Did Monetary Forces Cause the Great Depression? A Bayesian VAR Analysis for the U.S. Economy

Albrecht Ritschl and Ulrich Woitek

No 50, IEW - Working Papers from Institute for Empirical Research in Economics - University of Zurich

Abstract: This paper recasts Temin's (1976) question of whether monetary forces caused the Great Depression in a modern time series framework. We analyze money-income causalities and predict U.S. output in a recursive Bayesian framework, allowing for information updating and time-varying coefficients. The predictive power of money aggregates and the Fed discount rate is in general very weak and collapses after the crisis of the gold standard in 1931. In contrast, non-monetary variables, particularly leading indicators of residential construction and equipment investment, have impressive forecasting power, forecasting almost half the output decline already in mid-1929. Our recursive framework also allows to examine the stability of our estimated dynamic parameters. Recursive estimates of the monetary impulse responses exhibit remarkable structural instability and strongly react to monetary regime changes during the depression. This phenomenon is discomforting in the light of the Lucas (1976) critique, as it suggests that the money/income relationship may be endogenous to policy and was not in the set of deep parameters of the U.S. economy. Given the instability and poor predictive power of monetary instruments and the strong showing of leading indicators of real activity, we remain skeptical about a monetary interpretation of the Great Depression in the U.S.

Keywords: money/income causality; Great Depression; recursive estimates; conditional forecasts (search for similar items in EconPapers)
JEL-codes: C53 E37 E47 N12 (search for similar items in EconPapers)
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Citations: View citations in EconPapers (10)

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Working Paper: Did Monetary Forces Cause the Great Depression? A Bayesian VAR Analysis for the U.S. Economy (2000)
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