A New Paper on the Short, But Sweet, 1933 Recovery Confirms that Hawtrey and Cassel Got it Right

In a recent post, the indispensable Marcus Nunes drew my attention to a working paper by Andrew Jalil of Occidental College and Gisela Rua of the Federal Reserve Board. The paper is called “Inflation Expectations and Recovery from the Depression in 1933: Evidence from the Narrative Record. “ Subsequently I noticed that Mark Thoma had also posted the abstract on his blog.

 Here’s the abstract:

This paper uses the historical narrative record to determine whether inflation expectations shifted during the second quarter of 1933, precisely as the recovery from the Great Depression took hold. First, by examining the historical news record and the forecasts of contemporary business analysts, we show that inflation expectations increased dramatically. Second, using an event-studies approach, we identify the impact on financial markets of the key events that shifted inflation expectations. Third, we gather new evidence—both quantitative and narrative—that indicates that the shift in inflation expectations played a causal role in stimulating the recovery.

There’s a lot of new and interesting stuff in this paper even though the basic narrative framework goes back almost 80 years to the discussion of the 1933 recovery in Hawtrey’s Trade Depression and The Way Out. The paper highlights the importance of rising inflation (or price-level) expectations in generating the recovery, which started within a few weeks of FDR’s inauguration in March 1933. In the absence of direct measures of inflation expectations, such as breakeven TIPS spreads, that are now available, or surveys of consumer and business expectations, Jalil and Rua document the sudden and sharp shift in expectations in three different ways.

First, they show document that there was a sharp spike in news coverage of inflation in April 1933. Second, they show an expectational shift toward inflation by a close analysis of the economic reporting and commentary in the Economist and in Business Week, providing a fascinating account of the evolution of FDR’s thinking and how his economic policy was assessed in the period between the election in November 1932 and April 1933 when the gold standard was suspended. Just before the election, the Economist observed

No well-informed man in Wall Street expects the outcome of the election to make much real difference in business prospects, the argument being that while politicians may do something to bring on a trade slump, they can do nothing to change a depression into prosperity (October 29, 1932)

 On April 22, 1933, just after FDR took the US of the gold standard, the Economist commented

As usual, Wall Street has interpreted the policy of the Washington Administration with uncanny accuracy. For a week or so before President Roosevelt announced his abandonment of the gold standard, Wall Street was “talking inflation.”

 A third indication of increasing inflation is drawn from the five independent economic forecasters which all began predicting inflation — some sooner than others  — during the April-May time frame.

Jalil and Rua extend the important work of Daniel Nelson whose 1991 paper “Was the Deflation of 1929-30 Anticipated? The Monetary Regime as Viewed by the Business Press” showed that the 1929-30 downturn coincided with a sharp drop in price level expectations, providing powerful support for the Hawtrey-Cassel interpretation of the onset of the Great Depression.

Besides persuasive evidence from multiple sources that inflation expectations shifted in the spring of 1933, Jalil and Rua identify 5 key events or news shocks that focused attention on a changing policy environment that would lead to rising prices.

1 Abandonment of the Gold Standard and a Pledge by FDR to Raise Prices (April 19)

2 Passage of the Thomas Inflation Amendment to the Farm Relief Bill by the Senate (April 28)

3 Announcement of Open Market Operations (May 24)

4 Announcement that the Gold Clause Would Be Repealed and a Reduction in the New York Fed’s Rediscount Rate (May 26)

5 FDR’s Message to the World Economic Conference Calling for Restoration of the 1926 Price Level (June 19)

Jalil and Rua perform an event study and find that stock prices rose significantly and the dollar depreciated against gold and pound sterling after each of these news shocks. They also discuss the macreconomic effects of shift in inflation expectations, showing that a standard macro model cannot account for the rapid 1933 recovery. Further, they scrutinize the claim by Friedman and Schwartz in their Monetary History of the United States that, based on the lack of evidence of any substantial increase in the quantity of money, “the economic recovery in the half-year after the panic owed nothing to monetary expansion.” Friedman and Schwartz note that, given the increase in prices and the more rapid increase in output, the velocity of circulation must have increased, without mentioning the role of rising inflation expectations in reducing that amount of cash (relative to income) that people wanted to hold.

Jalil and Rua also offer a very insightful explanation for the remarkably rapid recovery in the April-July period, suggesting that the commitment to raise prices back to their 1926 levels encouraged businesses to hasten their responses to the prospect of rising prices, because prices would stop rising after they reached their target level.

The literature on price-level targeting has shown that, relative to inflation targeting, this policy choice has the advantage of removing more uncertainty in terms of the future level of prices. Under price-level targeting, inflation depends on the relationship between the current price level and its target. Inflation expectations will be higher the lower is the current price level. Thus, Roosevelt’s commitment to a price-level target caused market participants to expect inflation until prices were back at that higher set target.

A few further comments before closing. Jalil and Rua have a brief discussion of whether other factors besides increasing inflation expectations could account for the rapid recovery. The only factor that they mention as an alternative is exit from the gold standard. This discussion is somewhat puzzling inasmuch as they already noted that exit from the gold standard was one of five news shocks (and by all odds the important one) in causing the increase in inflation expectations. They go on to point out that no other country that left the gold standard during the Great Depression experienced anywhere near as rapid a recovery as did the US. Because international trade accounted for a relatively small share of the US economy, they argue that the stimulus to production by US producers of tradable goods from a depreciating dollar would not have been all that great. But that just shows that the macroeconomic significance of abandoning the gold standard was not in shifting the real exchange rate, but in raising the price level. The fact that the US recovery after leaving the gold standard was so much more powerful than it was in other countries is because, at least for a short time, the US sought to use monetary policy aggressively to raise prices, while other countries were content merely to stop the deflation that the gold standard had inflicted on them, but made no attempt to reverse the deflation that had already occurred.

Jalil and Rua conclude with a discussion of possible explanations for why the April-July recovery seemed to peter out suddenly at the end of July. They offer two possible explanations. First passage of the National Industrial Recovery Act in July was a negative supply shock, and second the rapid recovery between April and July persuaded FDR that further inflation was no longer necessary, with actual inflation and expected inflation both subsiding as a result. These are obviously not competing explanations. Indeed the NIRA may have itself been another reason why FDR no longer felt inflation was necessary, as indicated by this news story in the New York Times

The government does not contemplate entering upon inflation of the currency at present and will issue cheaper money only as a last resort to stimulate trade, according to a close adviser of the President who discussed financial policies with him this week. This official asserted today that the President was well satisfied with the business improvement and the government’s ability to borrow money at cheap rates. These are interpreted as good signs, and if the conditions continue as the recovery program broadened, it was believed no real inflation of the currency would be necessary. (“Inflation Putt Off, Officials Suggest,” New York Times, August 4, 1933)

If only . . .

9 Responses to “A New Paper on the Short, But Sweet, 1933 Recovery Confirms that Hawtrey and Cassel Got it Right”


  1. 1 Lars Christensen May 15, 2015 at 11:01 pm

    Great post David and a very good working paper. The paper very much reminded me of Scott’s unpublished book on the Great Depression.

    I fundamentally think a narrative approach to empirical studies of monetary events is better than traditional econometric studies as they are able to much better account for changes in expectations.

  2. 2 sumnerbentley May 16, 2015 at 6:37 am

    I did similar research about 20 years ago, now if only my publisher would do something with the manuscript. The slowdown after July was definitely caused by the NIRA. Gold prices rose substantially between July and January 1934, which should have been highly expansionary.

  3. 3 David Glasner May 16, 2015 at 7:16 pm

    Lars, Thanks. I agree wholeheartedly. There’s much that econometrics can contribute, but it should supplement, not displace, the narrative

    Scott, Absolutely. Your publisher ought to be ashamed. I apologize for not mentioning your work in the post as well, but I was rushed and forgot to include you in the discussion. Did wholesale and retail prices continue rising after July? I would have to go back and see if Hawtrey said anything about about the reasons why the recovery faltered after July. Have you read their paper? Do you have any other comments about it?

  4. 4 Benjamin Cole May 17, 2015 at 10:10 pm

    Marcus Nunes is indeed indipensible! As are Scott Sumner and David Glasner.
    I am less a fan of the jawboning Fed than I am of a Fed that buys $100 billion a month in bonds and says it will do so until certain growth targets are hit and sustained for a long time.
    The Fed today has a credibility problem. I would say the market expects the Fed to hit a 1.5% CPI regardless of economic growth.

  5. 5 JKH May 18, 2015 at 4:59 am

    Interesting stuff.

    Here is a short essay that picks up in 1934:

    http://www.voxeu.org/article/what-caused-recession-1937-38-new-lesson-today-s-policymakers

    It is written by the author of the same paper to which Marcus Nunes referred when you asked him about his gold sterilization reference in comments at his blog. You’re probably very familiar with the following events, but there is an interesting description of the sterilization issue:

    “When the dollar was re-pegged to gold at $35 per oz. in January 1934, the US essentially went back on a gold standard.”

    Gold inflows were not sterilized from January 1934 to December 1936. They were sterilized from December 1936 to February 1938. The policy reverted back to non-sterilization following that.

    My own interpretation of gold sterilization from an operational perspective is this:

    If under a gold peg the central bank holds the stock of gold that results from gold inflows, it has the option of “not sterilizing” them by allowing the expansion of bank reserves as part of the default payment mechanism. It writes a check and reserves expand.

    Alternatively, the central bank has the option of “sterilizing” such flows if it holds sufficient bonds on its starting balance sheet, which it can sell out to reverse the reserve expansion otherwise associated with gold purchases.

    If the gold stock is held off the central bank balance sheet in a separate government account, the default payment mechanism means funding net gold inflows by selling treasury debt, which automatically “sterilizes” any potential bank reserve effect – i.e. no net effect. This debt funding covers the payment for the gold purchase from the Treasury account at the central bank.

    (I think this latter case is the normal institutional arrangement in the modern era where there is no gold peg.)

    Thus, along the lines of that latter case, from the post referred to above:

    “But when the Roosevelt administration began to worry about the potential for higher inflation, the Treasury Department decided to sterilise all gold inflows starting in December 1936. In essence, its new gold holdings were held in an inactive account rather than with the Federal Reserve, where it would have become part of the monetary base and money supply. Thus, instead of allowing the monetary base to grow with the inflow of gold, the monetary base was essentially frozen at its existing level.”

    There is another interesting point about the doubling of bank reserve requirements at some stage in this time sequence:

    “And most studies of the Fed’s doubling of reserve requirements – most recently, Calomiris et al (2011) – have concluded that it had little impact on banks because they held abundant excess reserves, which they did not seek to rebuild after the new requirements took effect.”

    This is a sort of inverted QE phenomenon. Doubling required reserves is a type of QE exit strategy in effect. And the fact that such an “exit” had little effect on banks in that era is a sort of inverse to the point made by some (heterodox rogues!) in the modern era – that the actual reserve effect of a QE program itself has little consequence for bank credit behavior in the first place.

  6. 6 JKH May 18, 2015 at 7:57 am

    Clarifying one sentence from my comment above:

    “If the gold stock is held off the central bank balance sheet in a separate government account, the default payment mechanism means funding net gold inflows by issuing treasury debt”

    i.e. Treasury issues debt and pays for gold purchases from its account with the central bank, as part of ongoing deficit financing – as opposed to the central bank conducting separate operations as principal on its own balance sheet

  7. 7 Blue Aurora May 26, 2015 at 1:58 am

    That does look like a fine paper, Dr. Glasner. However…do you have any papers that are forthcoming in any scholarly outlets?

  8. 8 David Glasner June 1, 2015 at 12:12 pm

    Benjamin, Wby do you think the Fed has a credibility problem? What is the evidence that the 1.5% inflation rate is outside the acceptable range for the Fed? On the contrary, the Fed seems to be quite pleased with its inflation performance even while paying lip service to a 2% target.

    JKH, Thanks for reminding me about Irwin’s piece.

    Blue Aurora, No. Unfortunately, I’m still trying to get my papers with Batchelder and with Zimmerman accepted.


  1. 1 Sunday notes – Three working papers and three prediction markets | The Market Monetarist Trackback on May 17, 2015 at 12:34 am

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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.

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