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The Ends of 27 Big Depressions

Journal: American Economic Review

Date: 20240101

Author: Ellison, Martin; Lee, Sang Seok; O'Rourke, Kevin Hjortshoj

Abstract:
How did countries recover from the Great Depression? In this paper, we explore the argument that leaving the gold standard helped by boosting inflationary expectations, lowering real interest rates, and stimulating interest-sensitive expenditures. We do so for a sample of 27 countries, using modern nowcasting methods and a new dataset containing more than 230,000 monthly and quarterly observations for over 1,500 variables. In those cases where the departure from gold happened on well-defined dates, inflationary expectations clearly rose in the wake of departure. Instrumental variable, difference-in-difference, and synthetic matching techniques suggest that the relationship is causal.

Link: Google Scholar

Key Findings

Leaving Gold Standard Led to Recovery

Countries that abandoned the gold standard saw increases in inflation expectations and declines in real interest rates, facilitating economic recovery from the Great Depression

Timing of Recovery

Early leavers (Sep-Dec 1931) experienced faster recoveries compared to countries that maintained gold standard longer or only implemented exchange controls

Real Interest Rate Effects

Average decline in real interest rates one year after leaving gold was 8.4 percentage points, with 7.8 percentage points due to rising inflation expectations

Changes in Real Interest Rates After Leaving Gold

  • Most countries experienced significant drops in real interest rates within one year of leaving gold
  • Initial rises occurred in some early-leaving countries but reversed within quarters
  • The US saw the largest decline of 21 percentage points

Decomposition of Real Interest Rate Changes

  • Rising inflation expectations were the primary driver of falling real rates
  • Nominal interest rates played a minor role in most countries
  • Outside the US, inflation expectations accounted for 93% of the decline in real rates

Prices and Output After Leaving Gold

  • Prices stabilized immediately after countries left gold
  • Output showed gradual recovery in most countries
  • The US experienced exceptionally strong output recovery compared to other nations

Contribution and Implications

  • First comprehensive cross-country analysis of the role of inflation expectations in ending the Great Depression
  • Demonstrates that abandoning the gold standard was crucial for recovery by allowing expectations to adjust
  • Highlights the importance of monetary regime changes in shaping economic expectations and outcomes

Data Sources

  • Real interest rate changes chart based on Table II data showing changes after leaving gold standard
  • Decomposition chart constructed from analysis showing 7.8 of 8.4 percentage point decline due to inflation expectations
  • Price and output chart derived from Figure XII showing normalized indices around departure dates