Christina Romer Really Gets It

Marcus Nunes beat me to it, highlighting Christina Romer’s column in today’s New York Times, but her column today deserves all the attention and praise that it can get, and a lot more besides. Romer debunks then notion that real downturns that follow financial crises are necessarily deeper and longer-lasting than ordinary downturns, showing that the policy pessimism engendered by the notion that recoveries from recessions precipitated by financial crises are necessarily weak and drawn out, given currency by the recent book by Rogoff and Reinhart This Time Is Different, is not at all justified by the historical record.

I will just elaborate on a couple of points made by Romer. Citing the account of the Great Depression in the United States given by Milton Friedman and Anna Schwartz in their Monetary History of the United States, Romer observes:

The Friedman-Schwartz study found four distinct waves of banking panics in the early 1930s. After the first three, output plummeted. But after the last one, in early 1933, output skyrocketed, with industrial production rising nearly 60 percent from March to July. That time was very different.

What accounts for the difference? Romer explains:

[T]he policy response largely explains why output fell after the American banking panics in 1930 and 1931, but rose after the final wave in early 1933. After the first waves, the Fed did little, and President Herbert Hoover signed a big tax increase to replenish revenue. After the final wave, President Franklin D. Roosevelt abandoned the gold standard, increased the money supply and began a program of New Deal spending.

I don’t disagree with that, but I understand the process differently. It was the gold standard itself that had caused the downturn, because gold was appreciating (meaning that prices and wages were falling), causing profits to drop and business and households to stop spending. Bank failures were caused by a deflation that made it impossible for debts fixed in nominal terms to be repaid, so that the assets held by banks were becoming worthless. Bank failures were not the cause of the problem, they were a symptom of a problem — falling prices — inherent in and inseparable from the perverse dynamics of the gold standard. Once FDR abandoned the gold standard, the dollar depreciated relative to gold allowing dollar prices to start rising, the money supply increasing more or less automatically as a result.

Romer also disscusses a paper comparing the severity of the Great Depression in Spain and in the US.

Why was the Great Depression so much worse here than in Spain? According to an influential paper by Ehsan Choudhri and Levis Kochin, Spain benefited from not being on the gold standard. Its central bank was able to lend freely and increase the money supply after the panic. By contrast, in 1931, the Federal Reserve in the United States raised interest rates to defend its gold reserves and stay on the gold standard, setting off further declines in output and exacerbating the banking crisis.

It’s true that freedom from the gold standard allowed Spain to take monetary measures it could not have taken while on the gold standard, but the more important point is that by not being on the gold standard, prices in Spain did not have to fall to reflect the increasing value of gold. So the deflationary forces that suffused all the countries on the gold standard simply bypassed Spain and other countries not on the gold standard. It was not the increase in interest rates by the US that was caused the deflation in the US it was the gold standard. Raising interest rates were necessary only insofar as a country did not want to allow an export of its gold reserves.

In closing, I will just mention that the paper by Choudri and Kochin contains a diagram on p. 569 showing that Belgium experienced a rapid deflation and a big drop in industrial production in the early 1930s. In my post last week about the analysis of the Deutsche Bank comparing the euro crisis to the 1930s gold standard crisis, the diagram copied from the DB analysis seemed to indicate that Belgium did not suffer a substantial drop in real GDP. The Choudri and Kochin paper provides further reason to be skeptical about the graph in the DB analysis.


24 Responses to “Christina Romer Really Gets It”

  1. 1 Steve December 18, 2011 at 10:00 pm

    Good post, David.

    I’ve always been suspicious of the “Fed Did It” story of the depression. It wasn’t that they were completely stupid or completely malicious, it’s that they worshiped at the altar of gold. They chose the gold standard over the economy, because they lacked the political courage to see the writing on the wall. That’s the same problem we have today with the Fed and the ECB, a lack of courage to see through to the endgame without putting us through hell first.


  2. 2 Steve December 18, 2011 at 10:01 pm

    David, also I posted this on Marcus Nunes’ blog as well, but I’d be interested in your reaction:

    Isn’t the biggest flaw of the Reinhart and Rogoff study that it deals with lots of small, open economy financial crises? A small open economy that loses competitiveness has to bite the bullet and restructure, and it takes time to rebuild competitiveness. A closed economy that has a monetary crisis recovers as soon as monetary policy is fixed, no?


  3. 3 Mitch December 18, 2011 at 11:13 pm

    Nice article David. One thing I would point out is that neither you nor Romer mentioned that FDR also had a bank holiday shortly after coming into office, which presumably had the effect of cleaning out the bad banks – like Sweden and unlike Japan.

    In our present situation, we did it half way. We did have some good banks buy some bad banks, but it’s not clear (to me at least) whether the result is banks as strong as needed.


  4. 4 Frank Restly December 19, 2011 at 1:46 am

    During the Great Depression there were two kinds of currency – U. S. notes redeemable through the U. S. Treasury in Gold (and later silver) and federal reserve notes backed by debt.

    And so the gold standard was a limitation on fiscal policy not monetary policy.


  5. 5 bill woolsey December 19, 2011 at 5:27 am


    The gold standard restricts monetary policy by redeemability, not backing.

    Any use of gold as reserves for money, whether required on not, impacts the world demand for gold. And so, a demand for money is partly a demand for gold.

    In my view, gold reserve ratios are unnecessary. Generally, when there is an increase in the demand for money to hold, there is no economic necessity or benefit to adding gold reserves. The currency school hard money intervention of 100% marginal gold reserve requirements is completely wrongheaded. If people just want to hold more money, a zero percent marginal reserve policy is more sensible. Some kind of regulatory fractional reserve requirement (or a private rule of thumb) is undesirable, though not as bad as a 100% marginal reserve requirement.

    If the world demand for gold is rising relative to supply, the relative price of gold must rise. With all prices denominated in gold, that means that equilibirum prices and wages must fall. “Monetary policy” can only impact this by releasing gold reserves and so reducing the world demand for gold.

    The accounting balances and paper that nearly everyone uses as money is tied to gold by redeemability. Trying to increase its quantity to push prices up above the lower and falling equilibrium price level determined by gold is inconsisent with redeemability. Efforts to do this will result in a loss of gold reserves, which, as above, does impact the world demand for gold. For a small country this is trivial. The other possibility is to leave the gold standard–suspend or devalue. For the U.S. in the thirties, gold reserves were so vast that it could have releaseed enough gold to impact the world demand for gold significantly.


    Most of the Riehart and Rogoff examples involve a capital outflow. Foreign investors are rapidly removing funds from a particular country. Even if nominal expenditure on output is kept growing at a slow steady rate, there will be adverse effects on real output (the volume of domestic production measured in domestics goods prices) and a much larger adverse impact in terms of real consumption (further reduced becaues import prices are higher due to currency depreciation.) It is likely that real wages will perform the same. A lower labor share in domestic output because capital is more scarce, and much lower real wages because imports prices are higher. In many of the examples given by R&R there was plenty of nominal expenditure (too much in my view,) and real output and real wages still fell.

    The U.S. is not in that situation as of yet.


  6. 6 David Pearson December 19, 2011 at 8:12 am

    “Bank failures were not the cause of the problem, they were a symptom of a problem — falling prices.”

    Gary Gorton explains how the Great Financial Crisis had been underway for more than a year by the time “falling prices” were in view. Gorton describes a series of global, general runs on the collateral of the shadow banking system. This was not a subset of the liabilities of a corner of the financial system: it was the dominant liability (repo’s) of the dominant (in terms of credit growth) part of the global financial system. How could expectations of “falling prices” cause something that preceded those expectations?

    Imagine that two of the largest financial intermediaries in the world had failed in July 1929; and that these failures were preceded by a year of generalized runs on some of the largest global banks, a series of coordinated policy actions to rescue those same banks, and a crash in large bank equities. Would you still argue that “bank failures were not the cause of the problem” back then?


  7. 7 Becky Hargrove December 19, 2011 at 8:16 am

    The fact that Christina Romer not only gets it but also wants others to get it: a wonderfully unexpected Christmas present for me. Literacy gave women a chance at freedom. Monetary literacy gives women the chance to remain free.


  8. 8 I Miss Nixon December 19, 2011 at 1:35 pm

    Anything Romer says is nothing but CYA

    The woman failed horribly in her duties, her public trust to millions and millions of Americans. For starters, she over promised (unemployment won’t go above 8%) and then underperformed.

    Listening to her talk or reading her writing we know its dim candle, but did she not make room for the possiblity that she might be wrong and what the consequences would be, if she was.

    I checked on youtube for a good hari kari self instruction video, but didn’t find a good link


  9. 9 Becky Hargrove December 19, 2011 at 4:38 pm

    I Miss Nixon,
    Think for a moment that the parks you respect are gated to keep people out and only occasionally let humanity in. Whereas the park you now play in so gleefully has no gates, and is open to all.


  10. 10 I Miss Nixon December 19, 2011 at 5:44 pm

    Dear Ms. Hargrove:

    The constant off record conversation (Krugman, DeLong, etc.) is how blazing incompetent Romer and Summers were at governing.

    For Modernity, the weeks before and when Obama entered office were the Battle of the Bulge.

    We lost, This puppy is going down.

    Someday, when you are as long in the tooth as this writer you will understand that genius is not one, not two, but three contingency plans, if something goes wrong:

    “Gen. Eisenhower, realizing that the Allies could destroy German forces much more easily when they were out in the open and on the offensive than if they were on the defensive, told his generals, “The present situation is to be regarded as one of opportunity for us and not of disaster. There will be only cheerful faces at this table.” Patton, realizing what Eisenhower implied, responded, “Hell, let’s have the guts to let the bastards go all the way to Paris. Then, we’ll really cut ’em off and chew ’em up.” Eisenhower, after saying he was not that optimistic, asked Patton how long it would take to turn his Third Army (located in northeastern France) north to counterattack. Patton replied that he could attack with two divisions within 48 hours, to the disbelief of the other generals present. However, before he had gone to the meeting Patton had ordered his staff to prepare three contingency plans for a northward turn in at least corps strength. By the time Eisenhower asked him how long it would take, the movement was already underway.[70] On 20 December, Eisenhower removed the First and Ninth U.S. Armies from Gen. Bradley’s 12th Army Group and placed them under Montgomery’s 21st Army Group.[71]”

    Romer was so dumb she couldn’t understand how stupid her promise was; she did not understand that if she was wrong she was dooming millions of Americans, at best, to sad lives.

    If Romer were a lawyer we would be trying to take her ticket for incompetence.

    Because she is an economist, people pay attention to her even though she is so impeached she could never be a witness in a court room.

    Go figure


  11. 11 Becky Hargrove December 19, 2011 at 7:17 pm

    I Miss Nixon,
    Okay, here’s the thing. I take my hope wherever I can get it, for this cat has already used up a lot of her nine lives. You said, “We lost, this puppy is going down.” I could go down tomorrow but I’ll not give up on humanity between now and then. Believe me I know how fragile our systems and way of life are. Whatever anyone thinks of Christina Romer, the fact remains that she has inspired women to think about economic issues. How could we expect total competence from her, when she was but a handful of women who even dealt with macroeconomic issues in the present? That, and the conflicting visions she was trying to work with? That’s why I was encouraged, by the fact that if women are starting to engage in the bigger picture, they can take part in the solutions that are still possible. I know it sounds silly to you but her embrace of monetary stimulus actually makes my holiday better than it would have been. And yes, as you said, that is but one part of the picture. Just the same, we need monetary stability so that the other contingency plans (waiting in the wings) can have a chance to be discussed.


  12. 12 David Glasner December 20, 2011 at 9:21 am

    David, My view is that there were serious systemic problems that appeared before the acute September-November 2008 crisis. My claim is that September-November 2008 crisis could have been avoided if the Fed had not ignored signs of a rapidly worsening economy in the spring and especially the summer of 2008 because it was focused on a blip in headline inflation driven by forces outside the Fed’s control. In July 1929, the world economy was already starting to feel the effects of the burgeoning monetary demand for gold fueled by the Bank of France and Federal Reserve. There were no serious failures of financial institutions because it took awhile for the deflationary effects of increasing monetary gold demand to wreck havoc on the international financial system. I don’t think one can just posit the failure of two major financial institutions as an exogenous event.

    Becky, I am glad you feel empowered by Professor Romer.

    I Miss Nixon, Christina Romer may not have been a successful chairman of the CEA. However, CEA chairmen have rarely, if ever, been the most influential policy makers in any administration, so I don’t think it’s fair to hold her responsible for the poor performance of the economy since Obama took office. From what I can tell, her advice was consistently the best economic advice Obama was getting. I also think that you would be doing the rest of us a huge favor if you kept your hateful fantasies to yourself.


  13. 13 Anthony Migchels January 2, 2012 at 10:12 am

    Don’t fall for or/or.

    Both the Gold Standard AND rising interest rates have deflationary effects. The latter because it slows the velocity of circulation.


  14. 14 Anthony Migchels January 2, 2012 at 10:17 am


    The only rational thing you can say about both the FED and the ECB is that they have created a multi trillion disaster, together with the banks they were supposed to supervise.

    It is absolutely clear that in the light of their massive failures, both organizations have zero right to exist.

    The only reason this is ignored, is because the Central Banks are the rulers of this planet.


  15. 15 Anthony Migchels January 2, 2012 at 10:21 am

    Although it is true that Full Reserve Gold Standard banking is even worse (because Gold would be even scarcer and deflationary),
    the intrinsic injustice AND instability of Fractional Reserve Banking as proven by the multi trillion bank bail outs made ‘necessary’ by overleveraging makes one thing clear:

    Never again.

    Anybody should see the situation is lethal for both banking and the state of monetary theory as practiced within academia and banking circles.

    The damage cannot be explained away, the alternatives are there and thinking that it is just business as usual for the system is both wrong and highly irresponsible.


  16. 16 Anthony Migchels January 2, 2012 at 10:22 am

    Indeed. Proving once again that the instability of fractional reserve banking is completely unacceptable. Apart from being utterly fraudulent and wrong.


  17. 17 Anthony Migchels January 2, 2012 at 10:24 am

    Lol, women can’t survive without men.

    Their ‘freedom’ is therefore a result of male freedom.

    But don’t worry: the species can’t survive without women. ‘Equality’ is asymmetric.

    The idea that feminism has something to offer the monetary is one of it’s quainter notions…..


  18. 18 Anthony Migchels January 2, 2012 at 10:30 am

    I’m sorry, sloppy reading, you did not suggest anything related to my last sentence.

    Let me make up:
    You like the idea of leading female monetarist?

    Check out Ellen Brown and Margrit Kennedy.
    They are the real deal and they are the leaders of the future.


  19. 19 David Glasner January 3, 2012 at 1:27 pm

    Anthony, Velocity is the reciprocal of the demand to hold money. The rate of interest is the cost of holding money. An increase in the rate of interest makes holding money more costly. Thus, an increase in the rate of interest reduces the amount of money people want to hold. A decrease in the amount of money people want to hold increases the reciprocal of the amount of money people want to hold which means it increases velocity.


  20. 20 Anthony Migchels January 4, 2012 at 2:08 am

    This is an astonishing reply.
    If I hold money on my bank account, I will gain a higher return with higher interest rates. Therefore I will be more inclined to hoard it. Therefore velocity of circulation goes down.

    Interest has a deflationary effect. The higher the interest rate, the higher the deflation. Deflation hinders economic growth because it invites hoarding cash. It is appreciating. Making other investments relatively less lucrative.

    Interest is not the cost of holding money. It is the REWARD for holding money.
    Interest is the cost of credit.


  21. 21 David Glasner January 4, 2012 at 9:49 am

    Anthony, You said,

    “If I hold money on my bank account, I will gain a higher return with higher interest rates. Therefore I will be more inclined to hoard it. Therefore velocity of circulation goes down.”

    If you are talking about holding deposits that bear competitive interest, then a change in the interest rate has no effect on velocity, because the cost of holding money is not affected by changes in the rate of interest, the deposit rate changing by the same amount as the interest rate on loans.

    “Interest has a deflationary effect. The higher the interest rate, the higher the deflation. Deflation hinders economic growth because it invites hoarding cash. It is appreciating. Making other investments relatively less lucrative.”

    Your argument is difficult to follow because you are ignoring the effect of deflation on interest rates which is to reduce them. You need to posit a theory of interest rates and explain what is causing the increase in interest rates that you are starting from. There is more than one possible cause for an increase in interest rates and the implications for inflation and other significant economic variables differ depending on what is causing the initial increase in interest rates.

    “Interest is not the cost of holding money. It is the REWARD for holding money. Interest is the cost of credit.”

    Banks pay interest to their depositors only because they can make loans on which they charge interest if people are willing to hold their deposits. If people were not willing to hold bank deposits, banks would not be able earn money on the loans or could find some other source of funds with which to make loans. Interest on deposits is not the source of interest in general.


  22. 22 Frank Restly January 4, 2012 at 12:48 pm

    From the equation of exchange (this ignores taxes, equity finance, international capital flows, currency movements, and a lot of other things but is simple enough to understand):

    Debt * Velocity = Real GDP * (1 + Inflation Rate)

    RIR = Real Interest Rate
    IR = Inflation Rate

    Debt * Velocity = dD / dt {New debt issuance} + Debt * {RIR + IR} + IL {Illiquidity Preference} * Debt

    Letting Debt = exp ( f(t) ) where f is some function of time
    dD / dt = f'(t) * exp ( f(t) )

    exp ( f(t) ) * Velocity = f'(t) * exp ( f(t) ) + exp ( f(t) ) * (RIR + IR) + IL * exp ( f(t) )

    Velocity = f'(t) + (RIR + IR) + IL

    “If I hold money on my bank account, I will gain a higher return with higher interest rates. Therefore I will be more inclined to hoard it. Therefore velocity of circulation goes down.”

    Putting your money in a bank and earning interest on it is not the same as stuffing it in a mattress (aka hoarding). The reason is simple. The interest payments that you receive from the bank come from another individual who is paying off a loan.

    If an economy is full of mattress stuffers, then the illiquidity preference will go very low pushing velocity down.

    “Interest is not the cost of holding money. It is the REWARD for holding money. Interest is the cost of credit.”

    Interest is the cost of borrowing money. When you put your money in a bank and earn interest on it, that interest income comes from loans that the bank makes.

    Interest is a transfer mechanism in the same way that taxes and government spending are a transfer mechanism.


  23. 23 David Glasner January 6, 2012 at 8:51 am

    Frank, Sorry, but I don’t understand what your equations are trying to say. I don’t follow math unless I understand what the math is trying to say, otherwise my intuition is not engaged, and it is just a bunch of symbols, and I don’t have the time or patience to work out the intuition for myself. From the quotations you seem to be responding to, your comment is directed toward Anthony, so I don’t know if you were trying to comment on something I wrote.


  24. 24 Frank Restly January 7, 2012 at 11:15 am


    My response is to this statement:

    “Both the Gold Standard AND rising interest rates have deflationary effects. The latter because it slows the velocity of circulation.”

    The velocity of circulation is a function of the growth in the amount of outstanding debt (dD / dt), the nominal interest rate (RIR + IR), and Illiquidity preference (IL). Again there are other factors (equity finance, international capital flows, currency movements, etc.).

    And so rising interest rates in and of themselves do not slow the velocity of circulation. In fact as long as there are borrowers at high interest rates, the velocity of money will speed up, not slow down.

    But (and there is always a but), rising interest rates without borrowers at those rates will depress velocity via a flat or falling dD / dt (fewer loans are being made).

    The gold standard operated as a fiscal restraint on the federal government’s ability to increase its own debt. And so, in this way it acted to constrain dD / dt.

    Hope this explains things better.


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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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