Depressions and slumps

1
Depressions and slumps

• Objectives
• Understand why economies may experience prolonged
  and deep recession, drawing on the analytical
  tools we have developed and the experience of the
  US and Japan in the 1930s and 1990s
• Reading
• Blanchard, chap 22 (and some 14)
• Mankiw, chap 11

2
What is a depression and a slump?

• A depression is a deep and long-lasting
  recession.
• A slump is a long period of low or no growth,
  longer than a typical recession, but less deep
  than a depression.

3
How markets recover
4
How markets really recover
5
Real interest-rates

• Assume a loaf of bread costs 1 and the nominal
  interest-rate is 10. What is the true cost of
  borrowing 1 to purchase a loaf? Assume the rate
  of inflation is 10

6
Real interest-rates and IS/LM

• What matters for spending decisions, and thus
  what enters the IS relation, is the real interest
  rate
• What matters for the demand for money, and thus
  enters the LM relation, is the nominal interest
  rate

7
Real interest-rates and deflation
8
The liquidity trap
9
LM and the liquidity trap
10
IS/LM and the liquidity trap
11
Deflation and the liquidity trap
12
Implications for monetary policy

• Quick and decisive action
• Non-zero inflation targets

13
The Great Depression
14
Initial fall in spending
15
Contraction in nominal money

• M1 H x money multiplier

16
Deflation
17
Recovery

• Expansionary monetary policy
• 1933-41, nominal money increased 140, real money
  100
• New Deal
• Federal Deposit Insurance Corporation
• End of deflation
• Minimum wages

18
The Japanese slump
19
Rise and fall of the Nikkei
20
Deflation and the liquidity trap
21
Structural factors and the banking system