Deflation and the International Great Depression: A Productivity Puzzle

58 Pages Posted: 11 May 2005 Last revised: 16 Sep 2022

See all articles by Harold L. Cole

Harold L. Cole

University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER)

Lee E. Ohanian

University of California, Los Angeles (UCLA) - Department of Economics; National Bureau of Economic Research (NBER)

Ron Leung

Universite de Montreal

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Date Written: April 2005

Abstract

This paper develops the first dynamic, stochastic, general equilibrium analysis of the International Great Depression. We construct a new version of Lucas?s (1972) monetary misperceptions model, with a real shock (productivity) and a nominal shock (money supply). We use the model with a newly assembled panel data set from 17 countries between 1929-33 to quantify the fraction of output change and price change that is accounted for by these two shocks. Data limitations require us to develop a new procedure for identifying the two shocks. The identified productivity shock has a large country-specific component, and is highly correlated with actual productivity. The identified monetary shock has a large common component, and is highly correlated with money supply changes. We find that the model accounts for most of the variation in macroeconomic activity in the panel of countries. About 2/3 of output change is accounted for by the real (productivity) shock, and virtually all of the change in nominal prices is accounted for by the nominal (money supply) shock. The only variable we find that is highly correlated with the productivity shock is stock prices. We conclude that financial friction models are potentially the most promising class of models for understanding the Solow Residual during this period, and thus the Great Depression.

Suggested Citation

Cole, Harold L. and Ohanian, Lee E. and Leung, Ron, Deflation and the International Great Depression: A Productivity Puzzle (April 2005). NBER Working Paper No. w11237, Available at SSRN: https://ssrn.com/abstract=697162

Harold L. Cole (Contact Author)

University of Pennsylvania - Department of Economics ( email )

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Lee E. Ohanian

University of California, Los Angeles (UCLA) - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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Ron Leung

Universite de Montreal ( email )

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Montreal, Quebec H3C 3J7
Canada

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