from this simple VAR I was able to do a dynamic forecast of industrial production through the end of 2009. The figure below shows the results of this exercise. The blue portion of the line is the actual series while the red line is the forecast. (click on figure to enlarge.)


This simple bivariate model indicates the recession will last through August 2009. This implies that if the recession began in January 2008, then it should be a 20 month recession overall. This forecast assumes, though, the spread reaches a peak this month. If this assumption proves to be incorrect then the trough would be pushed back to a later date.

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."

More on the Business Cycle and the Church

I just presented a paper this past weekend looking at the dynamic response of religious participation and religious giving to economic shocks. This paper follows an earlier one where I found a strong countercyclical component to religious participation by evangelical Protestants and a slightly procyclical component for mainline Protestants. Economic theory provides good motivations for these results. Given my interest in this field of economics--yes, I am macroeconomist dabbling in the economics of religion--I was pleased to find the following video clip on CNN. It shows people turning to church as a means to smooth their consumption over this business cycle.

Liquidity Premium Sign of the Times

The Cleveland Fed used to provide TIPS-based expected inflation estimates that accounted for the TIPS liquidity premium. No more. (Click on figure to enlarge)