1

ECON 4580 FINAL REVIEW NOTE

10-15-09
Brittan and the Global Downturn
- Why did we do the US and then Brittan?
o Arent the economies doing the same things from the 20s and 30s?
o The Answer: NO! They are very different
o In the US
Economy is booming in the 20s, growth is relatively fast, housing,
durables increase
Then, 1929, great stock market bubble crashes, bank failures, etc
1929 was a very bad year, we dont get back to 1929 GNP until 1937, we
dont get out of recession until after the war
o In Brittan
The unemployment rate after WWI was high from 1921-1929
Years of double-digit unemployment
Slugging throughout inter-war period
Brittans economy is two parts:
One part is sluggish
One part grows quickly
Because Brittan grows sluggishly, downturn from 1929-1932 is not big
GDP fall 5%, much less than in US
Brittan gets out in 1932, gets back to 1929 level in 1934 and grows
rapidly
Brittan is off the gold standard in the interwar period, and it goes back to
its old exchange rate
- The British Economy
o Peter Temin and many other economic historians, when asked what is the cuase of
the depression, say its the ramifactions of WWI
o First World War is incredibly distuptive for Brittan
Leads to collapse of british trade in other economies
Internal problems: rapidly rising prices, significant inflation, large buildup
in national debt
Its forced off the gold standard, and its national debt balloons
o Three Consequences for British Post-War Economy
During the war, Brittan becomes heavily reliant on US for goods, both
domestic and war goods,
Becomes decreasingly able to pay for these goods through their
own exports
o Reasons:
Brittan goes to total war economy
German U-Boat blockade
o Because of this, Brittan runs huge trade deficits with the
US
o This eventually forces Brittan to go off the gold standard,
otherwise, US would have taken ALL of brittans gold
Brittan inflation issues paying for WWI
2

Brittan, during the war runs massive deficits, billion dollar deficits
Tax rate is going up, Brittan is trying to pay for war by increase
taxes, but it cant simply keep up, its too expensive
Brittan is running these deficits, and to pay for them, they are
printing money
This leads to rapid inflation
By 1920, prices are 150% above where they were in 1913
Prices going up 2.5x is chicken feed compared to most of Europe
Most of Europe experienced inflation rates far higher than this
British inflation was MUCH higher than US inflation
o War does not affect US like it affects Europe
This will become important because if you want to stay at your old
gold standard exchange rate, all other countries need to inflate at
the same exact level
o However, the correct exchange rate, should not be the old
gold standard
o Once Brittan is ready to go back on exchange rate, Brittan
wants to go back on old rate
o One of three things need to happen to successfully go back
to old rate
Need Miracle: US would need to inflate like crazy
Brittan will need to deflate on purpose
Brittan will need to drive its prices down,
but it is a very dumb policy, according to
Keynes
Brittan does this
Go back to 4.86, even though it is not the correct
exchange rate, overvaluing currency
You are making your goods, by the stroke of
a pen, more expensive
This is very dumb
o Thus, fixation on Gold Standard and fixation on pegging at
4.86
British treasury were horrified at size of deficits
Debt grows from 754 million to 6.1 billion from 1914 to 1919
o It essentially grows by a factor of 8 in 6 years
o Tax revenue goes up, but not nearly enough
Much of the debt was financed by 5% war loans
Government needs to pay a lot of money to service its national
debt
Debt interest grows form 41 milion/year to 345 million/year
In the interwar period, of government expenditures was
servicing debt
3

British governments desire to pay off the debt and keeping
country on gold standard at old rate meant they would sacrifice the
domestic economy
o Herbert hoovers policy on sterioids
Brittan, during the 1920s had policy of surpluses and high interest
rates, culminating in massive unemployment and sluggish growth
o Brittan is an economy based on exports
Exports, as a share of income,
1913: 29.9% of world manufacturing exports
o Biggest trading nation in the world
o 23.2% of national income comes from exports abroad
This number is enormous
1929: 23.6 of world manufacturing exports
o 17.6% of national income
1938: 22.4% of worlds manufacturing exports
o 9.8% of national income
1913 to 1938 is a massive drop
Brittan was the wealthiest country in Europe
Coal, Cotton, Wool and Ships are what made up the british
economy
Every one of the se sectors goes into freefall in the interwar period
British exports simply dry up, and go from being almost a quarter
to more like 1/10
th
of income
Why do these exports go down?
Their markets are cut off
o British sold to Asia and Latin America
o US takes over Latin America
o Japan takes over Asia
o It proves very difficult for the british to break back into
these markets, these markets are lost forever
Furthermore, many of these countries begins to supply themselves
o Neutral parties in war begin to manufacture their own
goods
o To protect these new industries, tariffs are put up to block
foreign goods
o Brittans decision to go back on the gold standard at $4.86 will cause british
goods to become overly expensive
o In 1932, when british bank slashes interest rates and institutes cheep money,
minor housing boom
o Colapse of export industries and rise of industries to british
Collapsing industries are in northern England
New industries are in midlands and south of England
10-20-09
The Stupidest of Stupid Government Policiesb
- Industrial growth in interwar Brittan
o In Brittan, there are failing industries
4

Old staple industries: coal, cotton, steel, shipbuilding
These are the ones that made Brittan great
Export oriented
o They built ships for the world
These industries are all located in the north of England, in
scoltland, south wales, etc
The Celtic Fringe
Losing 1 million jobs
o Growing industries
New, consumer oriented
Mainly domestic consumption
These gained slightly over 1 million jobs in the same period
they are located in the south and midlands
- The main source of power, in the 18
th
and 19
th
centuries was coal
o Industries had to locate near coal fields, there is no coal near London
o Electricity changes everything in the 20
th
century
It allows for industries to locate near the greater consumer market, London
- What does it mean?
o When you go to look at inter-war bittan, we find it is a massive regional problem
o We have a complete flip in where unemployment is
o Why? Because of weird reactions to WWI and the collapse of british export
industries
o What should be happening?
Migration, and they do
From 1923-1936, London and the south attract 1.1 million migrants. The
Celtic fringe loses 1.2 million migrants
Who migrates?
The people who migrate are young (15-29) and skilled (has some
amount of training or can take a fresh apprenticeship)
The problem is among older workers in the celtic fringe
o If you look at the NE of England, 17% of those
unemployment aged 45-64 had been unemployed for at
least 5 years
o There were absolutely no jobs, and they were not re-
trainable
o If you take all ages for NE, and figure out how long theyve
been unemployed on average, 71 weeks
The Return to gold
- By 1914, its been on the gold standard for 90 something years. Its willing to purchase
gold at 4.25 pounds.
- Brittan is the virtual center of financial markets
o US is buying gold at $20.67
o Therefore, one pound=$4.86
- For countries like Brittan and US that stay on gold standard for decades, there is a
beautiful fixed exchange rate
- The existence of stable exchange rates greatly facilitates international trade
5

o Everyone benefits from this, great growth 1870-1914
- After WWI, this international system collapses
o Exchange rate stability collapses
o During the war, theres massive inflation
o There would have been exchange rate stability if every group had the same rate of
inflation
o In 1920, the relative price would have been the same
What happens during and after the war is that country after country is
forced off the gold standard and their countries just collapse
US prices go up less than everyone elses
Prices in Brittan go up 150%
But, in comparison, is really nothing
o Hungary, prices from 1913-20s, went up 23000%
o Russia, 1913-20s, prices up 4 BILLION%
o Germany, 1913-20s, prices up 1 TRILLION%
Prices were going up in germany 600% week
Surpisingly, germany has a stable economy by 25-
26
Good News: US
o Look at Brittan and compare then with US rates
In august, 1915, when war was exactly one year old, Brittan decides to
devalue slightly
Aug 15, $4.76
Stays pegged until 1919 when Brittans central bank goes off gold
standard
April 1
st
, 1919, goes off gold
Act of pariliemnt that took Brittan off gold standard has clause,
saying our disallowing of the exports of gold will expire on Dec
31
st
, 1925 unless renewed
If parliament didnt do anything, Brittan would be forced back on
Jan 1926
As of april 1
st
, 1919, Brittan is off gold and bank of England has
stopped pegging pound
Pound falls through floor
Feb 20, pound down to $3.20
Brittan starts deflating like crazy in 1920
Early deflation is caused by recession, caused by the collapse of
government spending and demobilization
o Jan 1918, Cunliffe Committee
Consider currency problems in the post-war period
Clear Brittan will win
Clear that will need to go off gold
Reaches one conclusion with two parts:
Return to gold as quickly possible
Should return to gold at ONE exchange rate $4.86
6

o It should NOT consider returning to any exchange rate at
any other price
o Cunliffe committee wants to re-create the pre WWI
economy
Bank of England needs to drive down prices to get back to good exchange
rate but we can do it
Bank of England does this, and by mid 1924, pound back to $4.40
British prices are falling, US prices going up
Pound on Intl exchange rates getting more valuable
o 1924, Bradbury Committee
Advise chancellor of Exchequer, Churchill, what to do in order to
implement the recommendation of Cunliffe committee, in light of the fact
the pound is up to $4.40
Bradbury committee rejects going back on $4.40, we need to go back on
$4.86
Two ways to do this:
o Go back immediately and suffer consequences by
overvaluing currency
o Hope that british bank and US bank continue policies that
drive prices back to $4.86
o $4.40 is about 10% off from taget
1924, election conservatives go back to power, pound shoots up
By late fall, 1924, exchange is $4.79
o Discrepancy of 1.5%
Feb 1925, Bradbury committee recommends going back on gold standard,
noticing the small parity
April 28, 1925, Winston Churchill, announced Brittan was going back on
gold at $4.86
Off gold for slightly more than 6 weeks
o Why did they do it?
Why was everyone obsessed with going back onto gold at 4.86
All believed there were advantages of being on gold, and being on gold at
4.86
Exchange stability
o A nation built on exports, due to the stability, should be
back on gold
o However, that doesnt mean you should go back on gold at
$4.86
The idea of reconstructing pre-war international economy
o Brittans golden age
Exports 4% growth year
Low unemployment
Brittan was center of economic universe
Belief, if we return to gold, since were number 1 in euroupe,
France, Germany, Italy, belgans, etc, will go back onto gold
exchange rate at old levels
7

o Trade will increase sharply
o Export industries will boom like mad, and our
unemployment rate will go down
This is a huge gamble
o Though, the city fathers think this is a sure-bet
o We think we will shoot back to great times, high export low
unemployment
World trade is screwed up since no one is on gold standard
o Once we go back on, everything will be fine
This is the theory, but mostly wishful thinking
o There were a lot of problems with this
Lost export markets
Latin America and Asia
They thought once back on gold, these groups would buy british
This didnt happen
Returning to gold standard was not good enough, we have to return to gold
standard on old exchange rate
In theory, since all you need are stable exchanges, you can go back
on any level
You can go back on whatever, but you DONT need to go back on
$4.86
- Sayers and other defenders of Churchill said that it was a gamble, but it was a good
gamble and should have worked, except for three things
o First Lesson:
Never trust the French
France and Belgium dont play by british rules
Remember, if british do the sacrificing, all the European countires
will go back to exchange rates
They dont go back at old exchange rates, they go back at far far lower
levels
Go back at 1/5 of what the franc was when it went off
British: this is unfair. They are undervaluing their currency
Their goods, as it looks to foreigners, looks cheep
British goods look expensive
Brittan should have followed France and devalued its currency
However, Churchill defenders got an unfair trading advantage over Brittan
Sayers: If Brittan had gotten back at $4.40, Sayers says French would have
pegged their currency lower. Nothing Brittan could do
o Second lesson:
Never underestimate germans
After war, British thought that germany was not an economic competitor
anymore
Economy, post WWI was a basket case
1926, new regime, new currency, and put their house in order, and they
began to export
British never thought they were going to compete with the germans
8

No one thought that Germany was going to be an economic power
anymore
o Third Lesson:
Americans will not save you economically
British thought that US were going to inflate currency to make it easier to
go back to old exchange rates
US did not do that and british were upset over it
o Resetting to $4.86 thought it would create some economic nirvana, and create
WWI, but it didnt happen
- J.M. Keynes
o When the armistice was signed, the allies did not know how terrible shape they
were in
o Versallies treaty writing takes a nasty turn, allies try to stick it to germans
Keynes resignes over this
Keynes: Its idiotic economically what they are doing
Writes brilliant book The Economic Consequences of the Peace
Treaty will be disasterous for Europe
WWI had irrevolably changed the economic balance of power
Predicts that European powers will try and recreate/reconstruct
pre-WWI economy
Its not desirable to do that
Things have changed
o US more powerful
o Europe weaker
o Hard to go back to the way things were
1923: 186-219, Essays in persuation
knows that Brittan and France are looking to get back on gold
they have to decide between deflation/Devaluation
Their currencies have gone down in value,
o If you want to go to the Pre WWI-Exchange rate, you need
to deflate, since USs value went up during war
o Devaluing, weaker currency due to appreciated US
currency
Which is worse: deflation, driving down prices, is associated with
unemployment
o When prices fall, debt goes up
Its much less costly to go back on gold standard level you are
currently
o Those countries that have had stable inflation since 1913
should stabilize them at domestic prices level
o Feb 1925, Exchange rate back to $4.79
Bradbury committee says go back immediately
Kenyes: dont do it! This is a false exchange rate, this is speculation
Currency traders are tyring to take advantage of the conservative
policies
Real exchange rate is still about $4.40
9

If you go back to 4.86 with the stroke of the pen, you have
overvalued currency by 10%
o You would have raised your commodity prices by 10%,
and you are going to destroy your export industries
o Churchill does it anyway
Keynes responds with scathing attack: The economic consequences of
Mr. Churchill
Winston Churchill has just overvalued the pound by 10% while
leaving domestic prices unchanged
How do you go back, drive down prices 10%
Firms will break union contracts and cut 10% of wages, leads to
general strike 1926, all hell breaks loose in Brittan
10-22-09
Brittan and The Gold Standard
- John Maynard Keynes
o It is impossible to recreate the pre-WWI economy
o Do not go back on 4.86
o Churchills Dinner Party
Invited bankers and Keynes to discuss gold standard
Keynes kept his mouth shut,
o He had already conceded defeat
o April 1925, Brittan back on gold standard
o July, 1925, Keynes publishes the economic consequences of Mr. Churchill
Gold was at 4.79, but it did not represent the real exchange rate
The real exchange rate was 4.40, since the 4.79 was more of a spectulative
rate based on the conservatives taking power
Since the real exchange rate, based on imports/exports was 4.40, Churchill
had overvalued the currency at 10%
This makes the goods more expensive abroad
Internal prices/costs are the same
What does this mean if foreign prices go up?
Either foreigners say theyre going to swallow the cost increase, and
pay more
Orforeigners will not buy the british goods
o British goods are not competitive
o The only way for them to become competitive again is if
exporters lower their prices by 10%
So, firms go to their workers, break contracts and cut wages by 10%
o Wages are the main cost of production
o The reason they do this is because they need to be competitive
on world markets
Churchill has committed to drive down wages by 10%
Churchill: we will let the market drive down prices
The market will not do it rapidly and will not do it at the same time
Left to market adjustments, there is nothing that says that the
adjustments will occur fairly
10

What chruchill has done is made british goods look uncompeitive in foreign
markets
He has also made foreign goods more attractively priced
Churchill has thrown the country into a balance of payments crisis
The president of the board of trade has asserted in the househas
asserted it has been all to the good. The chancellor of the exquecker
has expressed the opinion that the gold standards effect on the coal
industry has no more effect on the industry than the gulfstreamthis
is of the featherbrained variety
So, if youre back on gold and you have a balance of trade deficit, youre
going to raise interest rates to attempt to get people to invest in local markets
To correct deficit and outflow of gold, in the long run is to lower
domestic prices Keynes,
o draconian way to get wage cut:
Give workers the following option;
Starvation through unemployment
Submission through wage cut
o Keynes: we just have to drive down prices like crazy
Fixates on cold miners
June 1924, British coal sold for 45 cents less on
world markets than US
o Brittan is exporting coal like crazy
June 1925, US coal is now cheaper by 63
cents/ton
British exports of coal collapse,
British coal-mining firms, who are unionized,
and have a contract, say we need to break the
contract and we need to cut your wages by 10%
Coal miners are pissed
But, the short run solution is to raise interest rates
Keynes: the market isnt fair
The end of lassiez faire: we have been taught that there is a fair and
natural law in the marketplace
o That may have worked up to WWI, but no one really believes
that anymore, its not true
o The market is one way to distribute goods, but its not the only
way
Coal miners are first victim of economic juggernaut
o Coal is a very competitive industry on world markets
o Government has wrecked coal industry
o Mine-owners have to do the only thing, and cut wages
o Coal miners are not happy but dont understand whats going
on, but why should they, Churchill doesnt understand
o Keynes thinks theres going to be mass unrest
The strategy is flawed and not well thought out
o Keynes solution:
11

Government should offer unions a deal:
Negotiate an across-the-board wage cut of 5%
Subject to a promise that the government would do everything in its
power to lower consumer price index by 5%
o Purchasing power doesnt budge, workers are the same off
But what about middle class? Government should implement a 5% increase
in income tax
Workers dont pay income tax
As workers accept wage cut, and middle and upper class sacrifice
equally
o No one was listening to Keynes in 1925
o The policy of the bank of England was explicit:
Set the bank rate higher, between and 1% higher than US discount rate
We want to people to put their short-term money into pounds instead of gold
o This is what a country should not do
The country is giving priority to a maintanece of a stable exchange rate to
sacrifice prices
Government is forced to jack up interest rates, stilfiling investment and
slowing economic growth
The bank of England is forced to sacrifice the exchange rate
Instead of giving easy money to help the unemployment rate,
Brittan deflates rather than devaluing
They did this because the city fathers thought it would be easy/short
term
o British Exports go up 9% from 1924-1939, imports go up 13%
However, the world exports go up 32%
There is world trade picking up, but Brittan is not participating
o World trade has gone up, but Brittan is not sharing in the gains.
o In fact, its worse than that
Export industries declining
o Keynes predicted industrial conflict:
Occurs in 1926
Mine owners were losing money
1926, they decide to break the union contract
To support strike by miners, trade union congress calls for a general strike.
2.5 million workers go on strike
General strike lasts for 9 days. Miners strike for 7 months. Workers
capitulate Mine owners get wage cut and increase of work hours.
Real purchasing power of mine owners go down 5%
o Government basically has two policy tools: monetary and fiscal policy
Monetary policy: changing interest rates
Fiscal policy is government spending
During recession: cut interest rates and increase government spending
During this recession, Brittan uses the monetary policy perversely
Furthermore, they use the fiscal policy perversely
o They are obsessed with getting rid of the WWI debt
12

o These are current account surpluses, not full unemployment
surpluses
The government is doing everything wrong in domestic policies
10-27-09
British Government Policy Objectives
- First policy objective: Stable exchange rate
o Go back on gold on $4.86/pound
- Second objective: retire/reduce national debt
o National debt gone way up due to WWI
o These were both attempts to go back to pre-WWI economy
- Reduce Unemployment rate
o Get back to normal levels of 5%
- Policy tools
o Monetary policy
o Fiscal policy
Can you fix three problems with two tools? If two work on one
o Monetary policy is not used right, interest rates are raised, raising inflation and
even worse for job creation. Unemployment rate rises
o Fiscal policy is also not used right
The british government runs current account NOT full employment
surpluses, meaning that there is massive unemployment
- Unemployment is 10-14%, what does the government do? Very little!
o British government decided to deal with unemployment back in the way it did in
the 1880s, through public works policies
o British localities had set up public works projects during periods of high
unemployment
o Public works policies should be undertaken by local authorities
o However, central government will set up unemployment grants committee that
will help subsidize some projects.
At least 50% of funding has to come from locality
How does localities pay for it? The localities raise taxes
The whole point is crazy: CITIES CANT RUN DEFICITS, so youre
raising taxes on those unemployed
- 1886, Joseph Chamberlin
- Public works: Unemployment tax money,
o Dec 1920-June 1929, would have created 42,000 jobs year
This is a tiny number
The avg unemployment rate was 1.2 million. For every hundred
unemployed workers, 3.5 of them could be employed with public works
jobs
o Rationale:
1: Public works jobs merely alter the time-distribution of unemployment
You build something today, you cant do it tomorrow
Public works is robbing the future of jobs
13

2: Any work on public works projects must inevitably be subtracted from
private sector today
This is crowing out with gusto
Productivity can also be lowered with public works jobs
So, you are not creating jobs in the future, but you are not creating any
jobs today
o In the 1920s, the conservative and labour party both say public works wont work
o However, the liberals take a different tack
During the 1920s, the liberal party, under David Llyod George, was a
staunch supporter of public works to stem unemployment
Party put out book in 1928 called brittans industrial future
Election in 1929 where conservatives in power run against labour and
liberals, is that parties put out manefestos
Liberal manifesto: We can conquer unemployment
Lloyd georges pledge: We are ready with schemes of work which
we will put into operation. It will reduce the unemployment. This
will not add one penny to national or local taxation
What does he pledge to do:
Spend 125 million pounds/year on public works
o Telephone development
o Electrical development
o Land drainage
o Extending London underground
o Roads/bridges
o Public housing
Will put hundreds of thousands to work each year
There will also be indirect effects
o Increased purchasing power, the workers will spend the
money,
o thus they will increase purchasing power on food, clothing,
entertainment, etc
Lloyd George: I will get unemployment rate down to normal
proporations
There were about 1.5 million unemployed workers in 1929
o Normal proportions is around 500,000 workers
I will spend 125 million/yr for two years
o That will create 600,000 jobs, but it will in total create 1
million jobs
o Indirectly, it will create 400,000 jobs
o This is the keynsian multiplier
o Gets battered by both labour and conservative
o Lloyd George is saved by Keynes
Essays of persuasion 118-34: A program for expansion
Real title: Can Lloyd George do it?
Can Lloyd George get unemployment back to real levels?
o Theres work to be done
14

Theres 1.5 million people unemployed
o Usually the market solves these issues, but for whatever reason the market is not
fixing the issue
Stanley Baldwin: it is financially sound to keep 10% of population
unemployed
Keyens and Hend: this is sheer nonsense
o The major objective is crowing out/limiting capital
The government could spend more money but the total government
expenditures could not increase
LG, K (money multiplier)=1.67
SB , T, K=0
o Keynes sand Hend say the idea that the money multiplier is wrong
Argument is the capital stock is fixed and is insufficient to employ
workers
Thus, it is now natural to have a 14% of unemployment
If the capital stock is fixed, if one firm gets more capital, one firm gets
less capital
Thus, it is impossible to raise number of jobs
Not only can government not do it, but the private sector cant do it either
o Keynes and Hend reject this
They believe Lloyd George can do this, and the money can come from
three sources:
First: Unemployment insurance funds
o What Keynes and Hend say is that the government is not
employing workers, but the government is still spending
money on unemployed workers
o The government has spend 500 million pounds on
insurance
o Its giving workers to do nothing instead of working
o Why not give the 50 million pounds that are being used in
unemployment and transform it into wages
Second: Savings are going to waste
o Its going to waste because its not being demanded by
entrepreneurs
o Treasury makes an assumption that every pound saved by
the public is turned around and invested by industry, none
is horded
o Untrue. During downturns, money is saved that is not
invested,
o During downturns, private savings S > I
o There is money out there ripe for the taking
S-I is a positive number
Why cant the government use it to put people to
work?
o Money saved that is not being used to put people to work in
the private sector
15

Third source: reduction in foreign lending
o Divert savings being used abroad to US
o The idea that foreign investment will be reinvested in
Brittan doesnt work
Keynes & Hend, the multiplier is at least K=2. For each one million
dollars spent, it will create 600,000 jobs directly. However, there is also
the indirect purchasing power, and indirect costs related to these public
works
You will stimulate all industries if you put all this together. You will
create at least as many jobs indirectly as you will directly
So, Lloyd George doesnt need to create 600,000 jobs, he only
needs to create 500,000 jobs
- Could Lloyd George really have done it?
o Glynn and Howells (1980)
They believe multiplier is much lower, 1.26
K=1/1-mpc
In reality: 1/1-(MPC-MPI)
MPI=marginal propsnsity to import
Glynn and Howells, its quite high
For every 100 pounds, that worker will spend 35.5 pounds on
foreign goods
o Glynn and Howells are cheating: they dont do the calculations for 1929, they do
it in 1932
In 1932, its the peek of the depression in Brittan, there are 3.2
unemployed workers
To get it down to 5%, would need to create 2.8 million jobs
o What would it have cost to create 5%
conclusion: if you believe the multiplier is 1.26, required government
expenditures is 537 million pounds
that is an enormous number
70% of what government planned to spend in 1932
o Problems:
This is a bait and switch
Multiplier is way too low
Also, bizarre assumption that government spending means deficit
They dont understand that people pay taxes if employed
10-29-09
Glynn and Howells
- Conclude that Keynes and Lloyd George are wrong
- Glynn and Howells attempt to discover how many jobs do you want to create through
public works
- Glynn and Howells are cheating, getting unemployment rates back to normal rates in
1932, which was nearly triple what it should have been
16

o 1929: when Lloyd George is proposing public works, 1.5 million unemployed
(500,000 jobs need to be created)
o 1932, time which Glynn and Howells use for calculation 3.4 millon unemployed
2.8 million jobs need to be created)
- P=Marginal product of labor
o Glynn and Howells: increase in GNP to get up to full employment=676 million
o Government spending needs to go up Y/ multiplier
If multiplier is one, G and Y are the same
Government spending does not need to go up as much as GNP, it only
needs to go up by the multiplier
When you put these together, G=E*P/K, that is what you need to increase
government spending by
o Glynn and howells say that that Lloyd George and Keynes forgot an important
point
British workers will spend a lot of their new income on foreign goods
o Glynn and Howells estimate marginal propensity to import is .355
Because of the high marginal propsneity to import, you get a low
multiplier, 1.26
o To create 2.8 million jobs, you will need to raise 537 million pounds.
This is a huge number
This is almost 14% of GNP
Government spending would have had to increase to a massive number to
get unemployment down
You would have to increase the Government expenditure by 70% to get
the jobs needed
This could not have possibly have happened, the government could
not just go out and borrow 14% of GDP
This is both politically and economically unfeasible during
peacetime
It would have created massive crowding out
o The conclusion: Its impossible, the program would have not worked using Glynn
and Howells calculations
The government could not get us out of the depression
Bizare Problem: Why would you attack Lloyd George for a problem he is
working to fix in 1929 by looking in 1932
Theyve invented a straw man
- Hatton
o Redoes Glynn and Howell
Recalculates the multiplier
Does it by making different assumptions about the marginal propensity to
import
o Assumption 1: How big is the multiplier due to the marginal propensity to import
Glynn and Howells: K=1.26, MPI=.355
Hatton: K=2, MPI=.21
The number Hatton thus generates for government spending 338 million,
45% more than what government wants to spend
17

What does this do to the deficit?
People getting jobs will get money and will pay taxes
Furthermore, government social service spending will go down
Tax revenue will go up
How do we calculate how much does the deficit go up when spending
goes up by 100 pounds
Roger Middleton
o For Brittan in 1930s, effects of increased taxes and social
spending changes, means the deficit goes up 56
If multiplier is 2, you can increase jobs by 2.8 million by
increasing deficit by 41 million,
o Tax revenue increases and social spending decreases
If the multiplier is 1.26, deficit will be much higher
o Robert Lucas, K=0. you can spend until the cows come home, and you will create
no jobs
o It really matters what the multiplier is to know what to spend
- Looking at Lloyd Georges policy in 1929: could he have done it?
o Glynn and Howellss multiplier, K=1.26
Cost 192 million pounds to put people to work
Deficit would have gone up by 86 million
o If multiplier is 2: to create 1 million jobs, cost 125 million/yr
o Lloyd George has his number almost perfect if the multiplier is 2
o Lloyd George says something dumb
I can do this without increasing the deficit by one penny
Its wrong, but not completely wrong
o If you believe middleton and hatton, deficit would increase by only 15 million
o Under these assumptions, Lloyd George was right, unemployment could have
been reduced to normal levels with a minimal increase in the deficit
The Depression
- The Morals
o The what doesnt go up, doesnt need to come down
o The smaller they are, the softer they fall
- The depression that starts is not all that bad in Brittan,
o But Brittan has had unemployment rates of 10-15% in the 1920s
o The british economy does not have a domestic boom in the 1920s, there is no
roaring 20s
o We have the farmers in the early 20s going into debt like crazy, we have the huge
increase in durables spending
o We have this huge increase in bubble spending
o This does not happen in Brittan
o By overvaluing their currency, they make their growth even more sluggish
o Thus, the depression looks MUCH less severe in Brittan than it does in the rest of
the world
o What drives downturn is a collapse in exports
From 1929-1932, GDP only goes down by 4.8%, so this is nothing
18

But exports go down 37.5%
Whats driving the british downturn is not a domestic problem, but its a
collapse in exports
The US Sneezed and the world got the flu
o The US bought enormous amounts of primary products from third world country
Third world countries spent a lot of money buying british goods
When the US economy collapses, US stops buying primary products,
meaning British exports collapses
o The depression in Brittan is very regional
The parts of Brittan doing badly in the 20s does even worse in the 30s
1929: Wales unemployment 18.8%, 1932, 31%
Coal fields and shipbuilders regions, up 18%
Scotland, unemployment up 17.8%
London, much less, up 8%
o British call this the slump of 1929
Affects some part of Brittan much worse than others
Mainly the export areas
Again, Brittan has no housing boom in the 1920s, no motor vehicle boom
in the 1920s, no agricultural boom in the 1920s, no bank failures, and no
stock market crashes
o Brittan does have one thing: unemployment gets a lot worse
o Unemployment gets up to 22.1% in 1932
This is primarily concentrated in the Celtic fringe
- British policy during the depression
o The good : Cheep Money
o The bad: Tariff Protection
o The really bad/stupid: Balanced Budgets
o Cheep Money
British monetary policy in the 1920s was governed by the gold standard
Pre 1925: we need to drive down prices to get back on gold
standard in 4.86
Post 1925, we need to maintain our currency at 4.86
It was governed by the exchange rate
British raise interest rates to high levels to prevent gold outflow
However, this slows down the british economy
High investment means slow economic growth
The belief: saving the gold standard would have created a huge
burst in economic growth/long-run nirvana
Once the US collapses, everything gets much, much worse
The bank of England has been fighting like crazy to keep gold high
Exports collapse even worse
Balance of trade is much worse, gold standard is much worse
It gets much worse in 1931 when Credit Aunstalt in Vienna fails
With the huge trade deficits the british are running, speculators begin to
think that Brittan is going to go off gold
19

Speculators begin to withdraw from the pound before the currency
is devalued
They need to jack up rates even higher to protect gold, but this is
insane
The only thing to do is go off the gold standard. September 21
st
,
1931, Brittan goes back off gold, allowing the pound to
float/depreciate
o The pound plummets
March, 1932, value of pound is down to 3.40
Remember, US is still on gold standard
Treasury begins to do the opposite of what it did before
Treasury likes the low exchange rate because it makes british
goods cheep on foreign markets
1932, exchange equalization account
Allows british treasury to manage pound to make it cheep
This is a complete about-face in policy, and it works until april
1933
The policy of cheep currency doesnt work after US drops gold standard
When US goes off gold, dollar collapses, but that makes value of
pound go up
By end of 1933, the exchange rate is back to about $5.00, and remains
above 4.86 until WWII starts
Irony: Brittan the US fought like crazy to keep on gold standard, and on
4.86, and destroyed the economy to do it. after markets were completely
open, the exchange rate got to 4.86
o Brittan goes off gold, and all of a sudden, the british treasury were no longer
slaves to the exchange rate
This leads to a massive policy shift
The bank of England is forced to keep exchange rates high
The bank rate is kept between 4.5 & 5.5 percent
At the end the bank rate is up to 6%, stays at 6% until feburary 1932
From 1925 to 1932, Brittan has very high interest rates, and very slow
growth of the money stock
The money stock grows about 2%/yr
From 1929-1931 money stock grows slightly
If you look at british high powered money, it is slightly more than
1931
o

11-3-09
British Policy in the 1930s
- Three Parts
o Cheep Money
20

o Tariffs (revenue)
Not draconian, protective tariffs
o Balanced budgets (surpluses)
- Cheep Money
o 1925-1931, Brittan has very restrive monetary policy because they are desperately
attempting to stay on gold standard
Back on at 4.86,
o It gets much worse, 1929 after US market collapses, Brittans exports collapses
o To counteract balance of trade deificts, to stay on gold standard, Brittan would
need to raise interest rated
1925-1932, Bank of England kept their discount rate above discount rates
above everyone else
This was to attract London money in the short term
They are keeping inerest rates high, but this is choking off investment
o Everything changes in September 21
st
, 1931
o In feburary, 1932, complete about-face in monetary policy, cheep money
From februrary to june 1932, the discount rate is cut from 6% to 2% in a
series of steps
o British treasury is throwing a lot of money into moneystock
Growing at rate of 2%/yr
It had declined slightly because of bank failures
1930, high powered money was less than it was in 1921
British monetary policy had been contractionary throughout 20s
o However, complete about-face by the 1930s
1932-1936, money stock growing at 6%/yr
o Once gold is gone, british go to extremely expansionary monetary policy to
jumpstart domestic economy
It works brilliantly
Pent up for domestic housing in Brittan
Completely opposite of US
From 1929-1932, expenditures on residential construction go down
1.5%, but goes down by an astronomical number in US
From 1928-1932, hosuing has actually gone up,
1933, expenditure goes from 131 million pounds to 172 million pounds
1932-1933, goes up by 3.3%, increase is a lot less than 31%
Gross domestic fixed capital formation has actually fallen by 28 million
pounds
Spending on plant and equipment goes down 1932-1933
Not working everywhere
o Therefore, the domestic housing market is single-handedly pulling Brittan out of
recession
Housing is basically saving Brittan
Housing boom is driven by cheep money
o Why did Brittan get out of depression
Got off gold standard
Turnaround in Brittan is going off gold standard
21

You cant do cheep money on gold
Expansionary monetary policy
Depression in Brittan is largely an exogenous event
It is not something that occurs in british economy
Collapse in exports
- Tariffs
o Brittan was the bastion of free trade in the world
o When Brittan went free-trade in 1846, much of Europe cut tariffs sharply
o However, in the 1870s, most of Europe threw up nasty tariffs, in 1890s tariffs got
even bigger
o Brittan remains free-trade throughout all this
o When your economy is running balance of trade deficits, you need to figure out a
way to balance again
If you cant increase exports, you can cut imports
The most simple way: pass a tariff
These rumblings for tariff gets much louder during US economy
collapse
o Keynes is in favor of a revenue tariff
There was unbearable pressure on English pound
Bank of England could not continue to raise interest rates
The government put on a tariff to ease balance of trade deficit
Its not a protective tariff
It is a revenue tariff, make some money, cut imports
Use money to ease budget problems
Keynes says this in march, 1931, when Brittan is on gold standard
In September 1931, Keynes makes a huge about face
Everything is different, because now that weve gone off gold, the
value of the pound is falling like crazy
This is doing the tariffs job for us
British goods become cheeper to foreigners
Balance of trade problems fixes itself
Pound is depreciating by 25%
o Imports will go down naturally
o Tariff, however, does nothing to help exports, and may hurt
exports
The value of the pound dropping will lead to huge boom in exports
10% duty on imports
Revenue tariff excludes commonwealth areas, Canada, Australia, etc
Tariffs effect on economic recovery:
Overall the contribution to the economy was a wash, it was very
modest
It helps some industries, it hurts others
o Helps: iron/steep & cotton
10% duty leads to much higher domestic production
of these goods
o Hurts: Shipbuilding & housing
22

Shipbuilding hurt because material prices go up
Shipbuilding already the most depressed
industry in the country, this is just making it
even worse
Housing boom: iron and steel is important in
housing
o When you add all this together, theres not much of an
effect
- Balanced budget
o Labour and conservatives think that a balanced budget was important to economic
recovery
o Argument: business confidence is key to economic growth
One of the keys to business confidence is confidence in the economy,
confidence that the budget is under control and ready
o The current account budget from 1929-1930 are deficits not run by choice
They are deficits that occur by accident
Tax revenue falls automatically, spending on government insurance
automatically goes up
British government responds to these deficits much like hoover does in the
US
We need to do something, and what were going to do
o Avg Inc Tax Rate:
1929-1930 20%
30/31 22.5%
31-33: 25%
34/35: 22.5%
o Government did not expect that there would be so many bad years in a row,
unemployment insurance is supposed to balloon up and down to counteract
good/bad years
o That changed in 1934, unemployment insurance needed to pay for itself
Workers were taxed more, companies were taxed more
o Late 1930s, shift in fiscal policy, increase in government spending
Fear of Hitler
Churchill was the one pushing this
1930s, british defense spending goes way up
While defense spending goes up by four fold in 10 years, however,
spending in other sectors goes down
This is not keynsian policy, this is a fear of hitler policy
o Roger Middleton
Constant employment budget
We cant look at the full employment because Brittan never came
close to full employment
However, Ill look at 1929 and 1937, the closest Brittan came to full
employment (that was not even close)
The budget is contractionary, and gets even more contracionary as the
slump gets worse, 1929, contractionary, 1934, even more contractionary
23

This is because government is trying to balance its current account budget
British fiscal policy is very contractioanry
It turns around in 1933-1934, but only because of defense spending
o Defense jobs: 1935: 445,000 to 1938: 1,482,000
80% of the jobs created in Brittan from 1935-1938 were created in defense
industry: that may include linkages
It is a great way to get people back to work, and it breaks the budget issue
- Brittan is getting out of depression because it goes off gold and it is helped by a shift
out of contractionary budgets through rearmament
- Says law
o The lowest unemployment before the rearmament was 9%
o If you asked economists as to why, economists would point to Says Lay
o Jean Baptist Say
Supply creates its own demand
Theres always enough money in the economy to buy all the goods
produced
There are downturns, but this is from misallocation
If you let the market alone, money will flow from glut sectors to
underutilized sectors
o Its very hard to reconcile says law
Why was the unemployment rate so high for so long
If you believe in says law, you have to believe wages are flexible
Sowhy are wages sticky?
o Keynes came up with theory that Says Law is Hogwash
There is a possibility that economy can get stuck in liquidity trap
o Trade unions keep firms from being flexible;
Trade unions refuse to negotiate wage contracts
Unions are willing to accept reverse seniority layoffs to keep downturns
o If youre a worker that isnt getting laid off, your wages go up, due to deflation
o Other story: british unemployment insurance system was uniquely generous
between the wars
If unemployment insurance is generous, the cost to be unemployment has
gone down, and the cost of leisure has gone down,
A lot of this unemployment is voluntary, these people are not actively
searching for new jobs
o The market works fine, but is being screwed by UI and trade unions
o
11-5-09
Unemployment in Inter-war Brittan
- unemployment between 1924-1937 is very high
o yet, 1951-1973, unemployment rate 2.1%
- It is no surprise that keynsian economics was invented during the interwar period
- Benjamin and Kochin, (JPE, 1979)
o When it came out, Paul Craig Roberts wrote a response in the wall street journal:
24

Phantom Unemployment
o Benjamin and Kochin say Keynes is nuts
o Unemployment in brittan is insanely high: 1921-38, Average=14.2%,
o There is a paradox: respectable growth rates, very high unemployment
o The reason for this is not because the market failed
o The reason is, according to Benjamin and Kochin, is the national system of
unemployment insurance, with uniquely generous aspects
o Their story is going to be UI is uniquely generous, because of this, there is high
unemployment, and much of this unemployment is thus voluntary
o The benefit/wage ratios is hovering around 50%
The benefit wage ratio in 1913, is 27%
The B/w (1921-1938) about 50%
If brittan had stayed with a b/w ratio of 27%, unemployment would have
been much lower
Once you take out the voluntary unemployment: 5.3% unemployment in
1927.
Unemployment (minus voluntary) rate would have eventually hit a low
number, if not for the fact Brittan got back on gold in 1925, sending
unemployment rate back up
o The Benjamin and Kochin story is one where the economy works but it keeps
getting hit by bad shocks
Big Shocks WWI, Great Depression
Smaller Shocks: Gold Standard
o National unemployment insurance established in 1911, only covers 15% of
workers and can only receive for a small amount of weeks, benefit wage ratio is
very low
UI in 1911 is an alright system
o 1920, unemployment insurance has changed, benefits are extended to workers age
16 and older. Also increases benefits A LOT
Remember, students left school at 14
Excludes agriculture and domestic servants
o Liberalized during the 1920s, getting the B/W ratio to 50%
- Why is the benefit wage ratio so high?
o No experience rating:
You can experience rate firms and workers
Experience rating: the more you lay off workers, the more UI tax you
should pay
The worker who is laid off a lot should be taxed higher (Ignore)
Firms that lay off workers more pay higher UI taxes
In great Brittan, there is zero experience rating. They pay taxes based on
their workforce.
In Brittan, there is no cost for laying off more workers, the marginal cost
is zero
o Beneifts are not tied to wages
25

Wages are tied to benefits, so that if two workers are laid off, the worker
making 40,000 year will get higher benefits than the worker making
20,000 year
In Brittan, based on workers age, whether they are male/female, and
children
30 year old male with wife and children will get more than 30 year
old single man
Regardless of what they made on the job
Five workers with identical wages can get seriously differnelevens
of wages depending on family situation
They will have a high benefit, but a low wage, some individuals
will have benefit/wage rations close to 100%
o Waiting period
UI has very short, almost non-existent waiting period
When youre laid off, you wont get a job on Monday, in Brittan, the
waiting period was one week before they can get benefits
You can merge every other day as continuious days, and then merge non-
working days within 10 weeks
As long as there is a bridge of no wages, you are immediately eligible
This is called the OXO system
o OXO is a boullion cube company
OXO system is an organized short time
People were sharing jobs:
o If you work more than 50%, you are not elgible for UI
o If you work exactly 50% of the time, you are elgible for the
UI
People will get 75% pay for 50% work, this is a very attractive
option
When you put the oxo system on top of it, this will lead to more
unemployment
- Whats going on here:
o Generous UI should raise unemployment in two ways:
o Unemployment insurance will lead to creation of sticky wages
Workers dont like having wage cuts
UI, along with trade unions, lead to a system without wage cuts
We dont have a perfect world where the markets are flexible, wage is
now set at old wage
Workers will not accept wage cuts
o Benjamin and Kochen, since they dont like wage cuts, say workers will favor
sticky wages and layoffs over market economy wage rate
This will lead to higher unemployment
o Average duration of a spell of unemployment will rise
The more wages you get, the lower the cost of foregone wages are, and the
logner you can search for a job
o If you set a reservation wage higher, the odds you will get the wage you demand
is high
26

Good news, when you get a job, you will be getting a job thats higher
than you would have if you set a lower eage
o The cheeper it is to search, and with generious UI it is, the longer you will search
for a higher reservation wage
o Problems
During their regression, they bias their W up by using the average weekly
earnings of all FT employees.
They get the coefficient on benefit.
There is large, positive impact on the ratio
They oly use 18 data points for the regression
o Result: UI is sucking people into unemployment due to overgenerosity of
unemployment insurance
- Juveniles
o Look at three catagories: people aged 16-17, 18-20, & 21-24
16-17 unemployment 5%
18-20 unemployment 10%
21-24 unemployment 15%
o UI goes up as you get older
o Wages go up too, but not as fast as benefits
o Turns out that if you look at b/w replacement rates
B/W (16-17) < B/W (18-20) < B/W (21-24)
o This is consistent with a story that says the B/W ratio really matters
o They regressed Juvenile unemployment rate on the average wage ratio: it had no
effect
- Married Women
o Fact 1: the unemployment rate for married women was above that for single
women from 24-28, but the difference was much smaller after 1931
o Fact 2: Unemployment for females is less than for Males, but the gap gets bigger
after 1931
o Why?
The unemployment insurance system is changed in 1931
The anomalies regulation
Married unemployed women dont want to work, they want to use
the UI to supplement their husbands income
Makes it much more difficult to get unemployment benefits if
married woman
1931-1932: Unemployment rate for men: 21% to 25.4%,
Unemployemnt rate for women 18 to 13%
This proves married women are abusing the system, and that its UI that is
jacking up unemployment rates
Boyer: I dont think this is true. All it proves is that if you refuse
people benefits, theyre not unemployed
o Its a counting phenomenon
o I dont think it has anything to do with womens motives
11-10-09
27

Unemployment in Inter-War Brittan
- Benjamin and Kochin (1979, Journal of Political Economy)
o Considered a brilliant write-up of the post war British economy
o Basically says Keynes is wrong and that the market clears itself
- Regression
o Unemployment is the function of the benefit/wage ratio plus the function of total
output minus some trend output
How much is output below trend
And given the benefit wage ratio, does that matter
They will fixate on the coefficient on the benefit wage ratio
As it gets higher,
o 16-17 year olds has low unemployment rates, but it kept going up from 18-20 and
from 21-24 year olds
Benefit/wage go up in each group
o Women and married women
If you look at female unemployment after 1931, it goes down
Reason: anomalies reg (1931)
Married women didnt want jobs but they wanted unemployment
benefits
What the law did was it made it significantly harder for single men
and women to get benfits
This doesnt mean anything
If youre disallowed from unemployment insurance, you will not
be counted in the unemployment rate
- At the end of their paper, a brief discussion on the regional unemployment problem
o The big problem in inter-war Brittan was the regional and structural nature of it
o Its much higher in some areas and some sectors
o How do you explain this?
Admit that unemployment in export industries
Also admit that these industries were concentrated in the north of Brittan
Finally, the collapse of export industries led for them to decline
o They move onto asking why these individuals remain unemployed for so long?
o Their answer: these regional/industrial concentrations of unemployment were
because of cross-regional variations in wage rates
o Benefits are not tied to wages
Low-wage areas will have high benefit wage ratios on average
High-wage areas will have low benefit wage ratios on average
o Oh brother moment:
The decline in the demand for labor is whats causing all this
If the demand for labor goes down, it will raise unemployment, and drive
down wages
This will drive down the benefit wage ratio coefficient and have
nothing to do with the benefit wage ratio
Its simple supply and demand
28

o What would the unemployment rate look like in post-war Brittan had there been
no generous UI
Experiment: we now know the impact on the replacement rate of the
coefficient
We can use that coefficient and what happens to the benefit wage
ratio to reconstruct the unemployment had there been a small
benefit/wage ratio
What if B/W had stayed at its 1913 level in inter-war Brittan
o Instead of being 50% as it was in inter-war Brittan, what if
it was at 27%
If no unemployment
The unemployment rate would be moving downward had it not been for
the gold standard back on in 1925
Unemployment rate jumps up again in 1930, but its a huge shock to the
british economy, USs fault, but not the markets,
1932, the invisible hand comes to the fore, and 1937 everything is back to
normal
You have to subtract in about 5%, about 1/3 of the unemployed
These are those who do it voluntarily
Once in unemployment, they will search longer and enjoy their
leisure, because it drops sharply
If youre Benjamin and Kockin, you believe the labor market works
- Criticisms of Benjamin and Kochin
o Points covered
Was the UI system uniquely generous?
Can it discuss regional issues?
Does that regression really make sense?
Is the regression result robust?
o Metcalf, Nickell, and Flores
The b/w is very high
There is no experience rating
Benefits are not tied to wages
B/W Argument: The post war period in terms of b/w wage ratios is more
generous than in the inter-war period
Experience rating: there was no experience rating in post war Brittan
either, so that doesnt make sense
Benefits tied to wages: still not tied in post war
Waiting period: even more easy to get unemployment benefits
It seems like B & K are comparing inter-war Brittan to post-war
US, since US has everything Brittan does not (expeirnece and
benefits to wages)
Thus, in none of these regards the UI system is not too generous in inter-
war Brittan
However, it looks very generous compared to US
Yet, it does not look as good compared to post-war Brittan
o Collins
29

Regions argument
The Benjamin and Kochin story are telling an aggregate story, but we all
know the unemployment issue is regional and structural
The B & K story will only work if high wage industries have low
unemployment, and if low wage industries have relatively high
unemployment
Works some of the time
Doesnt work in Coal mining:
o Its high wage and high unemployment
o B&K: High wage means low B/W ratio meaning U is low,
but thats not the case
Works in Cotton
Really doesnt work in shipbuilding
o High wage sector and very high unemployment
Works in Gas distribution
B&K works in some sectors and not in others
In more than half the time, it doesnt work
In some cases, he gets a negative coefficient benefit/wage ratio
o Omrerod and Warsick
They plot the unemployment data against the benefit wage ratio
1921-1929, negative slope
o High b/w ratios lower unemployment and visa versa
1930s,
o unemployment rate bouncing all over the place and b/w
stay stable
What the heck is going on in 1920?
o 19 data points, and you have an outlier, thats bad
o And if you have a time series, thats really bad
This picture isnt fair because its not taking into account output
1920-1938, coefficient of 18.3
1921-1938, , coefficient becomes 12.6
1/3 of impact goes away
If you rerun regression, and add a time trend coefficient falls to 5.6
and is no longer significantly different than zero
This huge coefficnet on B is very robust
- Eichengreen
o Dataset: from new survey of London life and labor (1929-1931)
An attempt to estimate household poverty in London
Its a 1-in-50 household survey
It has all the data so you can construct a B/W ratio for every worker
surveyed
11-12-09
Barry Eichengreen
- Issues with b/w ratio
30

o The aggregated numbers does not effectively convey the general state of british
unemployed as used by Benjamin and Kochin
- Barry Eichengreen found the NSLLL
o Surveyed 1 in 50 households in londoin
o Eichengreen has dataset with 2,440 males aged 18 and over
Knows their age, knows their wage
He can construct their precise b/w ratio, even if theyre not unemployed
If you know their household, you can know their b/w ratio
o Problem: survey done over three years
In October 1930, the UI/benefit system was changed
Eichengreen cannot figure out when an individual house was surveyed
Thus, for each house, he needs to calculate two different b/w ratios, pre-
1930 and post-1930 b/w ratio
- Eichengreen calculates the replacement rate, the b/w ratio
o The unemployment rate decreased as the replcmacement rate increased
This was against what Benjamin and Kochin predicted in their levels
o This suggests the Benjamin and Kochin story is too simple
Ignore the Replacement rate below 20%
o Looking at non-household heads, get a different result using either pre or post
1930 replacement rates
There is a significant effect on unemployment benefits for non-household
heads
Goes away in post 1930s numbers,
1930 UI change: 20% increase in benefits
- Assuming Benjamin and Kochin are correct pre 1930 data is correct
o Divide adult males into two groups: household heads and non-household heads\
o Why would this matter for household heads vs non-household heads
Household heads need to work, this money is needed. Household had
income is needed, and theyre not willing to stay unempoloyed to have
less income, theyre simply not responsive to this incentives
Cost of leisure isnt zero
o Secondary wage earners had the leisure to take a look and find better paying jobs
that may suit their skill set more properly
o Benjamin and Kockin: If B/w ratio calculation was between 50-52%, looking at if
1913 b/w ratio existed, u 1/3 more lower
o Eichengreen: b/w ratio 39-42%, b/w 1913 b/w u 1/7 to 1/5 lower
- Crafts: Long-Term unemployment
o A problem for older workers
Short term is less than 3 months
Long term greater than 12 months
Normal unemployment term: 3 and 12 months
o Sept 1929 10.7% of unemployed long-term
o June 1937, 27.5% of unemployed long term
o London Umeployed
0.2% have been unemployed for five years
Average unemployment duration 15.3 weeks
31

o Northern Unemployed
30% unemployed for 1 year
10% unemployed for five years
72 week unemployment spell
These jobs are not coming back: these are huge differences
o Age categories
Wales, 45-64, average unemployment two years
o Interesting fact from data,
Huge gaps in any region
older you are, longer unemployed
o Unemployment inflows and outflows
Odds you will remain unemployed based on how long you have been
unemployed befor
Interesting notes:
Take any region, any age group, and go from left to right
Always get the same result, no matter where you live, no matter
what the age category, it becomes harder and harder to find a job
Significance
Heterogeneous workers
o Good workers and bad workers who both lose their jobs
o Good worker has the same probability of finding a job
every period
o Bad worker has same probability
Good workers find jobs and share of workforce gets
bad
Duration dependence
o Your skills atrophy over time
o It gives the longer you are unemployed, the longer the
adverse signal you will be unemployed for
Cost of unemployment
Unemployemnt forecast- U Rate * duration
1929: Unemployment 10.4, Average Spell: 22.3 weeks, index 100
1933: Unemploynment 19.9, spell: 39, 333.4
1937: Unemployment 10.8, spell 41.6, index,, 193.6
Cost for unemployment 30x higher for older Welshmen than middle-aged
Londoners
o You need to look at how long you are unemployed
11-17-09
Crafts: Long Term Unemployment
- Lots of long term unemployment in interwar Brittan
- Crafts ask the question: can UI be the reason that unemployment is so high in interwar
Brittan?
o Crafts runs a regression from 1932-1939, has quarterly data
32

Does not have output data, so for his measure of his output data, he had
quarterly data on bankruptcies
o Short-term unemployment rate
Here we get a positive impact on the b/w ratio
Theres a big positive effect: Thats support for the Benjamin and Kochin
Oxo system, leading to organized short term and employment
o However, Crafts is looking at long-term unemployment
If you run that on the b/w ratio on bankruptcies
Young workers can migrate can retrain and start oer
If youre over 45, the odds youre willing to migrate at age 45 are quite
low
The other thing: even if you want to be trained to do something
else, who is going train you
o Who will hire a 50 year old coal worker and get retrained in
automobile manufacturing is ludacris
o If youre Benjamin and Kochin, you believe that these people like being
unemployed
o However, various publications suggest that these unemployed workers would go
back to their old job, at their old wage, or even a pay cut
o Simply reducing the B/w ratio back to the 1913 level is ludacris
- Other notes
o A lot of workers have stopped looking for work because they have become
depressed
o This type of behavior is encouraged to some degree by unemployment insurance
o If you are a skilled worker and take an unskilled labor, you will be reclassified as
an unskilled worker, and you will not be able to refuse an unskilled job
o The UI system makes people less desperate,

Post WWII Economy
- William Beveridge
o Head of LSE
o Beveridge in 1942 issued a report which became the foundation of the british
welfare state
The Beveridge report
o 1944, month before invasion of Normandy, government issued a white paper on
employment policy
British government begins to talk about employment policy in peacetime
British and US have great fear what peace will mean
Both US and Brittan had high unemployment rates during interwar
period
There was a fear that something was wrong with capitalism
Once war ended, and government spending went down again, and
soldiers sink back into unemployment, and goes back into
depression
33

o British government decides to make a statement that it will do whatever it can to
stop high unemployment
Brittan commits itself to high and stable level of employment
Commits to doing this with Keynsian style policies
British still has some anti-Keynsians, but has some young, trained
Keynsians, who want to use these policies to fight unemployment
o Beveridge, in 1944, publishes a book called: Full employment in Free society
British government should strive to maintain unemployment level at no
higher than 3%
Even Keynes thinks this is crazy
Election in Brittan in 1945, Churchill, the conservative, is running
for re-election, of course,
the great man who has saved Brittan, gets slaughtered in the
election
Labour party says it will give british the welfare state and to
maintain unemployment at around 3%
o The british are optimistic and thinking what it will do in peacetime
- US:
o When war ends in 1946, congress passes its version of the white paper that comes
out in Brittan in 1944
Employment act of 1946
Incorrectly regarded as a Full Employment act, but it is not
The government must promote maximum employment, production, and
purchasing power
Government does not define target
o Bill was greatly watered down in congress
Original bill did pledge full employment, pledged government spending,
that it would generate a full employment level of production
The law does two other things:
The bill sets up the economic report of the president
o Set forth conditions for which there will be useful
employment for those able and willing to seek work
o Signal for government to keep unemployment low
Sets up council of economic advisors
o It is the council of economic advisors that publishes the
report
This bill is opposed in congress by those who consider it liberal spending
Truman and Eisenhower do not do much with the council of economic
advisors
Both appointed businessmen as the chairman
o Truman and Eisenhower
1948-1960, economy does well,
Average unemployment 5%, Unemployment highest in 1958
Inflation is bad in 48 and 51
Running small surpluses and deficits except in 1959
Inflation rate below 3%
34

Mind recessions in a few years
Ignoring Europe, japan, and soviet union, the US economy appeared to be
performing well
However, comparing the rest of the economies around the world,
US looks sluggish
What kind of economic policies did Truman and Eisenhower
follow?
Eisenhower and Trumans budgetary policies: adopt a budget thats
balanced at a high level of unemployment, but let it go into deficit or
surplus based on busts and booms through automatic stabilizers
Automatic stabilizers
G=T
G=tY, you can set tax rates to balance the budget at full
employment if you know what level full employment GNP
spending is
If youre not at full employment, if Y is less than FE, given the tax
rates youve set, you will automatically go into deficits
If the economy is overheating, government spending falls, budget
goes into surplus, dragging down economy slightly and economy
goes back to full employment
These will not work if the government budget is only a small share of
GNP
The larger government spending is as a share of GNP, the larger
the effects of automatic stabalizers
o 1920s, Government share of GNP: 3%
o 1950s, 15-18%
o 1990s, 21.8%
o 2000, 18.4%
o 2060 est: 31%
o 1960: JFK is running for president against VP Richard Nixon
What does Kennedy criticize Eisenhower?
Economic growth under Eisenhower is relatively slow
In the last three years (1958-1960), the economy seems to be
slowing down even faster
Under Eisenhower, GDP was growing 2-2.5% yr.
o Kennedy says this is nowhere near our potential
o Our potential is 3.5% year
Giving compound interest,
Labor force is growing 1.5% year
Labor productivity is growing at 2%/yr
Adding these together, this is how fast we should be
growing,
This is on the low end, compared to the rest
of the industrialized world
A 3.5% rate of growth is compatable with the economy operating
at full employment
35

Kennedy essentially gives a number for full employment: 4%
o Weve slid into a gap from 1954-1960s
1958-1960, it just keeps getting bigger
o This is through Arthur Ochun & Ochuns law:
Determined the correlation between unemployment
and the gap
When the economy was basically sitting at 4%, the
unemployment rate goes up
Were growing too slow
What worries Eisenhower:
Inflation rate
1959, the deficit explodes to 12.8 billion, 2.6% of GNP
In 1958-1959, Eisenhower decides he needs to turn to active policy
o Argues at end of 1958 that he will set a new high priority
for the administration, which is a budget surplus
o We have been told in the past that republicans have been
worried more about inflation/unemployment
Eisenhower: If the government runs a surplus
o Slows down inflation
o Also, if we run a surplus, the government can use the
money its taking in to buy part of the national debt, held by
Americans
People who were holding debt will invest it in firms
it will finance public investment
if youre holding onto government debt, you will
not hold onto public sector investment, the public
will still want to get a rate of return, and that will
sprun on economic growth, he doesnt say what this
will do to unemployment
o what it seems to do in the short run is it slows down an
economy with high unemployment
the government remains sluggish in 1960, economys sluggishness
can be blamed on eisenhowers move to balance the budget/run a
surplus
Kennedy wins the election, he takes office, and he starts our being like
Eisenhower and Truman, with one exception
Kennedy, as an economic objective, sets 4% unemployment
Defines full employment
Also wants more rapid economic growth
As the president to officially express a goal, its still the case that he
tries to achieve objectives using orthodox economic principles, like
Truman and Eisenhower, maintains that he wants to balance the
budget
The economy begins to grow, like under Roosevelt,
However, it slows in the summer of 1962,
Kennedy is told that economy will go into recession in 1963
36

Kennedy proposes a tax cut for 63
11-19-09
Kennedy-Johnson Tax Cuts
- 1959, US goes into recession badly under Eisenhower
o Run a 12.8 billion deficit, unemployment close to 7%, inflation close to 3%
o Eisenhower believes there has to be something behind this, by buying debt,
Americans will get money back and invest in economy
o Also raises taxes, to some extent.,
- Eisenhower wants to have a budget at full employment
o Budget passed in 1959 according to kennedys economic advisors, would
have been at surplus at full employment
- Kenney increases spending by 6.5 billion, from 1961 to 1962
o Economy starts growing, unemployment gets down to 5.5%
o Kennedy, at the moment, is not making any drastic changes in policy
Inflation is down
Deficit goes up a bit, 7.1 in 1962
Debt 1.3% of GDP
- Summer of 1962, Kennedy calls for active policy that will jumpstart economy
o Jan 1963, in state of union message, and in other budget speeches, called for
congress to pass a very large tax cut
o it has become increasingly clear that the largest single full employment of
our manpower and resources is the unrealistically heavy drag on federal
income taxes on purchasing power and incentives
This sounds like Regan, but it aint
The thing thats killing us is the unrealistic purchasing power and
incentives
Saying this in Jan, 1963
Budget deficit in 1962, was 7.1 billion
Considered, at the time, rather large
People do not want a bigger deficit
How do you cut taxes and not have taxes go up?
Kennedys economic advisors came up with an argument to reduce
anxiety that tax cut would reduce deficit,
E Carry Brown, Full employment budget
At full employment, this budget would be at surplus
The concept of the full employment budget was invented by E.
Carry brown
Kennedys economic team uses it to explain what they will do
37

Once the economy hits the breakeven point: the economy is
now hampered by the government
o Government will put a drag on economic growth and
surplus if the budget reaches to breakeven
Kennedys team calls the difference between the breakeven
point and full employment fiscal drag
Fiscal drag will never result in economy growing quickly
Fiscal drag was the result of Eisenhower in 1959
o Kennedys plan: will have across the board tax cut, will shift tax revenue
down at any level of GNP
In short run, drop of tax revenue
We will not balance the budget until we hit full employment, we will
have a massive stimulus on the economy from Ya to Yfe
They have cut tax rates, but increased tax revenue
This works because there is a massive stimulus in the economy
- This sounds like supply side economics, Jack Kemp, Regan, and Laffer
o But walter Heller says you need to increase aggregate demand
A tax cut balanced by a cut in government spending will not lead to
any rapid growth, it will not eliminate fiscal drag
As a result, reganonomics would not work because it would not deal
with the issue
o Regan: The problem with the economy is the government itself
The governments taxes have lead to problems with saving and
investing
- This is not the kennedy program
o A stimulus program, generated by a big tax cut, would generate an increase in
demand, which will jumpstart the economy
- Did it work?
o US Tax rate: 20%-91% 1963
Dropped to 14%-65% in 1964
o The economy was not in bad shape, but this was a big stimulus
o This is instituted immediately, people instatenously see more money in their
paychecks
o At 1964 income levels, tax liabilities were cut by 14 billion, 11 billion went
to this in tax cuts and 3 billion went to corporations
This is a huge stimulus package
o It looks like it worked very nicely
The deficit in 1963 was 4.8 billion, but then it shoots down, the deficit
in 1965 is down to 4.8 billion
38

Essentially, would have had a 14 billion dollar tax cut, and the dficit
in the first year its in effect would have gone up by 1.1 billion
Spending would have gone up in 1964, and would have had a 14
billion tax cut, but the deficit would have only gone up by 1.1 billion
Its clear that the economy was strongly stimulated by government
policy
- Milton Friedman
o Money stock has grown from 1959-1960 had grown 5.6%
o Friedman believes the reason or the slowdown in growth was not caused by
the fiscal drag, but was caused by the fact the money supply was growing so
slowly
o Slow rates of money stock and slow rates in growth of economy
o From 1961 to 1966, Money stock grew more than triple rate, 19.7%
o Keynsian policy does not work, according to Friedman
- Unemployment rate keeps falling in 1968, due to Vietnam war
o Inflation begins to grow, up to 4.2% in 1968, budget deficit balloons to 4.2
billion, making it the biggest peacetime deficit in percentage terms
o Johnson, is in some ways like Hoover, and had some extraordinarily bad luck
Johnsons great dream was the Great Society
Bad news: Johnson was obsessed with the not being the president that
would lose southeast asia
- Johnsons spending
o Social programming goes up 41%,
o Defense spending goes up 30%
o Government spending goes up rapidly, and there is no increase in tax revenue
o This causes the economy to overheat in 1966, and its causing inflationary
problems
- The council of economic advisors is telling Johnson, you cant keep this up without
raising taxes
o You need to increase taxes or you are going to cause serious inflationary
pressures
o They are not willing to increase taxes for those reasons, but Congress will
look at Johnsons budget and say that you will lose the Great Society
o You will need to cut spending on the war, and doesnt want to be the people
who will lose indo-china to the war
o Finally, in the summer of 1967, Johnson makes a proposal to congress for
what he calls a Tax Surcharge a 10% short term increase in taxes to try and
make up for the deficitis at the moment,
By june, 1968, Johnson is not out of the race, Hubert Humprey is
running against Nixon
39

o This generates, for the Nixon Administration, a small budget surplus in 1969
From 1969 until Clinton, no president ran a budget surplus
o The problem: its too little too late
o Oil Shock, inflation hits 11% 1974,
But unemployment is not going down
- The beginning of Stagflation
o The idea that unemployment and inflation would not go up at the same time
o It was believed because of the Phillips curve, there would be a consistent
trade-off
It does not hold beginning in 1973, unemployment and inflation go up
at the same time
o 1974: Nixon Resigns, Gerald Ford takes over
Johnson He played too much football without a helmet
o 1976: End of Ford Administration
Unemployment 7.6%
Inflation rate is not good, but down from 11%
Deficit, 73 billion, 4.2% of GNP
Highest unemployment and deficit, but he almost beat carter
- Carter Era
o Deficit kept going up: but we have the second oil crisis/shock in 1979
o 1980 is the last year of Carters presidency
o 1980 horrific year: 7.1% unemployment, 13.1% inflation rate, deficit of 73.1
billion,
o Carter challenged by Kennedy in his own party, and gets Slaughtered in
general election against Regan
- What we see from 1973-1980 is everything going to hell
o Unemployment, inflation, and deficit is going up
o Keynsian economics is not working
Were running big deficits but we are not growing
o This was considered the Death of Keynsianism, and demand side
o caused the rise of supply side economics
- Supply side economics
o Arthur Laffer:
The laffer curve:
If the tax rate is zero, tax revenue will be
If the tax rate is 100%, you will have no revenue, people will
stop working
At the top of the curve, there is a breakeven point
Laffers assumption: if youre to the left of Point B, if you increase
tax rates, you will get more money
40

If youre to the right of the breakeven point, you will get a
perverse result,
If you cut tax rates, you increase incentives for working, saving, and
investing, and that is what will stimulate the ecnonomy
The laffer curve does not justify the kennedy tax cut
Laffer Curve: Incentives are the key to growth and the economy has
completely screwed up incentives
o Regan latches onto Laffer
Regan: Cut tax rates 10% year for three straight years
Regans six proposals: wins an electoral landslide
Sharp reduction in non-defense spending, other than safety
nets
Slower and stedier monetary growth for reducing inflation
Substantial reduction in government regulations of economy
Large increase in defense spending
Bringing federal budget back into a few years (fiscal 84)
Put out by regans chief economic advisor, Murray Weitenbaum, puts
out document: americas new beginning
Contends the following: the most important cause of the
economic problems has been the government itself, excessive
government spending, high marginal tax rates, and inefficient
regulation of the economy
The new economic program will reverse the debilitating combination
of sustained economic distress that faces the econbomy, reduce
negative expectations, and rekindle entrepenruail activity
11-24-09
Reganomics
- Key Points
o 10% Tax cut/year for three years
Kemp/Roth Tax Plan
High tax rates are holding down productivity
If we can lower tax rates, individuals will work harder, save more, and invest
more
o Sharp reduction in funding on non-defense spending
Except safety net issues
o Slower and steadier monetary growth
Problem with the economy is the government itself
o Balanced budget by fiscal 1984
- Will Rekindle nations entrepreneurial activity
o Regans advisors, once they adopt the regan program, assume that within one year,
1982 growth will grow to 4.2%
Compared to 1.1% growth
41

We will exceed long-term average trend in the post-war world
Very rapid economic growth
o Inflation: in three years, we will get it under 5%
o Unemployment, by 1986, will be down to 5.6%, from 7.8% in 1981
- How will we do this?
o Increase productivity
How to do it?
Eliminate excessive government spending
Decrease marginal tax rate
Eliminate haphazard regulations
- Misery index: inflation and unemployment rate put together
o 1960: misery index is 7.3%
o 1980: misery index is 17.2%
Been quite high since 1973
o Regan: we will get it down
- How will it work?
o Is it just Kennedy/Johnson tax cut? NO!
Kennedy is a demand side tax cut
o Regan story is that its the government problem
The supply side is screwed up
By cutting taxes, were going to create incentives for people to save more and
invest more
This is the whole key to supply-side economics
o Regan knew, as all politicians knew, is that it would be political suicide to reduce
spending
However, you could cut rate of growth of spending
Everyone, except for the truly needy and the defense dept, would be asked to
help curb control
o Shifts in budget priorities:
More spending on defense, less on public works, and other non-defense
spending
Non-defense spending goes up 25 billion over three years
Increase defense spending by 92 billion
o Balanced budget by 1984, and surplus by 1986
- Supply side economics may have worked, but it was set up to fail
o It cant possibly work
o The idea is that they will massively jumpstart the economy by cutting taxes,
o but the problem is that they will slash the money stock growth
o They will do two things at once, slash inflation and create rapid economic growth
However, the policy to slash inflation is a contractionary policy
o There was a reason: inflation was out of control
Using contradictory policies will get you in trouble
If they wanted rapid economic growth, the fed needed expansionary monetary
policies
- What happens
o 1981: first phase of tax cuts begins
42

o Congress raises defense spending sharply, passes non-defense measures
o The fed also slashes the growth of the money stock
What happens?
Instead of a great economic spurt, US goes into major recession since world
WWII
Unemployment goes up to 9.7% instead of down to 7.2%
o By the Fall of 1981: The regan administration changes its projection and says there
may be deficits of over 100 billion/year
o Feb 1982, changes estimate of a balanced budget to a 80+billion deficit
o 1983: projecting deficits of over 200 billion
o Reason is simple: tax cut didnt generate the tax revenue they were thinking it would
It didnt go up because the economy didnt jump-start, it nose-dived
Short term: Spending went up, but receipts went down
1981-1984:
Income +tax rev up 2.4%
Spending: up 25.6%
o Defense spending up 44%
o Non-defense spending up 20%
o Worst record of deficits:
1983: 6.0% of GDP, Regan
1933: 5.9% of GDP, FDR
1936- 5.5% FDR
1985: 5.1% Regan
1986: 5.0% Regan
1984: 4.8% Regan
1992: 4.7% Bush I
1991: 4.5% Bush I
o 1982: Even with these loophole closings and revenue enhancements, deficit is way
up
o 1985: Congress does something drastic:
Gramm-Hollings-Rudman
Great act that wont work:
Act specified a path of deficit ceilings
We need to get them down, and in five years, we need a balanced
budget
If it does not get down, it will become a dreaded trainwreck
o Dreaded trainwreck: across the board cuts in federal spending,
including defense (maybe not Medicare and Social security)
Belief was that if we put in the ceilings, no dreaded trainwreck would
occur
What happens in 1987: The dreaded trainwreck is about to occur
They rework the ceilings, it wasnt much of a trainwreck anymore
- 1988: Regan leaves office, Bush I enters office
o Read my lips: no new taxes
Bush agrees to tax increase in 1990
Spending keeps going up faster than any tax increase
43

Spending goes back upto 7.4%, deficit goes up to hundreds of billions
- 1992: Clinton wins office
o Taxes raised and deficit was cut
o American people responded by throwing democrats out of congress
American people thus believe in free lunches
- Delong and Summers
o How would you measure if the macro economy functions as well as it used to?
(1988, brooking papers of economic activity )
o What Delong and Summers do is they look at two periods, 1890 to 1930, and 1950 to
1987
Compare actual output per working adult with potential
Potentital is connecting economic peaks
What you have is gaps: gap between actual and potential movements
per worker
Gaps are bigger than they are 1950 to 1987
Average gap between average and potential output was 50% greater in
1890 to 1930 than it was 1950 to 1987
Potential is slowing down, and the gaps are getting bigger
If you compare 1950 to 1970 with 1890 to 1930, the mean output gaps are
double the output from 1950 to 70
The good news: the mean output gap is only 30% greater in 1890-30 than
1970-87
o Thus, the macro economy functioned much better in 1950-70 than 1970-87
o Could government policy caused this?
Few aspects of post-stable world
More stable financial system after the war due to federal deposit insurance
and fed acting as lender of last resort
Increased use of discressionary fiscal and monetary policy
Third pillar: growth of automatic stabilizers
Increase in growth of automatic progressive taxation, and increase in
growth of GNP
Increased financial stability helps, banks are failing, but nothing like they
used to
Discressioanry fiscal policy, according to DeLong and Summers has been
used twice
Kennedy/Johnson
Regan
Do they have stabilizing effect?
o Kennedy cuts did
o Regans policy did not, it was destabilizing
Discressionary policy does not work well because no one predicts when
downturns occur
Tend to develop rapidly, these issues take a lot of time
o Delong and Summers, who are good keynsians, say discressionary policy is not the
answer
44

In their view, the reason we had done so well is because of automatic
stabilizers
Could also explain why western europe did so well in post-war
o Welfare states have huge automatic stabalizers
o Delong (journal of economic policy):
1890-1916: if there was a 5% increase in unemployment, this would
automatically lead the budget more towards deficit, 0.28% of GNP increase
1950-1995: 5% increase in unemp: 3.5-4.5% deficit increase as share of GNP
o This, according to Delong, causes the economy to function so well after the war
o Delong: there are two types of deficits:
countercyclical deficts, which are good, automatic stabalizers
structural deficits, occur year after year, regardless of economy
these are bad, they are harmful to economic growth, someone needs to
pay the debt sometimes, and drives down interest rates which drives
down investment
deficits are NOT good all the time, and the idea of structural deficits,
will be disasterous
the fact that structural deficits are bad, the idea that countercyclical
deficits are not good
Keynes did not argue for structural deficits
12-1-09
FINAL EXAM WED, DEC 16
TH
, 2-4:30, WARREN HALL 245, 360
FORMAT IS SAME IS MIDTERM! DO ONE ESSAY AND HAVE CHOICE OF ONE
OF TWO ESSAYS. FINAL WILL LOOK LIKE A MIDTERM, BUT IT SHOULD NOT
BE ANY LONGER.
OFFI CE HOURS: DEC 1
ST
3-4:25 pm, DEC 3
RD
, 4-5 PM, DEC 10
TH
, 3:30-4:30PM, MON
14
TH
, 3:30-5:00, TUE 15
TH
, 3:30-5:00
PAPER IS DUE: 4:00PM, FRIDAY

Delong and Summers
- Compared potential output to actual output 1890 to 1930
o The economy has functioned much better since WWII than since 1930
o Gap had shrunk significantly since 1950,
1988 dollar terms, a bonus of 50 billion dollars a year, pure welfare gain
o But it hasnt been bought at the expense of inflation
If you take out the inflation peak years in 1970s, it hasnt been all that bad
o Bad news: economy functioned much better from 1950 to 1970 than from 1970 to
1987
o Output gap is huge in 1950-70, twice as big 1890 to 1930
o But compare 1970-1987, only 30% higher than in 1890 to 1930
Something has gone wrong
45

o Whats the hero here?: Automatic stabalizers
Government/budget is automatically shifting into deficit into downturns
Bigger deficit, bigger downturns
Making deficit smaller and even going into surplus during booms
What makes automatic stabalizers work better than it used to?
Big government
Bigger government is as a share of domestic product, the more
oomph automatic stabailzers have
Gov as share of GNP
Progressive taxation
Good times, people move into higher tax brackets
Bad times, people move into lower tax brackets which drive down
tax revenue
Welfare state (social spending)
Goes up in downturns, down in good times
- Romer
o Lets not get ahead of ourselves
Delong and summers got this result, saying that the economy is better than
it used to be, but romer says theres a problem here
The problem is that the data, used in the pre-1930 period,
This is not government-collected data
They were made up using census data and whatever output forces existed:
GNP-Simon Kuznets
Unemployment: Lebergott
For decades, everyone used Kuznets and Lebergott series as gospel
What Romer found out is that these series have volatility built into them
which may not, and possibly do not exist
Romer reconstructed GNP numbers from 1890s and 1930s and
unemployment from period
Redid Kuznets and Lebergott
Looked at these are measures of volatility, big is bad, small is good, the
closer to zero is a better thing
Romer Compared those numbers to the volatility of business cycles
Numbers from Kuznets were much higher than Romers
According to Kuznetss numbers, Macro economy was twice as
volatile from 1893-1927 than were from 1951 to 1980
Unemployment, Lebergott, numbers are hugely different than
Romers
o Unemployment volatility 1893-1927 is three times as
volatile than 1951-1980
Romer says Leibergott and Kuznets numbers are not calculated correctly
They built in extra volatility that was not there
Romer reconstructs movements in national product from 1890s to
1927
Romers redone numbers are much less volatile than the redone series
46

Romers series is much less volatile than both Kuznets and
Leibergotts
It changes how economy looks
Yeah the numbers are still worse, pre 1928 numbers are still
different, but not very big
The pre-great depression economy is not nearly as volatile as we
used to believe
If the pre-1930 economy is only slightly more volatile than the post war
economy, thus, despite the big government, despite automatic stabilizers,
despite fine-tuning the economy, were doing hardly any better than if we
left the economy alone
Thus, macroeconomic policy has had little effect on the stability of
the American economy
Shes not challenging the post WWII numbers
o But weve been comparing the numbers with a straw man
something that did not exist, overly volatile conclusion
Concludes: results show that the great depression was a unprecedented
collapse of a reasonably stable economy
One could go beyond this is the unbelievable turmoil and say that
WWI and the collapse of the gold standard brought this on
- Delong
o In a more recent paper, brad Delong has responded to Romer on unemployment
o Romers unemployment series is right that Leibergotts
o Belief that romer and/or weir are superior to leibergotts
o But adds more: extends unemployment numbers back to 1870s, using similar
adjustments to construct the numbers back to the 1870s, just for unemployment
o Romers numbers are for the economy as a whole, and that includes agriculture
But the further back in time you go, the larger agriculture is as a share of
the workforce
He constructs a non-farm unemployment rate
There is not a lot of unemployment in agriculture
Agriculture is stabilizing,
Malthus: industry is cyclical, agriculture is stable
o What Delong does is not look at agriculture, because the agricultural sector was
quite large up to WWII
The agriculture sector would damp down unemployment, and post WWII,
agricultural sector is tiny, so does it with and without agriculture
o Compare 1870 to 1910 std dev of nonfarm unemployment compared t o 1946-
1975, three times less std deviation unemployment
really matters with agriculture how it works, share of agriculture is so
small
o look at 1980 to 1910 compared to 1901-1930, less std deviation in unemployment
1901-1930, but higher time spent in recession
o Calculate proportion of time spent in recession
Of the time spent in recession, its still twice as high
o Should the great depression be included in this calculation
47

DeLong asks why is the great depression excluded by romer?
Romer believes it is a unique occurance that could not happen at any other
time
If you believe great depression was result of processes , then we should
include
o Question: is great depression something that was bound to happen under
economic structures of the time, or was it a unique occurance?
If it was a unique freak occurance, it should not be included
If it was not, then include it
Current Crisis
- The current recession began in December 2007
- Economy began modest recovery in third quarter of 2009, but its not clear if its real, cash
for clunkers and hosuing tax credit
- Unemployment hit 10.2% in October
- October was the worst unemployment since 1983, worst unemployment rates were in
1982, 10.8%
o There were people who are predicting 11-12% unemployment rates
- Bush policy response:
o Feb 2008 passed economic stimulus plan, one time tax rebate of 300-600
dollars/person
Rebates: 152 billion
o Attempt to jump-start economy
o Hank Paulson: Troubled Asset Relief Program, TARP
TARP: 700 billion
Also bailed out fannie mae and Freddie mac
- Obama is elected in 2008, and feburary, congress passes American Recovery and
Reinvestment Act, spends 787 billion
- Thats a lot of coin
o Obama plan has something for everyone:
Three main parts
Federal Spending
o Infrastructure and social programs, 357 billion
o 81 billion for public works
o 81 billion for protecting the vulnerable
40 billion for extending unemplopyment insurance
benefits, 19.9 billion for food stamps, etc
Tax relief
o 288 billion
o 237 billion for individuals, 51 billion for companies
Money for state and local fiscal relief
o 144 billion
o States and local governments cannot run deficits
- Is it gonna work?
o Romer and Bernstein put out a document that it wold raise GDP by the end of
2010 and create between 3.3 and 4.1 million jobs
48

- Response of economists:
o Reponse is decidedly mixed
Supported by Joseph Stiglets, Krugman and Samuelson
o Liberal economist Robert Solo: program is too small, too late, and should have
had more job creation
Infrastructe spending, 81 billion, Solo wanted more
o Conservative economist martin Feldstein supports stimulus, but on the same lines
of Robert Solo
Too little job creation for such big deficit
o Stimulus is opposed by conservative and libertarian economists
- This is not an ideological issue: they are very deeply divided on whether the stimulus
package can work, and will it cost too much for what its delivering
o Same argument that JM Keynes, Lloyd George, etc is: How big is the fiscal
multiplier, what effect will government spending have on the economy
o Those whoa gree believe muiltiplier believe its greater than 1
o Opponents believe its less than one, some believe its essentially 0
o Keynes, and Henderson say, in Can Lloyd George do it? its essentially 2
Linkage and direct effects
o No one else argues the multiplier is that high
o Congressional budget office has nine separate multipliers
For each one of the nine multipliers has two choices
o Romer and Bernstein has two multipliers: one for government spending and one
for tax cuts
Their multiplier for government spending is 1.6
Tax cuts: 1.0
grounds that if the government spends money, it will spend all of it
if people are given money, may save or buy imports
multiplier of 1 means if government cuts taxes by 100 billion, gnp
goes up by 100 billion
o no free lunch
o Romer and Bernstein are in the administration, these are optimistic numbers
o Cogan et al believe the multiplier is 0.4
If government spending goes up by 100 billion dollars, GDP only goes up
by 40 billion
Whats happening? Crowing out
Private spending in their model, goes down by 60 billion
What it means is that interest rates will be forced up, money gets
deflected, people will not borrow at higher interest rates,
government is pulling money out of private sector
GNP will go up, but it will not get that much bang for buck
o Robert Barro: Multiplier is essentially 0
Virtually 100% crowding out
Criticizes multiplier greater than 1, free lunch that would make Charles
ponzi proud
Government is somehow more able than the private sector to marshall
resources
49

Multiplier is equal to zero
Every dollar of government spending means one dollar less of
government spending, youre no better off than befor
If you believe that the private sector is better at spending, there
could be negative private sector multipliers
o Economist magazine
In economy in full employment, economy close to zero
However, bigger unemployment, bigger multiplier is going to be
Multiplier in down economy can be greater than 1
12-3-09
Read George Orwell and E. White Bockey
Current Stimulus
- Robert Barro: how can it be possible that the government can allocate resources more
efficiently
- Debate over whether stimuls policy will work/stimulate economy
- Argument over fiscal multiplier: how big is it?
o Same debate over Lloyd George in Brittan in 1920s
- Romer, Bernstein: govt spending=1.6, Tax cut=1.0
- Cogan, et al, multiplier is 0.4,
o There is crowding out, private sector spending is down when government
spending is up
- Barro, multiplier is essentially zero, during large wars, multiplier is 0.8
- Thus, Barro is animatedly against any government stimulus program
- The size of the multiplier varies over time, varies significantly across countries as well
- Countries that import a lot, open economies, will have lower multipliers than countires
that are more economically closed
o More closed economy, government spending will go further
o Spending money on foreign goods will do nothing to benefit, in terms of
employment
- The Economist: bigger downturn, bigger multiplier
o At full employment, government spending will do nothing at all, government
spends money at full capacity, it must come from private sector, thus fiscal
multipliers are near zero
o The more idol resources, its no surprise that the multipler in the 1930s is larger
than 8 or 10 years ago
o Its perfectly reasonable to believe government spending will be greater than one
with idle resources
o People may react differently to government spending programs/borrowing
50

If spending bolsters confidence, it will lead people to spend more, which
will generate economic growth
If people respond positively to stimuls program, it will work
If people freak out stimulus program, if it inspires fear and anxiety, it will
not work
Thus, the size of the multiplier depends on expectations
- Projected deficit in 2009, 1.7 trillion dollars, percent of GDP, 11.2% of GDP
o Biggest peacetime deficit, as a share of GDP, was the regan deficit of 1983 which
was 6%, this is virtually double the peacetime deficit
o This is small compared to the WWII deficits
o Even without Iraq and Afghanastan, prof believes that it would be one of the
highest deficits in history
o These are still bigger than anything we had in Vietnam or Korea
o Where is money coming from? Fall of 424 billion, 20% increase in spending
133 billion of money is TARP
291 billion is bailout of fannie mae and Freddie mac
In any case, these numbers are disconcerting
o Individuals worry about inflation due to low interest rates and deficits
o However, Congressional budget office estimates inflation rates of only 1.5-2%
For those who are terrified of inflation, CBO does not share fear
o The deficits are very optimistic guesses of what will happen to deficit
They are assuming that government will keep spending under control
Post-War Brittan
- In 1944, British government puts out white paper saying it is an important thing to try
and keep unemployment low, because there was a fear that once the war ends and
soldiers come home, that the british economy will slide once again back into depression
- 1945, after VE day, Brittan has election
o Churchill is running for reelection as a conservative
o One of the things Churchill says is that we cannot promise too much to british
people
We cant promise low unemployment and welfare state, because we do not
know if we can afford it
o The labor party says they will bring in the welfare state and the beveridge plan,
and will follow white paper and pledge whatever they can to bring about full
employment
- Who do you vote for?
o Do you vote for the war hero or the labor party and the promise of a better future
o Both parties are accepting welfare state and keeping low
o Conservatives in Brittan were trying to get welfare state
51

- By 1950s, conservatives pledge they will not dismantle welfare state
- Looking at statistics, Brittan is like US but only magnified
o 1946-1973, Brittan is in a golden age
o 1974 onward,
economy in Brittan has not done well
- The golden age
o From 1920 on: the british government redefines what it means to be unemployed
o The unemployment rates were bad, but they were worse than the official numbers
The official numbers were a mirage by the Thatcher and Major
governments
o Avg unemployment rate from 46-63: 2.0%
Between 1946-1970, unemployment rate was over 3% for 4 months
o When Beveridge claimed the government should stay below 3%, even Keynes
thought he was insane, and said they should pledge a more attainable rate
o Inflation rate from 46-70 was 4.6%
High but not terrible
o Main cause: wages increase because of low unemployment, the labor market is
incredibly tight
When the economy is booming and there is no idle resources, wages can
increase rapidly
o Workers are doing incredibly well
Economists claim they have solved macroeconomic problems
- They were in for a rude shock in the 1970s
o 1974-1999: avg unemployment rate: 9.3%
Avg inflation: 7.4%
Inflation goes up 2.8% and unemployment more than quadruples
- If you compare Britain to US, looking at unemployment rates, it looks like US is real
laggard
o From 1974-99, US averaged 6.6%, much better than the 9.3
- Unemployment in 1980s in Brittan is above 10% for the majority of the decade
- What jumps out is how good was the golden age was
o US is looking very bad compared to Brittan
o Question: whats wrong with American labor market at the time? Or whats right
with the british labor market?
- R.C.O Matthews (EJ 1968): Why has Brittan had full employment since the war?
o Matthews: We all know what the typical explination is: the british government
has adopted a full employment policy, and thats the cause of full unemployment
o The government is increasing aggregate demand, when its quite low
o The government had made up the fiscal policy during downturn, the keynsian
revolution is a success, were home free
52

o It appears in 1968, this is all true:
o Matthews, however, says this story is not right
When you look at the data, the first thing you see is that the british
government is running current account surpluses, equaling 3% of GNP
Government fiscal policy, in reality, has actually allowed government to
run current account surpluses
Government is not helping the economy at all,
If thats the case, whats going on? What makes the period so much
different?
Looks at consumption spending, government spending, exports, etc
Peak periods of demand, looking at investment
1929: 8.8%
1937: 10.3%
1955: 15.6%
1960: 17.2%
1964: 18.6%
These numbers are not only high compared to interwar, these numbers
were also high pre-1914
They are incredibly high
Whats driving the post-war economy is very rates of investment in the
private sector
Whats driving this investment?
The reason has to be either demand or supply
This is largely a demand story
It appears that the investment demand schedule in post war Brittan has
been abnormally high
This is very strange?
Why?
The reason the investment demand schedule is so high because it
was so low in the previous 40 years
1908, Brittan had serious downturn, but in 1914, WWI started,
very little private investment, interwar period was very screwed
up, total average investment rate was quite low,
WWII, there was massive destruction of british plant and
equipment by bombing
1908-1948: domestic stock of fixed capital was growing at rate of
1% year, insanely low
Average growth rate of 1% year
o Imagine pent up demand for 40 years, 40 years of
unrealized investment opportunities
53

All of a sudden, economy explodes with pent up demand, there is
cyclical boom of gigantic, biblical proportions
This is a historical accident, the reason Brittan has this boom because of
how badly the economy performs during WWII
If this is a huge historical accident, its going to end, and it will end fairly
soon
The reason weve been doing so well is because of how badly things have
gone with the two wars and in between
We will come back to earth, and will come back shortly
o When he wrote this, many people began to agree with Matthews 10 years later
Interesting thing to think about: Delong and summers: could be a big
explanation that 50-70 was a good economic time is the same story
Pent up demand during the 1930s and 40s
o Could be the reason all of western europe did so well in post-war was because of
pent up demand that all started with WWI
- However, there is one weird issue with this story:
o Why cant the demand story tell us everything?
o If this is all pent up demand, what should be happening?
The peak investment should be going down after the middle, peak should
be in the 50s and the investment should decline in the 60s
o But that doesnt happen
o Thus, maybe there is a government stimulus story
o One possibility is that interest rates have been historically low, but doesnt
explain why it would go up, unless interest rates went down in the 60s
o Another: Tax policy is being changed in ways to benefit business
Evidence tax policy changed in the 60s
Grants for distressed areas and it spears that this tax treatment gets more
generous and drives these numbers up
Tax policies towards business,
o Another; change in expectations based on government policies
British business has more faith in stability of economy after WWII and
that risk is going down
Business believes government rhetoric
If you believe risk is down, you will make larger investments
Evidence you should be seeing: profit rates should be low,
o However, possible it was an accident
o The golden age could have been the rainbow after the great flood
- Things really fell apart in the 70s and 80s
54

- We all blame Margret thatcher, and she has a lot to be blamed for, but the prime minister
in 1976, but James Callaghan, labor prime minster said in 1976, we used to think we can
spend our ways out of downturns, but this is not true anymore
o There was no reason, after Callaghan said this, that there was no reason to vote
conservative
- In 1985 white paper in unemployment policy, it basically said the workers and trade
unions were to blame for unemployment, if they want to take jobs, they should accept
lower wages
o Jobs will be created to the extent that they will accept that workers can afford
- Final nail in coffin for Keynsianism in 1985
E. Wight Bakke
- looked to understand the effect of the british system of unemployment insurance on the
willingness and ability of the worker to support himself
- workers estimate of unemployment insurance
o workers are in favor of some unemployment insurance
o confused and frustrated at times, but in general appreciation of the security given
o to the question: should the state support us when were out of work is responded
to by: the state isnt just giving it to us, were paying for it
- effects of unemployment insurance
o kept workforce at minimum way of life, unrest at minimum and communist
agitation minimal
o higher utilization than otherwise
- security vs fear
o the fact that the social security system provides a feeling of security, or that it
reduces the feat, may have some effect
- effect on willingness to work
o worker comes to a period of unemployment with experiences and attitudes
o there are distinguishable groups of workers in the menbersip in which is
determined by life circumstances, and the folkways and attitudes which have
grown of these
o many assume unemployment insurance causes individuals willingness to work,
Bakke refutes
o worker feels helpless with fate
o workers enterence into work has been early, required to contribute to the family,
cut off at 14-16
o chapter on foresight: difficultires to practice of foresight when it had to be
adjusted to smaller and variable minimum wage
o workers satisfaction on job is limited by monotomy of word
55

- difference in attitude amongst workers towards unemployment vary between conditions
of life as well as skilled vs. unskilled worker
o several factors on mans willingness to support himself
scale of wages
occupational status and opportunites
discipline of his training and experience
the regularity of his employment
length of time out of work
possibility and practice of foresight
group association
attractiveness of home surrpounding to be preserved
religious and moral influences
possibility of satisfaction
personal character and qualifications
o skilled worker has advantage
skilled worker has higher wages as head of household, artisans have
budget surplus
occupational status is favorable for worker
initial advantage of training sets of children sets one group apart from
another
the unskilled laborder is more victim to severe periods of unemployment
skilled laborer has better foresight
artisans are more frequently members of trade unions
home surrounding different to rents paid and space available, home
ownership larger in skilled arena
church membership higher in skilled groups
safasfaction of laborer at work was limited to wage, skilled worker had
more interesting work, higher wage, and better homelife
o social leglislaiton between skilled and unskilled worker
different effect on different groups
basis for developing support are strong in all groups that a signle item in
the whole setting conteracts the total influence
- activities when unemoployed
o found that 80% of those unemployed who found jobs did so by the efforts made
outside the exchanges, job hunting was seen to be well-developed and possible
methods thoroughly exploited
o unemployment insurance served as a check so that men did not take odd jobs
o unemployment insurance also acted as a deterrant for individuals to strike out for
independent work
o british labor is very immobile so far as movement between localities is concerned
56

unemployment roots individuals to their locality
majority of those british out of work are not loafers, only single digit of
those unemployed\
- pauperization
o argument that giving individuals money without adequate return will pauperize
them
o not clear what pauperization involves
circumstances that make It necessary for a macn to make a living by
sponging off the state instead of unearned fortune
o unployment benefit isnt much but such as it is saves a man from the necessity
from sacrificing his socio-economic group
o to the extent it places a barrier between him and that hopeless and discouragement
is the essential characteristics of pauperism
o unemployment insurance has not made paupers, it has revealed some of them and
supported them
o criticism of insurance is that it treats lives alike which are in reality, very unlike
- conclusion
o fear of concerning the effect of unemployment insurance on the malingering
tendencies of human nature seems to undermine the purpose of social insurance
o there are few who work with exceeding ambition and few who are overly lazy
social insurance is not involved with them, it is involved with those who
are good indiviudlas making the best of the situation presented
o problem of social insurance is first of all to make more secure happiness or
ordinary man
o it is as effective a remedy for the problems of pobery and maladjustment to stop
the movement in that direction as it is to apply remedies once an indivudla or a
family has arrived
o the value is not that a system of insurance says you cant eat if you dont work,
but it is if you do work, you can eat.