Great Expectations and the End of the Depression

By Gaudi Eggertsson

The Recovery was a result of a shift in expectations.

Shift in expectations was spurred by a policy regime change.

Policy regime change was the elimination of “dogmas” i.e. Gold standard, and other deflationary policies

Following the change demand was stimulated by low real interest rates and inflation expectations

What ended the Depression?

Hoover Gold standard Balanced Budget Small Government Tax increases to

make up for loss of tax collection

Government Policies (Dogmas)

Roosevelt• Elimination of the

Gold Standard• Reflation• Low Real Interest

Rates• Government Deficit

After Roosevelt’s inauguration he stated that the prime goal was to reflate prices to pre- depression levels within 1-3 years

Roosevelt made it no secret what is goals were, often his quotes would show up in newspapers

Reflationary Quote from Roosevelt1. “We are agreed in that our primary need is to insure an increase in the

general level of commodity prices. To this end simultaneous actions must be taken both in the economic and the monetary fields.”

Changing Expectations

Saying that inflation is going to take place and doing is two completely different things.

Roosevelt knew he had to make his reflationary talk credible

He did this by expanding the government through deficit spending.

Changing Expectations

Small Government Dogma: Balanced Budget Dogma: For simplicity, the “gold standard” dogma is excluded from the model, but President Hoover

was a strong supporter of the gold standard. This dogma can be added without changing the results because the US government held gold in excess of the monetary base at the time, so this constraint was not binding

Hoover Regime:

The Model

Roosevelt Regime:

The Model

Roosevelt regime is committed to a lower nominal interest rate, higher prices, and a permanent increase in the money supply

Roosevelt’s comments become credible when the public observes a huge increase in government spending

Data suggests that 70-80% of the recovery is because of inflationary expectations

The other 20-30% in explained by the National Industrial Recovery Act (NIRA) and other reflationary policies

The Model

Changes in the expectations of future money supply had more of an effect then the Governments extreme spending

Elimination of old Dogma’s explains the change in expectations

With the absence of a regime change the economy would have continued to falter

Conclusion