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Abstract:
This paper examines the ability of a simple stylized general equilibrium
model that incorporates nominal wage rigidity to explain the magnitude and
persistence of the Great Depression in the United States. The impulses to our
analysis are money supply shocks. The Taylor contracts model is surprisingly
successful in accounting for the behavior of major macroaggregates and real
wages during the downturn phase of the Depression, i.e., from 1929:3 through
mid-1933. Our analysis provides support for the hypothesis that a monetary
contraction operating through a sticky wage channel played a significant role
in accounting for the downturn, and also provides an interesting refinement to
this explanation. In particular, both the absolute severity of the
Depression's downturn and its relative severity compared to the 1920-21
recession are likely attributable to the price decline having a much larger
unanticipated component during the Depression, as well as less flexible
wage-setting practices during this latter period. Another finding casts
doubt on explanations for the 1933-36 recovery that rely heavily on the
substantial remonetization that began in 1933.
Full paper (645 KB PDF)
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