Money, Sticky Wages, and the Great Depression

Board of Governors of the Federal Reserve System International Finance Discussion Papers Number 591 September 1997 Money, Sticky Wages, and the Great Depression Michael D. Bordo, Christopher J. Erceg, and Charles L. Evans NOTE: International Finance Discussion Papers are preliminary materials circulated to stimulate discussion and critical comment. References in publications to International Finance Discussion Papers (other than an acknowledgement that the writer has had access to unpublished material) should be cleared with the author or authors. IFDPs are available on the WEB at www.bog.frb.fed.us.

Money, Sticky Wages, and the Great Depression Michael D. Bordo, Christopher J. Erceg, and Charles L. Evans* 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. Keywords: Dynamic General Equilibrium Model, Sticky Wages * Bordo is a professor of economics at Rutgers University and NBER fellow (bordo@rci.rutgers.edu), Erceg is a staff economist in the Division of International Finance of the Federal Reserve Board (ercegc@frb.gov), and Evans is an assistant vice president and economist in the Research Department of the Federal Reserve Bank of Chicago (cevans@frbchi.org). The views in this paper are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or of any other person associated with the Federal Reserve System. The authors thank Ben Bernanke, Steve Cecchetti, Chris Hanes, Evan Koenig, Robert Kollmann, Andrew Levin, Prakash Loungani, Sergio Rebelo, Anna Schwartz, John Taylor, and Michael Woodford for comments on an earlier draft, as well as seminar participants at the Federal Reserve Board, the Federal Reserve Bank of New York, and the NBER Monetary Economics Group.

(cid:17)(cid:14) )NTRODUCTION ! FULL UNDERSTANDING OF THE FACTORS WHICH LED TO THE ’REAT $EPRESSION IN THE 5NITED 3TATES CONTINUES TO ELUDE ECONOMISTS(cid:14) -ANY CONTRIBUTING FACTORS MAY HAVE BEEN IMPORTANT (cid:213) INCLUDING THE STOCK MARKET CRASH OF (cid:17)(cid:25)(cid:18)(cid:25) (cid:8)-ISHKIN (cid:17)(cid:25)(cid:23)(cid:24) AND 2OMER (cid:17)(cid:25)(cid:25)(cid:16)(cid:9)(cid:12) THE NONMONETARY EdECTS OF BANKING PANICS (cid:8)"ERNANKE (cid:17)(cid:25)(cid:24)(cid:19)(cid:9)(cid:12) A DRAMATIC INCREASE IN WORLD TARIdS (cid:8)-ELTZER (cid:17)(cid:25)(cid:23)(cid:22) AND #RUCINI AND +AHN (cid:17)(cid:25)(cid:25)(cid:22)(cid:9)(cid:12) ADHERENCE TO THE GOLD STANDARD (cid:8)%ICHENGREEN (cid:17)(cid:25)(cid:25)(cid:18)A AND 4EMIN (cid:17)(cid:25)(cid:24)(cid:25)(cid:9)(cid:12) AND AN AUTONOMOUS DROP IN CONSUMPTION (cid:8)4EMIN (cid:17)(cid:25)(cid:23)(cid:22)(cid:9)(cid:14) .EVERTHELESS(cid:12) &RIEDMAN AND 3CHWARTZ(cid:218)S (cid:8)(cid:17)(cid:25)(cid:22)(cid:19)(cid:9) HYPOTHESIS(cid:12) THAT THE FAILURE OF 5(cid:14)3(cid:14) MONETARY POLICY TO OdSET BANK(cid:13)PANIC INDUCED DECLINES IN THE MONEY SUPPLY WAS THE PRIMARY CAUSE OF THE 5(cid:14)3(cid:14) DOWNTURN BETWEEN (cid:17)(cid:25)(cid:18)(cid:25) AND (cid:17)(cid:25)(cid:19)(cid:19)(cid:12) PROBABLY REMAINS THE MOST WIDELY SUBSCRIBED EXPLANATION(cid:14)(cid:17) 4HE RECENT LITERATURE(cid:12) WORKING WITHIN THE CONTEXT OF THE MONETARY EXPLANATION(cid:12) HAS FO(cid:13) CUSED ON THE MECHANISM BY WHICH THE MONETARY COLLAPSE WAS TRANSMITTED TO THE REAL ECON(cid:13) OMY(cid:14) 7HAT IS IN CONTENTION IS WHETHER THE REAL EdECTS OF THE MONETARY CONTRACTION WERE ATTRIBUTABLE TO NOMINAL WAGE RIGIDITIES (cid:8)"ERNANKE AND #AREY(cid:12) (cid:17)(cid:25)(cid:25)(cid:22)(cid:9)(cid:12) TO INCREASED BANKRUPT(cid:13) CIES ASSOCIATED WITH DEBT DE(cid:226)ATION (cid:8)&ISHER (cid:17)(cid:25)(cid:19)(cid:19)(cid:9)(cid:12) OR TO A SEVERE DISRUPTION IN THE PROCESS OF (cid:231)NANCIAL INTERMEDIATION DUE TO LARGE(cid:13)SCALE BANK FAILURES (cid:8)"ERNANKE(cid:12) (cid:17)(cid:25)(cid:24)(cid:19)(cid:9)(cid:14) 2ECENT EMPIRICAL RESEARCH HAS FOUND SUPPORT FOR THE HYPOTHESIS THAT MONETARY SHOCKS OPERATING THROUGH A STICKY WAGE CHANNEL PLAYED AN IMPORTANT ROLE IN ACCOUNTING FOR THE $EPRESSION IN THE 5NITED 3TATES AND ELSEWHERE(cid:14) )N AN IMPORTANT PAPER(cid:12) %ICHENGREEN AND (cid:17)3OMERECENTSURVEYSOFTHE$EPRESSIONPERIODARECONTAINEDINPAPERSBY"ORDO(cid:8)(cid:17)(cid:25)(cid:24)(cid:25)(cid:9)(cid:27)"ORDO(cid:12)#HOUDHRI(cid:12) AND 3CHWARTZ (cid:8)(cid:17)(cid:25)(cid:25)(cid:21)(cid:9)(cid:27) #ALOMIRIS (cid:8)(cid:17)(cid:25)(cid:25)(cid:19)(cid:9)(cid:27) %ICHENGREEN (cid:8)(cid:17)(cid:25)(cid:25)(cid:18)B(cid:9)(cid:27) AND 2OMER (cid:8)(cid:17)(cid:25)(cid:25)(cid:19)(cid:9)(cid:14) (cid:17)

3ACHS (cid:8)(cid:17)(cid:25)(cid:24)(cid:21)(cid:9) FOUND THAT REAL WAGES TENDED TO BE HIGHER AND INDUSTRIAL PRODUCTION LOWER AMONGCOUNTRIES THAT REMAINED ON THE GOLDSTANDARD(cid:14) 4HESE AUTHORS INTERPRETED THEIR RESULTS AS CONSISTENT WITH THE STICKY WAGE HYPOTHESIS(cid:14) )NSOFAR AS COUNTRIES THAT REMAINED ON GOLD EXPERIENCED COMPARATIVELY LARGER PRICE DECLINES(cid:12) THE STICKY WAGE HYPOTHESIS PREDICTS THAT THEY WOULD ALSO TEND TO EXPERIENCE LARGER INCREASES IN REAL WAGES(cid:12) AND CORRESPONDINGLY LARGER OUTPUT CONTRACTIONS(cid:14) "ERNANKE (cid:8)(cid:17)(cid:25)(cid:25)(cid:21)(cid:9) AND "ERNANKE AND #AREY (cid:8)(cid:17)(cid:25)(cid:25)(cid:22)(cid:9) CORROBORATED THESE PREDICTIONS EMPIRICALLY USING PANEL DATA ON A LARGER SET OF COUNTRIES THAN THE %ICHENGREEN(cid:13) 3ACHS STUDY(cid:14) "ERNANKE AND #AREY ALSO TRIED TO ASSESS THE EXTENT TO WHICH THE PRICE DECLINE OPERATEDTHROUGHASTICKYWAGECHANNEL(cid:12) ORTHROUGHOTHERMECHANISMSSUCHASDEBT(cid:13)DE(cid:226)ATION(cid:14) 4HEY CONCLUDED THAT (cid:221)OUR EVIDENCE FAVORS THE VIEW THAT STICKY WAGES WERE THE DOMINANT SOURCE OF NONNEUTRALITY (cid:8)P(cid:14) (cid:24)(cid:24)(cid:16)(cid:9)(cid:14)(cid:222) /UR PAPER FOCUSES ON THE ABILITY OF THE STICKY WAGE HYPOTHESIS TO EXPLAIN THE ’REAT $E(cid:13) PRESSIONINTHE5NITED3TATES OVERTHE(cid:17)(cid:25)(cid:18)(cid:25)(cid:13)(cid:19)(cid:22)PERIOD(cid:14) 7HILETHEPREVIOUSLY MENTIONED CROSS(cid:13) COUNTRY REGRESSION RESULTS SERVE AS AN IMPORTANT MOTIVATION FOR OUR ANALYSIS(cid:12) THOSE (cid:231)NDINGS DO NOT QUANTIFY THE EXTENT TO WHICH THE STICKY WAGE CHANNEL CAN ACCOUNT FOR THE MAGNITUDE OF THE $EPRESSION AND ITS PERSISTENCE(cid:14) 4HROUGH SIMULATIONS OF A GENERAL EQUILIBRIUM MODEL(cid:12) OUR PAPER PROVIDES A QUANTITATIVE ASSESSMENT OF THE EXTENT TO WHICH MONETARY SHOCKS WORK(cid:13) ING THROUGH THE STICKY WAGE CHANNEL CAN ACCOUNT FOR THE SEVERITY OF THE $EPRESSION AND ITS DURATION(cid:14) 4HE ECONOMY WE STUDY HAS A FAIRLY TYPICAL NEOCLASSICAL STRUCTURE WITH A REPRESENTATIVE AGENT AND CAPITAL ACCUMULATION(cid:14) &OR SIMPLICITY(cid:12) MONEY IS ASSUMED TO BE VALUED BY AGENTS (cid:18)

THROUGH A MONEY(cid:13)IN(cid:13)THE(cid:13)UTILITY FUNCTION SPECI(cid:231)CATION(cid:14) !S ALWAYS(cid:12) A CONTENTIOUS PART OF THE ANALYSIS IS HOW TO INTRODUCE MONETARY NONNEUTRALITIES(cid:26) WE ASSUME THAT NOMINAL WAGES ARE SET IN ADVANCE(cid:12) AND INVESTIGATE THE IMPLICATIONS OF TWO DIdERENT TYPES OF WAGE(cid:13)SETTING MECH(cid:13) ANISMS(cid:14) 4HE (cid:231)RST SPECI(cid:231)CATION ASSUMES THAT WAGES ARE SET IN FORWARD(cid:13)LOOKING &ISCHER(cid:13)’RAY CONTRACTS (cid:8)E(cid:14)G(cid:14)(cid:12) ’RAY (cid:17)(cid:25)(cid:23)(cid:22)(cid:12) &ISCHER (cid:17)(cid:25)(cid:23)(cid:23)(cid:12) +ING (cid:17)(cid:25)(cid:25)(cid:16)(cid:12) #HO AND 0HANEUF (cid:17)(cid:25)(cid:25)(cid:19)(cid:9)(cid:14)(cid:18) 4HE ALTERNA(cid:13) TIVE SPECI(cid:231)CATION ASSUMES THAT WAGES ARE SET THROUGH 4AYLOR CONTRACTS (cid:8)4AYLOR (cid:17)(cid:25)(cid:24)(cid:16)(cid:9)(cid:14) 4HE ADVANTAGE OF THE LATTER SPECI(cid:231)CATION IS THAT IT CAN POTENTIALLY ACCOMMODATE MORE PERSISTENT LABOR MARKET DISEQUILIBRIUM ARISING FROM MONETARY DISTURBANCES(cid:12) AS THE NOMINAL WAGE SET IN THE CURRENT PERIOD IS IN PART (cid:221)ANCHORED(cid:222) BY WAGE CONTRACTS IN THE PAST THAT ARE STILL IN EdECT(cid:14) 4HE MODEL IS SIMULATED OVER THE (cid:17)(cid:25)(cid:18)(cid:25)(cid:13)(cid:17)(cid:25)(cid:19)(cid:22) PERIOD BY INPUTTING ESTIMATES OF EXOGENOUS INNOVATIONS TO THE MONEY GROWTH RATE (cid:8)-(cid:17)(cid:9) INTO THE STATE(cid:13)SPACE REPRESENTATION OF THE LIN(cid:13) EARIZED MODEL(cid:14) -ODEL SIMULATIONS OF OUTPUT(cid:12) HOURS WORKED(cid:12) CONSUMPTION(cid:12) AND INVESTMENT ARE COMPARED TO ACTUAL DATA(cid:14) "OTH THE &ISCHER AND 4AYLOR CONTRACT VARIANTS OF OUR MODEL ARE SUCCESSFUL IN TRACKING THE DOWNTURN IN OUTPUT AND HOURS WORKED BETWEEN (cid:17)(cid:25)(cid:18)(cid:25) AND EARLY (cid:17)(cid:25)(cid:19)(cid:18)(cid:14) &OR EXAMPLE(cid:12) BOTH MODELS IMPLY AN OUTPUT DECLINE BETWEEN THE ONSET OF THE $EPRESSION IN (cid:17)(cid:25)(cid:18)(cid:25)(cid:26)(cid:20) AND THE (cid:231)RST HALF OF (cid:17)(cid:25)(cid:19)(cid:18) THAT IS WITHIN A COUPLE OF PERCENTAGE POINTS OF THE (cid:19)(cid:21)(cid:5) DROP THAT WAS OBSERVED (cid:8)IN LOGARITHMIC PERCENTAGE TERMS(cid:9)(cid:14) 4HE 4AYLOR SPECI(cid:231)CATION IS MORE SUCCESSFUL THAN THE &ISCHER SPECI(cid:231)CATION IN ACCOUNTING FOR THE PERSISTENCE OF THE DOWNTURN IN THE (cid:17)(cid:25)(cid:19)(cid:18)(cid:13)(cid:19)(cid:19) PERIOD(cid:14) 4HE &ISCHER SPECI(cid:231)CATION COUNTERFACTUALLY IMPLIES THAT THE STABILIZATION IN MONETARY (cid:18)&OR SIMPLICITY(cid:12) WE SUBSEQUENTLY REFER TO THESE CONTRACTS AS (cid:221)&ISCHER CONTRACTS(cid:14)(cid:222) (cid:19)

AGGREGATES IN (cid:17)(cid:25)(cid:19)(cid:18) SHOULD HAVE GENERATED A STRONG RECOVERY BY THE LATTER PART OF THAT YEAR(cid:14) 4HE 4AYLOR SPECI(cid:231)CATION DOES BETTER(cid:12) BUT IT CANNOT ACCOUNT FOR THE CONTINUED DROP IN OUTPUT THAT OCCURRED BETWEEN EARLY (cid:17)(cid:25)(cid:19)(cid:18) AND EARLY (cid:17)(cid:25)(cid:19)(cid:19) (cid:8)MOST OF WHICH WAS CONCENTRATED IN (cid:17)(cid:25)(cid:19)(cid:19)(cid:26)(cid:17)(cid:12) THE$EPRESSIONTROUGH(cid:9)(cid:14) %VENSO(cid:12) THE4AYLORMODELDRIVENBYEXOGENOUSMONEYSUPPLYSHOCKS CAN ACCOUNT FOR (cid:23)(cid:21)(cid:5) OF THE OUTPUT DECLINE (cid:8)OF (cid:20)(cid:20)(cid:5)(cid:9) THAT OCCURRED BETWEEN (cid:17)(cid:25)(cid:18)(cid:25)(cid:26)(cid:20) AND THE (cid:231)RST HALF OF (cid:17)(cid:25)(cid:19)(cid:19)(cid:14) 3IMILARLY(cid:12) THE 4AYLOR MODEL DOES WELL IN TRACKING THE BEHAVIOR OF HOURS WORKED AND INVESTMENT THROUGH EARLY (cid:17)(cid:25)(cid:19)(cid:18)(cid:12) THOUGH IT MISSES SOME OF THE ADDITIONAL DECLINE IN THESE VARIABLES THAT OCCURRED IN THE SUBSEQUENT YEAR(cid:14) )T PROVIDES A GOOD CHARACTERIZATION OF CONSUMPTION BEHAVIOR THROUGH THE ENTIRE DOWNTURN PHASE OF THE $EPRESSION(cid:14) &OUR KEY POINTS EMERGE FROM OUR ANALYSIS OF THE ABILITY OF THE STICKY WAGE MODEL TO EXPLAIN THE DOWNTURN PHASE OF THE $EPRESSION(cid:14) &IRST(cid:12) THE MECHANISM THROUGH WHICH THE STICKY WAGE MODEL PREDICTS THE MONETARY DECLINE WOULD AdECT THE MACROAGGREGATES SEEMS CONSISTENT WITH THE DATA(cid:26) OUR MODEL DOES A GOOD JOB OF TRACKING WAGE BEHAVIOR OVER THE PERIOD(cid:12) CORRECTLY IMPLYING A PRONOUNCED RISE IN THE REAL WAGE BETWEEN (cid:17)(cid:25)(cid:18)(cid:25) AND MID(cid:13)(cid:17)(cid:25)(cid:19)(cid:18)(cid:12) FOLLOWED BY A GRADUAL DECLINE UNTIL MID(cid:13)(cid:17)(cid:25)(cid:19)(cid:19)(cid:14) 3ECOND(cid:12) OUR MODEL SIMULATIONS AND SENSITIVITY ANALYSIS SUGGEST THAT IN ADDITION TO SLUGGISH WAGE ADJUSTMENT(cid:12) A LARGELY UNANTICIPATED PRICE DECLINE PLAYED A SIGNI(cid:231)CANT ROLE IN ACCOUNTING FOR THE SEVERITY OF THE $EPRESSION(cid:14) /UR RESULTS INDICATE THAT THE $EPRESSION WOULD HAVE BEEN CONSIDERABLY LESS SEVERE IN ITS REAL EdECT(cid:12) EVEN WITH AN EQUALLY LARGE PRICE DECLINE(cid:12) HAD A GREATER COMPONENT OF THE PRICE DECLINE BEEN ANTICIPATED(cid:12) OR IF NOMINAL WAGES HAD ADJUSTED MORE RAPIDLY TO THE REDUCTION IN LABOR HOURS(cid:14) 4HIRD(cid:12) OUR COMPARATIVE ANALYSIS OF THE (cid:17)(cid:25)(cid:18)(cid:16)(cid:13)(cid:18)(cid:17) RECESSION FURTHER HIGHLIGHTS THE LIKELY JOINT (cid:20)

IMPORTANCEOFTHEUNANTICIPATEDCHARACTEROFTHEPRICEDECLINEANDEXTREMELYSLUGGISHNOMINAL WAGE ADJUSTMENT DURINGTHE (cid:17)(cid:25)(cid:18)(cid:25)(cid:13)(cid:19)(cid:19)PERIOD(cid:14) )NTHE (cid:17)(cid:25)(cid:18)(cid:16)(cid:13)(cid:18)(cid:17)RECESSION(cid:12) OUTPUT FELL ONLY HALF AS MUCH (cid:8)IN PERCENTAGE TERMS(cid:9) AS THE ’REAT $EPRESSION PERIOD(cid:12) DESPITE SIMILAR(cid:13)SIZED CUMULATIVE DECLINES IN THE PRICE LEVEL(cid:14) 4HE LITERATURE HAS SUGGESTED THAT A MUCH LARGER COMPONENT OF THE PRICE DECLINE WAS ANTICIPATED DURING THE EARLIER PERIOD AND THAT WAGES ADJUSTED MORE RAPIDLY TO AGGREGATE DEMAND(cid:12) TWO FACTORS THAT COULD HELP EXPLAIN THE DIdERENT EXPERIENCES OF THE TWO PERIODS(cid:14) /UR SIMULATIONS INDICATE THAT THE OUTPUT DIdERENCES ACROSS THE TWO PERIODS CAN BE RATIONALIZED IF MUCH OF THE (cid:17)(cid:25)(cid:18)(cid:16)(cid:13)(cid:18)(cid:17) DE(cid:226)ATION WERE ANTICIPATED AND NOMINAL WAGES ADJUSTED MORE RAPIDLY IN THIS EARLIER PERIOD(cid:14) &OURTH(cid:12) OUR ANALYSIS OF THE (cid:17)(cid:25)(cid:19)(cid:19)(cid:13)(cid:19)(cid:22) PERIOD CASTS DOUBT ON 2OMER(cid:218)S EXPLANATION (cid:8)(cid:17)(cid:25)(cid:25)(cid:18)(cid:12) (cid:17)(cid:25)(cid:25)(cid:19)(cid:9) OF THE RECOVERY PHASE(cid:14) 2OMER ARGUES THAT THE RECOVERY WAS LARGELY ATTRIBUTABLE TO THE SUBSTANTIAL AND SUSTAINED INCREASE IN MONETARY AGGREGATES THAT BEGAN IN (cid:17)(cid:25)(cid:19)(cid:19)(cid:14) /UR MODEL AND 2OMER(cid:218)S HYPOTHESIS BOTH IMPLY A STRONG RECOVERY IN ECONOMIC ACTIVITY DUE TO THE STIMULATIVE EdECT OF THE REMONETIZATION AND ITS AdECT ON THE PRICE LEVEL(cid:14) (OWEVER(cid:12) THE MECHANISM THROUGH WHICH OUR MODEL GENERATES A RECOVERY (cid:213) NAMELY(cid:12) A FALL IN REAL WAGES (cid:213) IS BADLY AT ODDS WITH THE DATA(cid:14) )N FACT(cid:12) REAL WAGES ROSE SHARPLY BEGINNING IN MID(cid:13)(cid:17)(cid:25)(cid:19)(cid:19)(cid:12) AS NOMINAL WAGES ROSE MORE THAN PRICES(cid:14) 4HE LARGE RISE IN NOMINAL WAGES APPEARS TO HAVE BEEN LARGELY EXOGENOUS IN NATURE(cid:12) RE(cid:226)ECTING THE IMPLEMENTATION OF VARIOUS LEGISLATION(cid:12) INCLUDING THE .ATIONAL )NDUSTRIAL 2ECOVERY !CT (cid:8).)2!(cid:9)(cid:14) .)2! BASICALLY MANDATED WAGE SCHEDULES FOR VARIOUS INDUSTRIES(cid:14) 4HUS(cid:12) WHILE THE MONETARY EXPANSION OF (cid:17)(cid:25)(cid:19)(cid:19)(cid:13)(cid:19)(cid:21) PRESUMABLY MITIGATED THE ADVERSE EdECTS OF THE NOMINAL WAGE INCREASES(cid:12) WE CONCLUDE THAT THE MONETARY EXPANSION (cid:21)

WAS NOT NEARLY STRONG ENOUGH TO LEAD THE 5(cid:14)3(cid:14) ECONOMY OUT OF THE $EPRESSION(cid:14) ’IVEN THAT OTHER FACTORS(cid:12) INCLUDING THOSE EMPHASIZED BY "ERNANKE (cid:8)(cid:17)(cid:25)(cid:24)(cid:19)(cid:9)(cid:12) PROBABLY CONSPIRED WITH THE REAL WAGE INCREASE IN ORDER TO SLOW THE PACE OF THE ECONOMIC RECOVERY(cid:12) IT REMAINS FOR FURTHER RESEARCH TO PROVIDE A CONVINCING ACCOUNT OF THE FACTORS THAT PRODUCED THE ECONOMIC RECOVERY FROM THE ’REAT $EPRESSION(cid:14) 4HE REMAINDER OF THIS PAPER IS ORGANIZED AS FOLLOWS(cid:14) 3ECTION (cid:18) DISCUSSES THE BASIC MODEL AND PRESENTS THE TWO ALTERNATIVE WAGE CONTRACT STRUCTURES(cid:14) 3ECTION (cid:19) EXAMINES THE IMPULSE RESPONSE FUNCTIONS FROM A MONETARY DISTURBANCE(cid:12) WHILE SECTION (cid:20) COMPARES SIMULATIONS OF EACH MODEL(cid:218)S IMPLICATIONS FOR MAJOR MACROAGGREGATES TO THE CORRESPONDING DATA(cid:14) 3ECTION (cid:21) ATTEMPTS TO ACCOUNT FOR DIdERENCES IN THE RESPONSE OF OUTPUT TO SIMILAR(cid:13)SIZED PRICE DECLINES THAT OCCURRED IN THE (cid:17)(cid:25)(cid:18)(cid:16)(cid:13)(cid:18)(cid:17) RECESSION AND IN THE $EPRESSION(cid:14) 3ECTION (cid:22) CONCLUDES THE PAPER(cid:14) (cid:18)(cid:14) 4HE BASIC MODEL WITH WAGE CONTRACTS 4HE MODEL USED TO INVESTIGATE THE HYPOTHESIS THAT MONEY OPERATING THROUGH A STICKY WAGE CHANNEL CAUSED THE ’REAT $EPRESSION HAS A FAIRLY STANDARD NEOCLASSICAL STRUCTURE(cid:14) ! REPRE(cid:13) SENTATIVE AGENT MAKES CONSUMPTION(cid:15)INVESTMENT DECISIONS AND PORTFOLIO CHOICES IN A MANNER CONSISTENT WITH UTILITY MAXIMIZATION SUBJECT TO AN IN(cid:231)NITE(cid:13)HORIZON BUDGET CONSTRAINT(cid:14) 4HE PRIMARY DEPARTURE FROM A (cid:221)TYPICAL(cid:222) NEOCLASSICAL SPECI(cid:231)CATION IS THAT OUR MODEL ALLOWS FOR MONETARY NONNEUTRALITY BY DROPPING THE ASSUMPTION OF CONTINUOUS LABOR(cid:13)MARKET CLEARING(cid:14) )NSTEAD(cid:12) WAGES ARE DETERMINED BY &ISCHER OR 4AYLOR CONTRACTS(cid:14) )N THE SHORT(cid:13)RUN (cid:213)THE PERIOD BEFORE LABOR CONTRACTS CAN BE RENEGOTIATED (cid:213) HOUSEHOLDS ARE ASSUMED TO SUPPLY ALL LABOR (cid:22)

DEMANDED AT THE GIVEN WAGE RATE(cid:12) SO THAT THE QUANTITY OF LABOR ACTUALLY HIRED IS DETERMINED BY THE DEMAND FOR LABOR SCHEDULE OF THE REPRESENTATIVE (cid:231)RM(cid:14) /UR RATIONALE IN CONSIDERING TWO DIdERENT CONTRACT STRUCTURES IS THAT THEY PROVIDE TWO RATHER EXTREME PERSPECTIVES ON THE STICKY(cid:13)WAGE TRANSMISSION MECHANISM(cid:14) )N PARTICULAR(cid:12) IT IS WELL(cid:13)KNOWN THAT THE &ISCHER CONTRACT SPECI(cid:231)CATION BASICALLY IMPLIES THAT MONETARY INNOVA(cid:13) TIONS ONLY HAVE REAL EdECTS OVER THE CONTRACT INTERVAL(cid:12) WHICH IS ASSUMED TO LAST FOUR QUARTERS IN OUR ANALYSIS(cid:14) "Y CONTRAST(cid:12) THE 4AYLOR WAGE CONTRACT SPECI(cid:231)CATION CAN BE PARAMETERIZED TO ALLOW MONETARY INNOVATIONS TO HAVE EdECTS THAT PERSIST WELL BEYOND THE CONTRACT INTERVAL(cid:14) (cid:18)(cid:14)(cid:17)(cid:14) (OUSEHOLDS 4HE REPRESENTATIVE HOUSEHOLD SEEKS TO MAXIMIZE A UTILITY FUNCTIONAL OF THE FORM(cid:26) 8(cid:16) , nS4(cid:7)B (cid:26) S(cid:8) (cid:8)(cid:18)(cid:14)(cid:17)(cid:9) S / S(cid:28)(cid:15) S WHERE n IS THE DISCOUNT FACTOR(cid:12) B IS REAL CONSUMPTION(cid:12) , IS NOMINAL CASH BALANCES AT THE END OF PERIOD S(cid:12) AND / IS THE PRICE LEVEL(cid:14) 4HE PERIOD UTILITY FUNCTION IS GIVEN BY(cid:26) , , 4(cid:7)B (cid:26) S(cid:8) (cid:28) P KMB (cid:10)(cid:7)(cid:16)‘P (cid:8)KM(cid:7) S(cid:8) (cid:8)(cid:18)(cid:14)(cid:18)(cid:9) S / (cid:16) S (cid:16) / S S 4O FOCUS ATTENTION ON THE ROLE OF NOMINAL WAGE CONTRACTS IN DETERMINING LABOR MOVEMENTS(cid:12) WE ABSTRACT FROM THE HOUSEHOLD(cid:218)S LABOR SUPPLY DECISION BY OMITTING LABOR FROM THE UTILITY FUNCTION(cid:14) !SWEDISCUSSBELOW(cid:12)WEASSUME(cid:26) (cid:8)(cid:17)(cid:9)THATTHEHOUSEHOLDHASATIME(cid:13)INVARIANT(cid:12)TARGET VALUE OF LABOR HOURS DENOTED BY +(cid:12) AND (cid:8)(cid:18)(cid:9) THAT THE PROCESS OF WAGE ADJUSTMENT IMPLIED BY (cid:23)

EITHER OF THE TWO CONTRACT SPECI(cid:231)CATIONS THAT WE EXAMINE IS CONSISTENT WITH THE HOUSEHOLD SUPPLYING THIS QUANTITY OF LABOR IN THE LONG(cid:13)RUN(cid:14) !T ANY POINT IN TIME(cid:12) HOWEVER(cid:12) LABOR HOURS WILL VARY FROM + DEPENDING UPON VARIATIONS IN THE DEMAND FOR LABOR(cid:14)(cid:19) (OUSEHOLDS ACCUMULATE NOMINAL ASSETS ACCORDING TO THE FOLLOWING LAW OF MOTION(cid:26) ! (cid:28) ! (cid:10)(cid:7)1 ! (cid:10)6 + (cid:10)) * (cid:10){ (cid:10)7 (cid:8)‘(cid:7), ‘, (cid:10)/ B (cid:10)/ ( (cid:8) (cid:8)(cid:18)(cid:14)(cid:19)(cid:9) S S‘(cid:16) S‘(cid:16) S‘(cid:16) S S S S S S S S‘(cid:16) S S S S WHERE ) IS THE RENTAL PRICE OF CAPITAL IN NOMINAL TERMS(cid:12) * IS THE CAPITAL SUPPLIED TO (cid:231)RMS(cid:12) 6 IS THE NOMINAL WAGE RATE(cid:12) + IS TOTAL HOURS WORKED(cid:12) { IS NOMINAL (cid:231)RM PRO(cid:231)TS(cid:12) 1 IS THE NOMINAL INTEREST RATE ON BONDS(cid:12) ! IS NOMINAL BOND HOLDINGS(cid:12) 7 IS LUMP(cid:13)SUM CASH TRANSFERS FROM THE GOVERNMENT(cid:12) AND ( IS GROSS REAL INVESTMENT(cid:14) 4HE (cid:231)RST TERM IN PARENTHESES IN EQUATION (cid:8)(cid:18)(cid:14)(cid:19)(cid:9) IS HOUSEHOLD NOMINAL INCOME(cid:14) (OUSEHOLD INCOME CONSISTS OF INTEREST INCOME ON BONDS(cid:12) WAGE INCOME(cid:12) INCOME FROM CAPITAL(cid:12) (cid:231)RM PRO(cid:231)TS(cid:12) AND LUMP(cid:13)SUM CASH TRANSFERS FROM THE GOVERNMENT(cid:14) 4HE SECOND TERM IN PARENTHESES IS HOUSEHOLD NOMINAL EXPENDITURES(cid:12) WHICH CONSISTS OF SPENDING ON CONSUMPTION AND INVESTMENT GOODS(cid:12) AND ON ACCUMULATING CASH BALANCES(cid:14) (OUSEHOLDS PURCHASE INVESTMENT GOODS IN ORDER TO INCREASE THEIR STOCK OF PHYSICAL CAPITAL (cid:8)WHICH THEY IN TURN RENT TO (cid:231)RMS(cid:9)(cid:26) * (cid:28) (cid:7)(cid:16)‘p(cid:8)* (cid:10)( (cid:8)(cid:18)(cid:14)(cid:20)(cid:9) S(cid:10)(cid:16) S S (cid:19)7EHAVE EXAMINED VERSIONS OF OURECONOMYWHICH MODEL ENDOGENOUS LABOR SUPPLYCHOICES BY THE HOUSE(cid:13) HOLD(cid:14) 4HOSE RESULTS ARE QUALITATIVELY SIMILAR TO OUR (cid:231)NDINGS REPORTED HERE(cid:14) "Y ABSTRACTING FROM THE HOUSE(cid:13) HOLD(cid:218)SENDOGENOUSLABORSUPPLYDECISION(cid:12)HOWEVER(cid:12)ITISCLEARTHATWEARENOTATTEMPTINGTOEXPLAINTHE’REAT $EPRESSION WITH LARGE INTERTEMPORAL LABOR SUPPLY MOVEMENTS(cid:14) (cid:24)

4HE HOUSEHOLD(cid:218)S OPTIMIZATION PROBLEM IS TO CHOOSE B (cid:26), (cid:26)! * (cid:26)AND w TO MAXIMIZE (cid:8)(cid:18)(cid:14)(cid:17)(cid:9)(cid:12) S S S(cid:26) S(cid:10)(cid:16) S SUBJECT TO CONSTRAINTS (cid:8)(cid:18)(cid:14)(cid:19)(cid:9) AND (cid:8)(cid:18)(cid:14)(cid:20)(cid:9)(cid:26) (cid:18) (cid:19) 8(cid:16) nS4(cid:7)B (cid:26) , S(cid:8)(cid:10)w (cid:22) (cid:22) (cid:22) (cid:7)(cid:16)(cid:10)1 S‘(cid:16) (cid:8)! S‘(cid:16) (cid:10)6 S + S (cid:10)) S * S (cid:10){ S (cid:10)7 S ‘ (cid:23) (cid:23) (cid:23) (cid:8)(cid:18)(cid:14)(cid:21)(cid:9) S / S(cid:20) (cid:21) S(cid:28)(cid:15) S (cid:7), ‘, (cid:10)! (cid:10)/ B (cid:10)/ * ‘(cid:7)(cid:16)‘p(cid:8)/ * (cid:8) S S‘(cid:16) S S S S S(cid:10)(cid:16) S S 3EVERAL OBSERVATIONS ABOUT THE HOUSEHOLD(cid:218)S DECISION PROBLEM ARE IN ORDER(cid:14) &IRST(cid:12) BECAUSE HOUSEHOLD LABOR SUPPLY IS DETERMINED BY THE LABOR DEMAND OF (cid:231)RMS (cid:8)WAGE DETERMINATION IS DISCUSSED BELOW(cid:9)(cid:12) + IS NOT A CHOICE VARIABLE(cid:14) 3ECOND(cid:12) THE (cid:231)RST(cid:13)ORDER CONDITIONS IMPLY A S DEMAND FOR MONEY FUNCTION OF THE DOUBLE(cid:13)LOG FORM(cid:26) , P 1 KM S (cid:28) ‘KM (cid:16) (cid:10)KMB ‘KM S (cid:8)(cid:18)(cid:14)(cid:22)(cid:9) / (cid:7)(cid:16)‘P (cid:8) S (cid:16)(cid:10)1 S (cid:16) S 4HUS(cid:12) THE MODEL IMPLIES THAT HOUSEHOLD CONSUMPTION(cid:12) NOT OUTPUT(cid:12) IS AN ARGUMENT OF THE MONEY DEMAND FUNCTION(cid:14) !CCORDINGLY(cid:12) POSITIVE MONEY SUPPLY SHOCKS TEND TO HAVE SMALLER EdECTS ON THE PRICE LEVEL TO THE EXTENT THAT THEY INDUCE A RISE IN REAL MONEY DEMAND THROUGH THEIRSTIMULATIVEEdECTONCONSUMPTION(cid:14) 4HIRD(cid:12) THEMODELABSTRACTSFROM(cid:231)SCALPOLICYCONSID(cid:13) ERATIONS(cid:26) THE ONLY ROLE OF GOVERNMENT IS TO DISTRIBUTE LUMP(cid:13)SUM CASH TRANSFERS TO HOUSEHOLDS THAT IT (cid:231)NANCES BY PRINTING MONEY(cid:14) (cid:25)

(cid:18)(cid:14)(cid:18)(cid:14) &IRMS &IRMS RENT LABOR AND CAPITAL SERVICES FROM HOUSEHOLDS AT THE PREVAILING NOMINAL WAGE 6 S AND CAPITAL RENTAL PRICE ) (ENCE(cid:12) (cid:231)RMS SOLVE A STATIC OPTIMIZATION PROBLEM OF THE FORM(cid:26) S(cid:25) L@W { (cid:28) / %(cid:7)* + (cid:8)‘6 + ‘) * (cid:8)(cid:18)(cid:14)(cid:23)(cid:9) S S S(cid:26) S S S S S 4HE PRODUCTION FUNCTION %(cid:7)*(cid:26)+(cid:8) IS ASSUMED TO BE #OBB(cid:13)$OUGLAS(cid:26) %(cid:7)* + (cid:8) (cid:28) *t+(cid:16)‘t (cid:8)(cid:18)(cid:14)(cid:24)(cid:9) S(cid:26) S S S 4HE (cid:231)RST(cid:13)ORDER CONDITIONS TO THIS PROBLEM GIVE THE DEMAND FOR LABOR AND CAPITAL SCHEDULES OF A REPRESENTATIVE (cid:231)RM(cid:26) 6 % (cid:7)* (cid:26)+ (cid:8) (cid:28) S (cid:8)(cid:18)(cid:14)(cid:25)(cid:9) (cid:17) S S / S ) % (cid:7)* (cid:26)+ (cid:8) (cid:28) S (cid:8)(cid:18)(cid:14)(cid:17)(cid:16)(cid:9) (cid:16) S S / S (cid:18)(cid:14)(cid:19)(cid:14) 7AGE DETERMINATION 4HE MODEL IS COMPLETED BY DESCRIBING THE STOCHASTIC PROCESSES GOVERNING THE EVOLUTION OF WAGES AND THE SUPPLY OF MONEY(cid:14) 4HE WAGE CONTRACT STRUCTURES DISCUSSED BELOW BOTH IMPLY THAT MONETARY SHOCKS AdECT REAL WAGES IN THE SHORT(cid:13)RUN(cid:12) AND HENCE THE LABOR DEMAND AND OUTPUT SUPPLIED BY (cid:231)RMS(cid:12) BECAUSE PRICES BASICALLY RESPOND IMMEDIATELY TO SUCH SHOCKS(cid:12) WHILE WAGES TAKE SOME TIME TO FULLY ADJUST(cid:14) (cid:17)(cid:16)

(cid:18)(cid:14)(cid:19)(cid:14)(cid:17)(cid:14) &ISCHER CONTRACT SPECI(cid:231)CATION )N OUR SET(cid:13)UP(cid:12) &ISCHER WAGE CONTRACTS ARE ARRANGEMENTS IN WHICH THE NOMINAL WAGE PREVAILING J PERIODSINTHEFUTUREISSETINTHECURRENTPERIOD(cid:14) !TTHECONTRACTEDWAGE(cid:12) HOUSEHOLDSEXPECT TO WORK A TIME(cid:13)INVARIANT QUANTITY OF HOURS(cid:12) WHICH WE DENOTE BY +(cid:14) ! NATURAL CHOICE FOR + IS THE AVERAGE SHARE OF THE TIME ENDOWMENT SPENT WORKING(cid:12) TYPICALLY CALIBRATED TO BE IN THE RANGE OF THIRTY PERCENT(cid:14) ’IVEN THAT LABOR HOURS ARE DEMAND(cid:13)DETERMINED(cid:12) THE CONTRACTED NOMINAL WAGE(cid:12) SET AT TIME S TO APPLY IN PERIOD S (cid:10) J(cid:12) EQUALS THE EXPECTED VALUE MARGINAL PRODUCT OF LABOR OF A REPRESENTATIVE (cid:231)RM AT S (cid:10) J(cid:12) EVALUATED AT THE TIME(cid:13)INVARIANT HOURS WORKED + (cid:25) (cid:20) N O 6 (cid:28) $ / % (cid:7)* (cid:26)+(cid:8) (cid:8)(cid:18)(cid:14)(cid:17)(cid:17)(cid:9) S(cid:10)J S S(cid:10)J (cid:17)(cid:26)S(cid:10)J S(cid:10)J 4HUS(cid:12) THE NOMINAL WAGE IS SET SO THAT THE REAL WAGE THAT IS EXPECTED TO PREVAIL WHEN THE CONTRACT TAKES EdECT IS EXPECTED TO ALLOW HOURS WORKED TO EQUAL ITS LONG(cid:13)RUN AVERAGE LEVEL(cid:14) !LTHOUGH A MONETARY SHOCK CAN CAUSE HOURS WORKED TO DEVIATE FROM ITS LONG(cid:13)RUN LEVEL DURING THE SUBSEQUENT J ‘(cid:16) PERIODS(cid:12) NOMINAL WAGES FULLY ADJUST TO THE NEW POST(cid:13)SHOCK PRICE LEVEL AFTER J PERIODS(cid:14) -ONEY IS VIRTUALLY NEUTRAL AFTER J PERIODS(cid:12) EXCEPT FOR THE SMALL EdECT OF CAPITAL STOCK ADJUSTMENT THAT OCCURS ALONG THE TRANSITION(cid:14) 4HE APPROXIMATE NEUTRALITY OF MONETARY SHOCKS BEYOND THE LENGTH OF THE CONTRACT PERIOD IMPOSES A STRONG A PRIORI CONSTRAINT ON THE ABILITY OF MONETARY SHOCKS TO EXPLAIN BUSINESS CYCLE (cid:226)UCTUATIONS(cid:12) AT LEAST IF REASONABLE ASSUMPTIONS ARE MADE ABOUT THE LENGTH OF THE CON(cid:13) TRACT INTERVAL(cid:14) 7E ASSUME THAT WAGE CONTRACTS LAST FOUR QUARTERS(cid:14) 2ATHER THAN ATTEMPTING TO (cid:20)4HIS ASSUMES CERTAINTY EQUIVALENCE(cid:14) (cid:17)(cid:17)

DERIVE GREATER PERSISTENCE IN THE REAL EdECTS OF MONETARY INNOVATIONS BY STRETCHING THE LENGTH OF THE CONTRACT INTERVAL BEYOND A YEAR (cid:213) WHICH WOULD SEEM TO BE VERY DIbCULT TO JUSTIFY EMPIRICALLY(cid:12) GIVEN THE GENERALLY WEAK POWER OF LABOR UNIONS AT THE ONSET OF THE $EPRESSION (cid:213) WE CONSIDER ALSO THE ALTERNATIVE STAGGERED OVERLAPPING WAGE CONTRACT SCHEME SUGGESTED BY 4AYLOR (cid:8)(cid:17)(cid:25)(cid:24)(cid:16)(cid:9)(cid:14) (cid:18)(cid:14)(cid:19)(cid:14)(cid:18)(cid:14) 4AYLOR OVERLAPPING WAGE CONTRACTS )N THE 4AYLOR CONTRACT SPECI(cid:231)CATION(cid:12) THE LABOR FORCE MAY BE REGARDED AS DIVIDED INTO EQUAL(cid:13) SIZED COHORTS OF WORKERS(cid:12) WITH THE NUMBER OF COHORTS EQUAL TO THE LENGTH OF THE CONTRACT PERIOD(cid:14) 7ITH THE CONTRACT INTERVAL SET EQUAL TO FOUR QUARTERS(cid:12) THIS MEANS THAT THERE ARE FOUR COHORTS OF WORKERS(cid:14) $URING THE BEGINNING OF EACH QUARTER(cid:12) ONE OF THE FOUR COHORTS AGREES TO A NOMINAL WAGE THAT IT WILL RECEIVE FOR THE FOLLOWING YEAR(cid:14) &OR EXAMPLE(cid:12) COHORT ! AGREES TO A WAGE W DURING THE WINTER AND THIS PROCESS IS REPEATED BY THE OTHER COHORTS DURING THE S SUBSEQUENTTHREEQUARTERSOFTHEYEAR(cid:14) &OLLOWING4AYLOR(cid:8)(cid:17)(cid:25)(cid:24)(cid:16)(cid:9)(cid:12) THECONTRACTWAGEW DEPENDS S ON THE GEOMETRIC AVERAGE WAGE 6 OF ALL COHORTS IN THE ECONOMY THAT WILL PREVAIL OVER THE S (cid:8)FOUR(cid:13)QUARTER(cid:9) LIFE OF THE CONTRACT(cid:12) AS WELL AS ON THE EVOLUTION OF HOURS WORKED(cid:14) 3PECI(cid:231)CALLY(cid:12) THE CONTRACT WAGE OF THE COHORT RENEGOTIATING ITS WAGE AT TIME S IS GIVEN BY(cid:26) (cid:24) (cid:25) (cid:30) (cid:30) (cid:30) (cid:30) r s (cid:30) (cid:28) (cid:128) (cid:7)KM(cid:7)6 (cid:8)(cid:10)o(cid:7)+‘+ (cid:8)(cid:8)(cid:10)(cid:128) (cid:7)KM(cid:7)6 (cid:8)(cid:10) (cid:30) (cid:29) (cid:16) S(cid:10)(cid:16) S(cid:10)(cid:16) (cid:17) S(cid:10)(cid:17) KM(cid:7)W (cid:8) (cid:28) (cid:128) KM(cid:7)6 (cid:8)(cid:10)o(cid:7)+‘+ (cid:8) (cid:10)$ S (cid:15) S S S(cid:30) (cid:30) (cid:30) (cid:30) (cid:30) (cid:30) (cid:26) o(cid:7)+‘+ (cid:8)(cid:8)(cid:10)(cid:128) (cid:7)KM(cid:7)6 (cid:8)(cid:10)o(cid:7)+‘+ (cid:8)(cid:8) (cid:27) S(cid:10)(cid:17) (cid:18) S(cid:10)(cid:18) S(cid:10)(cid:18) (cid:8)(cid:18)(cid:14)(cid:17)(cid:18)(cid:9) (cid:17)(cid:18)

WHERE o (cid:27) (cid:15) AND 6 DENOTES THE GEOMETRIC AVERAGE WAGE OF ALL COHORTS IN THE ECONOMY AT S TIME S(cid:12) 6 (cid:28) W(cid:128) (cid:15)W(cid:128) (cid:16) W(cid:128) (cid:17) W(cid:128) (cid:18) (cid:8)(cid:18)(cid:14)(cid:17)(cid:19)A(cid:9) S S S‘(cid:16) S‘(cid:17) S‘(cid:18) WHERE WE TAKE (cid:128) (cid:28) (cid:15)(cid:25)(cid:17)(cid:20)(cid:12) FOR ALL H(cid:14) 7ITH (cid:128) (cid:28) (cid:15)(cid:25)(cid:17)(cid:20)(cid:12) REPEATED SUBSTITUTION OF (cid:8)(cid:18)(cid:14)(cid:17)(cid:19)A(cid:9) INTO H H (cid:8)(cid:18)(cid:14)(cid:17)(cid:18)(cid:9) YIELDS(cid:26) (cid:24) (cid:25) (cid:30) (cid:30) (cid:30) (cid:30) (cid:30) (cid:28) (cid:16) KM(cid:7)W (cid:8)(cid:10) (cid:16)KM(cid:7)W (cid:8)(cid:10) (cid:16)KM(cid:7)W (cid:8)(cid:10) (cid:16)KM(cid:7)W (cid:8)(cid:10) (cid:16)KM(cid:7)W (cid:8)(cid:10) (cid:30) (cid:29) (cid:16)(cid:17) S‘(cid:18) (cid:21) S‘(cid:17) (cid:19) S‘(cid:16) (cid:19) S(cid:10)(cid:16) (cid:21) S(cid:10)(cid:17) KM(cid:7)W (cid:8) (cid:28) $ (cid:8)(cid:18)(cid:14)(cid:17)(cid:20)(cid:9) S S(cid:30)(cid:30) (cid:30) (cid:26) (cid:16) KM(cid:7)W (cid:8)(cid:10)o 0 (cid:18) r +‘+ s (cid:30)(cid:30) (cid:30) (cid:27) (cid:16)(cid:17) S(cid:10)(cid:18) J(cid:28)(cid:15) S(cid:10)J !S IN 4AYLOR (cid:8)(cid:17)(cid:25)(cid:24)(cid:16)(cid:9)(cid:12) TWO FEATURES OF EQUATION (cid:8)(cid:18)(cid:14)(cid:17)(cid:20)(cid:9) ARE NOTEWORTHY(cid:14) &IRST(cid:12) CONTRACT WAGES HAVE AN INERTIAL OR BACKWARD(cid:13)LOOKING COMPONENT(cid:27) THAT IS(cid:12) PAST CONTRACT WAGES APPEAR IN THE EQUATION(cid:14) 4HIS INERTIAL COMPONENT RE(cid:226)ECTS IN PART THAT THE CURRENT CONTRACT WAGE DEPENDS ON THE CURRENT AVERAGE WAGE ACROSS ALL COHORTS(cid:12) WHICH ITSELF IS AN AVERAGE OF CONTRACT WAGES SET IN THE PAST THAT ARE STILL IN EdECT(cid:14) 4HIS INERTIAL COMPONENT OF WAGES TENDS TO (cid:221)ANCHOR(cid:222) THE CURRENT WAGE(cid:14) 3ECOND(cid:12) THE ONLY CHANNEL FORCING NOMINAL WAGES TO ADJUST ARE CURRENT AND FUTUREEXPECTEDLABORHOURS(cid:14) !CCORDINGLY(cid:12) THEPARAMETERo ISOFCRUCIALSIGNI(cid:231)CANCE(cid:26) GIVENTHE STRUCTURE OF DEPENDENCE BETWEEN THE CURRENT CONTRACT WAGE AND PAST AND FUTURE WAGE RATES(cid:12) IT CONTROLS HOW QUICKLY WAGES ADJUST TO CHANGING LABOR MARKET CONDITIONS(cid:14) ,OW ABSOLUTE VALUES OF o IMPLY COMPARATIVELY SLOW ADJUSTMENT OF NOMINAL WAGES (cid:213) AND(cid:12) AS SHOWN IN THE NEXT SECTION(cid:12) ALLOW THE MODEL TO ACCOUNT FOR MUCH MORE PERSISTENT REAL EdECTS OF MONETARY SHOCKS THAN THE &ISCHER SPECI(cid:231)CATION(cid:14) (cid:17)(cid:19)

(cid:18)(cid:14)(cid:20)(cid:14) -ONEY STOCK EVOLUTION 4HE MODEL ECONOMY ABSTRACTS FROM A BANKING SECTOR AND THE ENDOGENOUS CREATION OF MONEY(cid:14) 4HUS(cid:12) THE STOCK OF MONEY IS ASSUMED TO BE EXOGENOUSLY DETERMINED(cid:14) 4HE GROWTH RATE OF THE STOCK OF MONEY IS ASSUMED TO FOLLOW A (cid:231)RST(cid:13)ORDER AUTOREGRESSION OF THE FORM(cid:26) F (cid:28) F (cid:10)|F (cid:10)}(cid:1) (cid:8)(cid:18)(cid:14)(cid:17)(cid:21)(cid:9) S(cid:10)(cid:16) (cid:15) S S(cid:10)(cid:16) F (cid:28) KM(cid:7), (cid:8)‘KM(cid:7), (cid:8) (cid:8)(cid:18)(cid:14)(cid:17)(cid:22)(cid:9) S S S‘(cid:16) WHERE (cid:1) IS INDEPENDENT AND IDENTICALLY DISTRIBUTED (cid:8)I(cid:14)I(cid:14)D(cid:14)(cid:9) -(cid:7)(cid:15)(cid:26)(cid:16)(cid:8)(cid:14) S(cid:10)(cid:16) 4HE ASSUMPTION THAT THE MONEY GROWTH PROCESS EVOLVED EXOGENOUSLY OVER THE $EPRESSION PERIOD SEEMS REASONABLE GIVEN THE FOCUS OF THE PAPER (cid:213) TO DERIVE THE CONSEQUENCES OF THE MONETARY DECLINE (cid:8)AND SUBSEQUENT EXPANSION(cid:9) FOR REAL ACTIVITY(cid:12) IRRESPECTIVE OF THE SOURCES OF THE MONETARY DECLINE(cid:14) )N PARTICULAR(cid:12) THE MECHANISM THROUGH WHICH MONEY IS POSITED TO AdECT REAL ACTIVITY IN THE MODEL (cid:8)THE STICKY(cid:13)WAGE CHANNEL(cid:9) MEANS THAT EQUAL(cid:13)SIZED SHOCKS TO THE QUANTITY OF MONEY THAT MIGHT HAVE BEEN GENERATED FROM VERY DIdERENT SOURCES SHOULD HAVE SIMILAR EdECTS ON REAL ACTIVITY(cid:14) 3OME CANDIDATE ALTERNATIVE SOURCES INCLUDE THE EdECT OF &EDERAL 2ESERVE OPEN MARKET OPERATIONS ON THE BASE(cid:12) OR THE EdECT OF BANK PANICS ON THE MONEY MULTIPLIER(cid:14) /UR FORMULATION IS IN ACCORDANCE WITH THE RECENT LITERATURE INVESTIGATING THE STICKY WAGE CHANNEL(cid:14) 4HIS LITERATURE HAS MAINLY EMPHASIZED HOW VARIOUS SHOCKS WERE IMPORTANT BECAUSE OF THEIR EdECT ON MONEY AND THE PRICE LEVEL(cid:12) AND NOT BECAUSE THEY HAD A (cid:17)(cid:20)

LARGE DIRECT EdECT ON ACTIVITY (cid:8)"ERNANKE AND #AREY(cid:12) (cid:17)(cid:25)(cid:25)(cid:22)(cid:9)(cid:14)(cid:21) (cid:18)(cid:14)(cid:21)(cid:14) #ALIBRATION AND 3OLUTION -ETHOD 4HE MODEL(cid:218)S FREE PARAMETERS INCLUDE THE TECHNOLOGY PARAMETERS t AND p(cid:12) THE UTILITY FUNCTION PARAMETERS n AND P (cid:12) AND THE MONEY SUPPLY EVOLUTION PARAMETERS | AND }(cid:14) 4HE MODEL IS (cid:16) ASSUMED TO HOLD AT A QUARTERLY FREQUENCY(cid:14) 4HE CAPITAL SHARE PARAMETER t IS SET EQUAL TO (cid:16)(cid:14)(cid:19) AND THE QUARTERLY DEPRECIATION RATE TO (cid:16)(cid:14)(cid:16)(cid:18)(cid:12) IN THE RANGE OF TYPICAL ESTIMATES OF THESE PARAMETERS DERIVED FROM POSTWAR DATA(cid:14) 4HE DISCOUNT FACTOR n IS SET TO (cid:16)(cid:14)(cid:25)(cid:25)(cid:12) IMPLYING AN ANNUAL REAL INTEREST RATE OF ABOUT FOUR PERCENT(cid:14) 4HE SHARE PARAMETER P IS DETERMINED FROM THE HOUSEHOLD(cid:218)S STEADY STATE MONEY DEMAND (cid:16) FUNCTION(cid:12) UNDER THE ASSUMPTION THAT VELOCITY EQUALS ONE(cid:14) )N THIS CASE(cid:12) EQUATION (cid:8)(cid:18)(cid:14)(cid:22)(cid:9) IMPLIES(cid:26) P (cid:16)(cid:10)1 (cid:16) (cid:28) (cid:8)(cid:18)(cid:14)(cid:17)(cid:23)(cid:9) (cid:16)‘P (cid:16)(cid:10)(cid:17)1 (cid:16) WHERE 1 IS THE STEADY STATE VALUE OF THE NOMINAL INTEREST RATE(cid:14) "ECAUSE IT SEEMS REASONABLE TO ROUGHLY DE(cid:231)NE THE STEADY STATE VALUE OF A VARIABLE AS ITS AVERAGE VALUE OVER A (cid:221)TYPICAL(cid:222) PERIOD(cid:12) THE STEADY STATE VALUE OF 1 IS TAKEN TO BE ITS AVERAGE VALUE OVER THE (cid:17)(cid:25)(cid:18)(cid:17)(cid:13)(cid:18)(cid:24) PERIOD(cid:14) 5SINGTHEINTEREST RATEONTHREE(cid:13)MONTHCOMMERCIALPAPER(cid:8)TAKENFROMTHE"ALKE(cid:13)’ORDONDATA APPENDIX OF 4HE !MERICAN "USINESS #YCLE(cid:12) (cid:17)(cid:25)(cid:24)(cid:22)(cid:9) AS A PROXY FOR 1(cid:12) THE AVERAGE VALUE IS (cid:17)(cid:14)(cid:18)(cid:5) (cid:21)/N THE OTHER HAND(cid:12) THE FAILURE OF OUR MODEL TO ACCOUNT FOR THE DURATION OF THE $EPRESSION PERIOD MIGHT ARGUE FOR INCORPORATING AN ENDOGENOUS THEORY OF MONEY SUPPLY DETERMINATION(cid:12) SO THAT VARIOUS SHOCKS THAT (cid:221)INDIRECTLY(cid:222) AdECTED REAL ACTIVITY THROUGH THEIR EdECT ON MONEY AND THE PRICE LEVEL MIGHT ALSO EXERT DIRECT EdECTS OF VARYINGMAGNITUDE(cid:14) &OREXAMPLE(cid:12) BANK PANIC SHOCKS THAT INDUCED DECLINES IN THE MONEY MULTIPLIER AND HENCE AdECTED REAL ACTIVITY THROUGH THE CHANNEL OUTLINED IN OUR MODEL MIGHT HAVE AN ADDITIONAL EdECT TO THE EXTENT THAT BANK CLOSURES ASSOCIATED WITH THE PANICS RAISED THE COST OF (cid:231)NANCIAL INTERMEDIATION(cid:14) (cid:17)(cid:21)

ATAQUARTERLYRATE(cid:12) IMPLYINGTHATP (cid:28) (cid:15)(cid:25)(cid:24)(cid:23)(cid:22)(cid:14)(cid:22) 3IMILARLY(cid:12) THEMONEYSUPPLYPARAMETERS| AND (cid:16) } ARE ESTIMATED BY USING OBSERVATIONS ON THE GROWTH OF -(cid:17) OVER THE SAME PERIOD(cid:14) &ITTING A (cid:231)RST(cid:13)ORDER AUTOREGRESSION TO -(cid:17) GROWTH IMPLIES THAT | (cid:28) (cid:15)(cid:25)(cid:18)(cid:18) AND THAT } (cid:28) (cid:15)(cid:25)(cid:15)(cid:16)(cid:17)(cid:12) WHERE } IS IN UNITS OF QUARTERLY RATES OF CHANGE(cid:14)(cid:23) ! DISCUSSION OF THE IMPLICATIONS OF OUR SPECI(cid:231)CATION OF THE MONEY SUPPLY RULE AND SENSITIVITY OF OUR RESULTS TO THESE PARAMETER CHOICES IS PROVIDED BELOW(cid:14) 4HE APPROXIMATE DYNAMIC BEHAVIOR OF THE MODEL IS OBTAINED BY (cid:231)RST LINEARIZING THE APPROPRIATE NONLINEAR STOCHASTIC DIdERENCE EQUATIONS AROUND THE STEADY(cid:13)STATE VALUES OF THE STATEVARIABLES(cid:12)ANDTHENAPPLYINGTHEMETHODOF"LANCHARDAND+AHN(cid:8)(cid:17)(cid:25)(cid:24)(cid:16)(cid:9)(cid:14)(cid:24) 4HEEQUATIONS DETERMINING THE EVOLUTION OF THE STATE VARIABLES INCLUDE THE WAGE EQUATION (cid:8)(cid:18)(cid:14)(cid:17)(cid:17) FOR THE &ISCHER CONTRACT CASE OR (cid:18)(cid:14)(cid:17)(cid:20) FOR THE 4AYLOR CONTRACT CASE(cid:9) AND THE HOUSEHOLD(cid:218)S (cid:231)RST(cid:13)ORDER EQUATIONS FOR REAL BALANCES AND CAPITAL(cid:12) SUBJECT TO THE AGGREGATE RESOURCE CONSTRAINT(cid:14) (cid:19)(cid:14) )MPULSE 2ESPONSE &UNCTIONS &IGURES (cid:17)(cid:13)(cid:23) PLOT THE MODEL(cid:218)S IMPULSE RESPONSE FUNCTIONS (cid:8))2&(cid:9) TO A ONE(cid:13)STANDARD DEVIATION(cid:12) POSITIVEINNOVATIONINTHEGROWTHRATEOFMONEYFORTHE&ISCHERWAGECONTRACTSMODELANDTWO PARAMETERIZATIONS OF THE 4AYLOR CONTRACTS MODEL(cid:14) )N ONE 4AYLOR CONTRACTS PARAMETERIZATION(cid:12) NOMINAL WAGES RESPOND RELATIVELY SLOWLY TO DEVIATIONS IN LABOR HOURS FROM THEIR AVERAGE LEVEL (cid:22)4HE ANNUALIZED NOMINAL RATE OF INTEREST IS (cid:20)(cid:14)(cid:24)(cid:5)(cid:14) /UR DISCOUNT FACTOR IMPLIES A (cid:20)(cid:5) ANNUALIZED REAL RATE OF INTEREST(cid:14) )N(cid:226)ATION VARIED OVER THIS PERIOD BETWEEN SLIGHTLY POSITIVE AND NEGATIVE RATES(cid:14) (cid:23)4HEBASICRESULTSDISCUSSEDBELOWARENOTPARTICULARLYSENSITIVETOSUBSTITUTINGTHEGROWTHRATEOF-(cid:18)FOR -(cid:17)(cid:14) 4HE -(cid:17) DATA ARE TAKEN FROM &RIEDMAN AND 3CHWARTZ (cid:8)(cid:17)(cid:25)(cid:22)(cid:19)(cid:9)(cid:14) (cid:24)"ECAUSE THE MONEY STOCK GROWS AT A NONZERO RATE ON AVERAGE(cid:12) THE STATE VARIABLES REPRESENTING NOMINAL MAGNITUDES (cid:213) NAMELY THE NOMINAL WAGE AND PRICE LEVEL (cid:213) ARE SCALED BY THE STOCK OF MONEY SO THAT THE SYSTEM IS STATIONARY IN THE TRANSFORMED VARIABLES(cid:14) (cid:17)(cid:22)

(cid:8)o (cid:28) ‘(cid:15)(cid:25)(cid:16)(cid:9)(cid:27) AND ANOTHER(cid:12) WAGES RESPOND MUCH MORE RAPIDLY (cid:8)o (cid:28) ‘(cid:15)(cid:25)(cid:20)(cid:9)(cid:14) )N ALL OF THESE (cid:231)GURES(cid:12) THE INNOVATION OCCURS IN TIME PERIOD (cid:17)(cid:14) &IGURE (cid:17) PLOTS THE )2& OF THE PRICE LEVEL (cid:8)FOR THE &ISCHER AND 4AYLOR CONTRACT PARAMETER(cid:13) IZATIONS(cid:9)(cid:14) /N IMPACT THE MODEL PREDICTS THAT A POSITIVE INNOVATION IN THE STOCK OF MONEY INCREASES REAL MONEY DEMAND BY LESS THAN THE INCREASE IN THE MONEY SUPPLY(cid:14) 4HIS INNOVATION LEADS TO AN IMMEDIATE INCREASE IN THE PRICE LEVEL RELATIVE TO ITS BASELINE PATH(cid:14) &OLLOWING THIS INITIAL JUMP(cid:12) THE (cid:231)GURE INDICATES THAT THE PRICE LEVEL ACTUALLY DECLINES SOMEWHAT IN THE SHORT(cid:13) TO MEDIUM(cid:13)TERM(cid:14) 4HE PRICE LEVEL DECLINE RE(cid:226)ECTS THE RISING PRO(cid:231)LE OF CONSUMPTION AND ITS IN(cid:226)UENCE ON REAL MONEY DEMAND (cid:8)FROM EQUATION (cid:18)(cid:14)(cid:22)(cid:9)(cid:14) .EVERTHELESS(cid:12) PRICES CONTINUE TO BE HIGHER THAN BEFORE THE MONEY INNOVATION(cid:14) 4HE HIGHLY FRONT(cid:13)LOADED RESPONSE OF THE PRICE LEVEL IMPLIES THAT THE PRICE LEVEL INCREASES ASSOCIATED WITH POSITIVE MONEY INNOVATIONS ARE LARGELY UNANTICIPATED(cid:14) 4HIS IMPLICATION IS NOT PARTICULARLY SENSITIVE TO OUR CHOICE OF THE MONEY GROWTH PERSISTENCE PARAMETER |(cid:26) IN ORDER FOR MONEY GROWTH INNOVATIONS TO LEAD TO A PERSISTENT CHANGE IN THE RATE OF GROWTH OF THE PRICE LEVEL(cid:12) | MUST BE IN THE (cid:16)(cid:14)(cid:25) RANGE OR HIGHER (cid:8)ABOUT THREE TIMES OUR ESTIMATE(cid:9)(cid:14) 4HE (cid:231)GURE ALSO SHOWS THAT THE PRICE LEVEL )2&S DO NOT VARY SUBSTANTIALLY ACROSS THE THREE SPECI(cid:231)CATIONS(cid:12) THOUGH THE PRICE LEVEL EdECTS OF MONETARY INNOVATIONS ARE SMALLEST IN THE NEAR TOMEDIUMTERMINTHE 4AYLOR SPECI(cid:231)CATION WITH LOWo (cid:28) ‘(cid:15)(cid:25)(cid:16)(cid:14) )N THIS CONTRACT SPECI(cid:231)CATION(cid:12) A ONE STANDARD DEVIATION MONETARY INNOVATION HAS THE LARGEST EdECTS ON CONSUMPTION AND REAL MONEY DEMAND(cid:14) &IGURE (cid:18) PLOTS THE )2& OF THE NOMINAL WAGE(cid:14) )N THE &ISCHER CONTRACT CASE(cid:12) NOMINAL WAGES (cid:17)(cid:23)

DONOT RESPONDATALL DURINGTHE(cid:231)RSTFOURQUARTERSFOLLOWINGASHOCK(cid:12) BUTTHENJUMPTOALEVEL CONSISTENT WITH STEADY(cid:13)STATE LABOR HOURS(cid:14) 4HE 4AYLOR CONTRACT SPECI(cid:231)CATIONS ARE CONSISTENT WITH A GRADUAL ADJUSTMENT OF NOMINAL WAGES(cid:12) AND THE SPEED OF ADJUSTMENT VARIES DIRECTLY WITH THE ABSOLUTE VALUE OF THE PARAMETER o(cid:25) &IGURES (cid:19) AND (cid:20) PLOT THE )2&S OF THE REAL WAGE AND HOURS WORKED(cid:12) RESPECTIVELY(cid:14) )N THE &ISCHER CASE(cid:12) REAL WAGES REMAIN SUBSTANTIALLY BELOW THEIREQUILIBRIUMLEVEL UNTIL FOURQUARTERS AFTER THE SHOCK(cid:12) AT WHICH POINT THE REAL WAGE JUMPS TO A LEVEL SLIGHTLY ABOVE ITS STEADY(cid:13)STATE LEVEL (cid:8)DUE TO THE ABOVE STEADY(cid:13)STATE CAPITAL STOCK LEVEL(cid:9)(cid:14) #ORRESPONDINGLY(cid:12) WHEN REAL WAGES ARE UNUSUALLY LOW(cid:12) HOURS WORKED ARE MUCH HIGHER THAN THEIR STEADY(cid:13)STATE LEVEL(cid:27) HOURS WORKED FALLTOTHEIRSTEADY(cid:13)STATELEVELWHENREALWAGESINCREASE(cid:14) 4HEBEHAVIOROFHOURSWORKEDCLEARLY RE(cid:226)ECTS THE ASSUMPTION THAT LABOR HOURS ARE DETERMINED BY A BASICALLY STATIC LABOR DEMAND SCHEDULE(cid:14) &ORTHE4AYLORSPECI(cid:231)CATIONS(cid:12) THE)2&SOFTHEREALWAGEANDHOURSWORKEDAREQUALITATIVELY SIMILAR TO THOSE OF THE &ISCHER MODEL(cid:12) EXCEPT THAT THE ADJUSTMENTS TO THE STEADY(cid:13)STATE ARE RELATIVELY SMOOTH(cid:14) -OREOVER(cid:12) REAL WAGES ADJUST MUCH MORE SLOWLY AS THE ABSOLUTE VALUE OF o DECLINES(cid:12) IMPLYING THAT HOURS WORKED REMAIN ABOVE THEIR STEADY(cid:13)STATE LEVEL FOR A LONGER PERIOD(cid:14) #LEARLY(cid:12) THE )2&S INDICATE THAT THE 4AYLOR MODEL WITH LOW ABSOLUTE VALUES OF o PRODUCE MORE PERSISTENT MONETARY NONNEUTRALITIES(cid:27) AND THIS IS HOLDING THE CONTRACT LENGTH (cid:231)XED(cid:14) &IGURES (cid:21) THROUGH (cid:23) PLOT THE )2&S OF OUTPUT(cid:12) CONSUMPTION(cid:12) AND INVESTMENT(cid:12) RESPECTIVELY(cid:14) 3INCE THE CAPITAL STOCK ADJUSTMENT TENDS TO BE QUITE MODEST(cid:12) THE OUTPUT )2&S BASICALLY (cid:17)(cid:24)

MIRROR THE CORRESPONDING HOURS WORKED )2&S(cid:14) &OR CONSUMPTION(cid:12) THE PEAK RESPONSE TENDS TO BE CONSIDERABLY SMALLER THAN THAT OF OUTPUT(cid:12) RE(cid:226)ECTING THE TRANSIENT NATURE OF THE SHOCK(cid:218)S IMPACT ON INCOME(cid:14) 4HE ABSOLUTE MAGNITUDE OF THE CONSUMPTION RESPONSE IS LARGEST IN THE 4AYLORMODELWITHALOWABSOLUTEVALUEOF o(cid:12) SINCETHEEdECTSONHOUSEHOLDINCOMEARELARGEST IN THIS CASE(cid:14) 4HE STRONG RESPONSE OF INVESTMENT IN EACH OF THE CASES RE(cid:226)ECTS THE HOUSEHOLD(cid:218)S DESIRE TO SMOOTH CONSUMPTION BY INVESTING IN PRODUCTIVE CAPITAL(cid:14) (cid:20)(cid:14) #OMPARISONS OF -ODEL 3IMULATIONS WITH $ATA OVER THE (cid:17)(cid:25)(cid:18)(cid:25)(cid:13)(cid:19)(cid:22) PERIOD )N THIS SECTION(cid:12) TIME SERIES PLOTS OF OUTPUT(cid:12) CONSUMPTION(cid:12) INVESTMENT(cid:12) AND HOURS WORKED GENERATEDFROMMODELSIMULATIONSARECOMPAREDWITHCORRESPONDINGDATA(cid:14) 4HEOBJECTIVEISTO PROVIDE A QUANTITATIVE ASSESSMENT OF THE ABILITY OF THE STICKY WAGE MODEL (cid:8)INCLUDING BOTH THE &ISCHERAND4AYLORCONTRACT SPECI(cid:231)CATIONS(cid:9)TOEXPLAINTHEBEHAVIOROF MAJORMACROAGGREGATES DURING THE ’REAT $EPRESSION PERIOD(cid:14) (cid:20)(cid:14)(cid:17)(cid:14) $ATA 4HE DATA ON OUTPUT(cid:12) CONSUMPTION(cid:12) AND INVESTMENT USED IN THE COMPARISONS ARE PRIMARILY BASED ON THE QUARTERLY NATIONAL INCOME ACCOUNTS DATA CONSTRUCTED BY "ALKE AND ’ORDON (cid:8)(cid:17)(cid:25)(cid:24)(cid:22)(cid:9)(cid:14) 3OME EdORT IS REQUIRED IN ORDER TO (cid:231)T ACTUAL NATIONAL INCOME ACCOUNTS DATA INTO THE MUCH SIMPLER ACCOUNTING IDENTITY IMPOSED IN THE MODEL(cid:12) BECAUSE THE MODEL DOES NOT (cid:17)(cid:25)

SPECIFY EITHER AN EXTERNAL OR A GOVERNMENT SECTOR(cid:25)(cid:14) /UTPUT IS IDENTI(cid:231)ED AS REAL ’$0 FROM THE .)0!(cid:14) 4HE CONSUMPTION COMPONENT IN THE MODEL IS EQUATED WITH PRIVATE SPENDING ON NONDURABLE GOODS AND SERVICES PLUS A MEASURE OF PUBLIC CONSUMPTION SPENDING(cid:14) 4HE PUBLIC CONSUMPTION SERIES IS DERIVED FROM SUBTRACTING A MEASURE OF GOVERNMENT INVESTMENT SPEND(cid:13) ING FROM GOVERNMENT PURCHASES(cid:27) GOVERNMENT INVESTMENT SPENDING IS BASED ON INTERPOLATING ANNUAL DATA THAT APPEARS IN THE "%! PUBLICATION &IXED 2EPRODUCIBLE 4ANGIBLE 7EALTH IN THE 5NITED 3TATES(cid:14) &INALLY(cid:12) INVESTMENTISDE(cid:231)NEDASARESIDUALBETWEENOUTPUTANDOURMEASUREOF CONSUMPTION(cid:14) !LTHOUGH NET EXPORTS ARE INCLUDED IN THIS MEASURE OF INVESTMENT(cid:12) THIS SEEMS REASONABLE GIVEN THAT THE MODEL DE(cid:231)NES INVESTMENT AS FOREGONE CONSUMPTION(cid:14) 4HE HOURS WORKED SERIES IS DERIVED FROM MULTIPLYING TOTAL EMPLOYMENT BY THE AVERAGE LENGTH OF THE WORKWEEK IN THE MANUFACTURING SECTOR(cid:14) 4HE EMPLOYMENT DATA ARE QUARTERLY AND FROM THE "UREAU OF ,ABOR 3TATISTICS(cid:14) !GGREGATE WORKWEEK DATA ARE NOT AVAILABLE QUARTERLY(cid:12) SO WE USE THE AVERAGE HOURS WORKED PER WEEK IN THE MANUFACTURING SECTOR FROM THE .ATIONAL )NDUSTRIAL #ONFERENCE "OARD (cid:8)"ENEY (cid:17)(cid:25)(cid:19)(cid:22)(cid:9)(cid:14) !LL OF THESE DATA ARE DE(cid:231)NED IN PER CAPITA TERMS(cid:14) /URCOMPARISONSALSOINVOLVENOMINALANDREALWAGES(cid:14) 4HENOMINALWAGESERIESREPRESENTS AN AVERAGE OF PAYROLL WAGES IN (cid:18)(cid:21) MANUFACTURING INDUSTRIES(cid:14) !S WITH THE WORKWEEK DATA(cid:12) NOMINAL WAGE DATA ARE NOT AVAILABLE AT AN AGGREGATE LEVEL OUTSIDE OF MANUFACTURING(cid:14) 4HESE DATA WERE COMPILED BY THE .)#" AND ARE AVAILABLE FOR THE PERIOD (cid:17)(cid:25)(cid:18)(cid:16)(cid:26)(cid:19) TO (cid:17)(cid:25)(cid:19)(cid:22)(cid:26)(cid:18) (cid:8)"ENEY (cid:17)(cid:25)(cid:19)(cid:22)(cid:9)(cid:14) /UR REAL WAGE SERIES IS DERIVED BY DE(cid:226)ATING THIS NOMINAL WAGE SERIES BY THE ’$0 DE(cid:226)ATOR (cid:8)FROM "ALKE AND ’ORDON (cid:17)(cid:25)(cid:24)(cid:22)(cid:9)(cid:14)(cid:17)(cid:16) (cid:25))N OTHER WORDS(cid:12) OUTPUT EQUALS CONSUMPTION PLUS INVESTMENT(cid:14) (cid:17)(cid:16)4HE RESULTS REPORTED BELOW ARE ESSENTIALLY UNCHANGED WHEN WE CONSIDERED AN ALTERNATIVE MEASURE OF (cid:18)(cid:16)

(cid:20)(cid:14)(cid:18)(cid:14) 4HE DOWNTURN PHASE OF THE ’REAT $EPRESSION 4HEMODELISSIMULATEDOVERTHE(cid:17)(cid:25)(cid:18)(cid:25)(cid:26)(cid:20)(cid:13)(cid:17)(cid:25)(cid:19)(cid:22)(cid:26)(cid:20)PERIODBYINPUTTINGESTIMATESOFMONEYGROWTH INNOVATIONS OVER THAT PERIOD INTO THE STATE(cid:13)SPACE REPRESENTATION OF THE MODEL(cid:14) 4HE MONEY GROWTH INNOVATIONS ARE DERIVED FROM THE MONEY SUPPLY EVOLUTION EQUATION USING DATA ON -(cid:17) GROWTH AND THE PARAMETER ESTIMATES OF THE -(cid:17) GROWTH PROCESS (cid:8)EQUATION (cid:18)(cid:14)(cid:17)(cid:21)(cid:9)(cid:14) 4HE SIMULATIONS ALSO ASSUME THAT ALL MODEL VARIABLES (cid:8)INCLUDING THE GROWTH RATE OF -(cid:17)(cid:9) WERE AT THEIR STEADY(cid:13)STATE LEVEL IN (cid:17)(cid:25)(cid:18)(cid:25)(cid:26)(cid:19)(cid:14) "ECAUSE THE SIMULATED DATA ARE REPRESENTED IN (cid:221)PERCENT DEVIATION FROM STEADY STATE(cid:222) FORM(cid:12) HISTORICAL DATA ARE REPRESENTED IN A COMPARABLE FORM BY CONSTRUCTING EACH SERIES AS A LOGARITHMIC PERCENTAGE DEVIATION FROM ITS (cid:17)(cid:25)(cid:18)(cid:25)(cid:26)(cid:19) LEVEL(cid:14) %STIMATES OF THE INNOVATIONS TO MONEY GROWTH ARE PLOTTED IN &IGURE (cid:24)(cid:14) )T IS EVIDENT FROM THE (cid:231)GURE THAT OUR PARAMETERIZATION IMPLIES A SERIES OF LARGE NEGATIVE INNOVATIONS TO MONEY GROWTH BEGINNING IN (cid:17)(cid:25)(cid:18)(cid:25)(cid:26)(cid:20)(cid:14) )N FACT(cid:12) THESE INNOVATIONS ARE VERY CLOSE TO THE ACTUAL RATE OF MONEY GROWTH(cid:12) GIVEN THE LOW VALUE OF THE AUTOREGRESSIVE PARAMETER(cid:14) /UR MODEL IMPLIES THAT THESE NEGATIVE MONEY GROWTH INNOVATIONS SHOULD HAVE LED TO A SERIES OF LARGELY UNANTICIPATED DECLINES IN THE PRICE LEVEL(cid:12) AS SHOWN BELOW(cid:14) &IGURES (cid:25)(cid:13)(cid:17)(cid:18) DISPLAY THE EdECTS OF THE PRICE DECLINE ON OUTPUT(cid:12) HOURS WORKED(cid:12) CONSUMP(cid:13) TION(cid:12) AND INVESTMENT IMPLIED BY THE &ISCHER WAGE CONTRACT(cid:12) AND ALSO THE DATA FOR THESE VARIABLES(cid:14) )T IS CLEAR FROM THE SIMULATED DATA THAT THE NEGATIVE SHOCKS TO MONEY GROWTH OVER THE (cid:17)(cid:25)(cid:18)(cid:25)(cid:13)(cid:19)(cid:18) PERIOD WERE SUbCIENTLY LARGE TO ACCOUNT FOR A MASSIVE CONTRACTION IN ALL OF THESE MACROAGGREGATES(cid:14) ’IVEN ITS SIMPLE STRUCTURE(cid:12) THE MODEL DOES REASONABLY WELL FROM A NOMINALWAGESTHATCONTROLSFORCHANGINGINDUSTRYCOMPOSITION(cid:14) 4HISDATAWASPROVIDEDBY#HRIS(ANES(cid:27) SEE (ANES (cid:8)(cid:17)(cid:25)(cid:25)(cid:21)A(cid:12) (cid:17)(cid:25)(cid:25)(cid:21)B(cid:9)(cid:14) (cid:18)(cid:17)

QUANTITATIVE PERSPECTIVE IN (cid:231)TTING THE OBSERVED PATH OF OUTPUT AND HOURS WORKED UNTIL EARLY (cid:17)(cid:25)(cid:19)(cid:18)(cid:14) &OR EXAMPLE(cid:12) THE MODEL IMPLIES A (cid:19)(cid:18) PERCENT DECLINE IN OUTPUT RELATIVE TO ITS (cid:17)(cid:25)(cid:18)(cid:25) LEVEL BY (cid:17)(cid:25)(cid:19)(cid:18)(cid:26)(cid:17)(cid:12) WHICH IS VERY CLOSE TO THE (cid:19)(cid:21) PERCENT DECLINE THAT WAS OBSERVED(cid:14) (OWEVER(cid:12) THE MODEL PERFORMS POORLY ALONG SEVERAL DIMENSIONS(cid:14) "ECAUSE THE MODEL DOES NOT ALLOW MONETARY SHOCKS TO AdECT HOURS WORKED BEYOND THE ASSUMED LENGTH OF WAGE CON(cid:13) TRACTS (cid:8)ONE YEAR(cid:9)(cid:12) THE PATH OF HOURS BASICALLY TRACES THE PATH OF MONEY INNOVATIONS EXCEPT FOR A SHORT LAG (cid:8)SEE &IGURE (cid:17)(cid:16)(cid:9)(cid:14) !S A RESULT(cid:12) THE MODEL INCORRECTLY IMPLIES THAT THE STABILIZA(cid:13) TION OF MONETARY AGGREGATES IN THE SPRING OF (cid:17)(cid:25)(cid:19)(cid:18) SHOULD HAVE LED TO A SUBSTANTIAL RISE IN HOURS WORKED(cid:14) !LSO(cid:12) THE SUSTAINED REMONETIZATIONTHAT OCCURRED DURINGTHE (cid:17)(cid:25)(cid:19)(cid:19)(cid:13)(cid:17)(cid:25)(cid:19)(cid:22)PERIOD SHOULD HAVE LED TO AN EXTREMELY STRONG EXPANSION IN HOURS WORKED BEGINNING IN MID(cid:13)(cid:17)(cid:25)(cid:19)(cid:19)(cid:14) "ECAUSE THE PATH OF OUTPUT IS LARGELY DETERMINED BY THE PATH OF HOURS WORKED(cid:12) THE MODEL IS FAR Od THE MARK IN ITS PREDICTIONS OF A SUBSTANTIAL RECOVERY IN OUTPUT IN (cid:17)(cid:25)(cid:19)(cid:18) AND A MAJOR BOOM BY LATE (cid:17)(cid:25)(cid:19)(cid:19)(cid:14) &INALLY(cid:12) IT IS EVIDENT FROM &IGURE (cid:17)(cid:17) THAT THE MODEL SUBSTANTIALLY UN(cid:13) DERPREDICTS THE MAGNITUDE OF THE FALL IN CONSUMPTION THAT OCCURRED DURING THE $EPRESSION DOWNTURN(cid:14) 4HIS RE(cid:226)ECTS THE &ISCHER MODEL(cid:218)S IMPLICATION THAT MONETARY SHOCKS HAVE A VERY TRANSIENT EdECT ON PERMANENT INCOME(cid:14) )T IS CLEAR THAT ACCOUNTINGFOR THE PERSISTENCE OF THE DOWNTURN IN OUTPUT(cid:12) HOURS(cid:12) CONSUMP(cid:13) TION(cid:12) AND INVESTMENT WITHIN A PURELY MONETARY FRAMEWORK REQUIRES THAT MONETARY SHOCKS EXERT CONSIDERABLY MORE PERSISTENT REAL EdECTS THAN IS AdORDED BY THE &ISCHER CONTRACT SPECI(cid:13) (cid:231)CATION(cid:14) 4HE )2&S SUGGEST THAT THE 4AYLOR MODEL WITH SUbCIENTLY SLUGGISH WAGE ADJUSTMENT (cid:8)I(cid:14)E(cid:14)(cid:12) A LOW ABSOLUTE VALUE OF o(cid:9) MAY PROVIDE A BETTER ACCOUNT OF THE BEHAVIOR OF THESE (cid:18)(cid:18)

MACROAGGREGATES AFTER EARLY (cid:17)(cid:25)(cid:19)(cid:18)(cid:14) !CCORDINGLY(cid:12) WE SIMULATE THE 4AYLOR MODEL BELOW CHOOS(cid:13) ING o (cid:28) ‘(cid:15)(cid:25)(cid:16)(cid:12) WHICH IMPLIES )2&S THAT ARE CONSIDERABLY MORE PERSISTENT THAN IN THE &ISCHER SPECI(cid:231)CATION (cid:8)REFER AGAIN TO &IGURES (cid:21)(cid:13)(cid:23)(cid:9)(cid:14) 3OME JUSTI(cid:231)CATION FOR THIS PARAMETER CHOICE IS PROVIDED BELOW(cid:14) &IGURE (cid:17)(cid:19) COMPARES THE DATA ON OUTPUT BASED ON THIS PARAMETERIZATION OF THE 4AYLOR MODEL WITH THE CORRESPONDING SIMULATED SERIES OVER THE (cid:17)(cid:25)(cid:18)(cid:25)(cid:26)(cid:20)(cid:13)(cid:17)(cid:25)(cid:19)(cid:22)(cid:26)(cid:20) PERIOD (cid:8)REFER TO THE LINE MARKED(cid:221)WITHOUT -$SHOCKS(cid:222)IN&IGURES (cid:17)(cid:19)(cid:13)(cid:17)(cid:22)(cid:12) WHICHDISTINGUISHTHESE SIMULATIONSFROM A VARIANT THAT ALLOWS FOR MONEY DEMAND SHOCKS CONSIDERED BELOW(cid:9)(cid:14) 4HE MODEL TRACKS THE OUTPUT DOWNTURN EXTREMELY WELL THROUGH EARLY (cid:17)(cid:25)(cid:19)(cid:18)(cid:14) 4HE MODEL DOES MUCH BETTER THAN THE &ISCHER SPECI(cid:231)CATION IN ACCOUNTING FOR THE PERSISTENCE OF THE OUTPUT DOWNTURN BETWEEN EARLY (cid:17)(cid:25)(cid:19)(cid:18) AND MID(cid:13)(cid:17)(cid:25)(cid:19)(cid:19)(cid:14) 4HE 4AYLOR SPECI(cid:231)CATION CANNOT(cid:12) HOWEVER(cid:12) ACCOUNT FOR THE CONTINUED OUTPUT DECLINE THAT OCCURRED BETWEEN EARLY (cid:17)(cid:25)(cid:19)(cid:18) AND MID(cid:13)(cid:17)(cid:25)(cid:19)(cid:19)(cid:27) IN THIS CASE(cid:12) THE MODEL PREDICTS A SLIGHT RECOVERY IN OUTPUT OVER THAT PERIOD(cid:14) $ESPITE THIS SHORTCOMING(cid:12) THE MODEL STILL APPEARS TO DO REASONABLY WELL IN ACCOUNTING FOR THE MAGNITUDE OF THE OUTPUT DECLINE EXPERIENCED AT THE $EPRESSION TROUGH(cid:12) IMPLYING AN OUTPUT DECLINE OF (cid:19)(cid:16) PERCENT IN THE (cid:231)RST HALF OF (cid:17)(cid:25)(cid:19)(cid:19) (cid:8)FROM ITS (cid:17)(cid:25)(cid:18)(cid:25)(cid:26)(cid:19) LEVEL(cid:9)(cid:12) COMPARED TO THE (cid:20)(cid:20) PERCENT DECLINE OBSERVED(cid:14) ! MUCH MORE SERIOUS SHORTCOMING OF THE MODEL IS ITS SIGNI(cid:231)CANT OVERSTATEMENT OF THE RECOVERY(cid:218)S STRENGTH BEGINNING IN LATE (cid:17)(cid:25)(cid:19)(cid:19) OR EARLY (cid:17)(cid:25)(cid:19)(cid:20)(cid:14) )N PARTICULAR(cid:12) IT PREDICTS THAT THE REMONETIZATION BEGUN IN LATE (cid:17)(cid:25)(cid:19)(cid:19) SHOULD HAVE ALLOWED OUTPUT TO RECOVER RAPIDLY TO ITS PRE(cid:13)$EPRESSION LEVEL AND SURPASS IT BY THE SECOND HALF OF (cid:17)(cid:25)(cid:19)(cid:20)(cid:14) !S SEEN IN &IGURE (cid:17)(cid:20)(cid:12) THE MODEL PROVIDES A FAIRLY GOOD CHARACTERIZATION OF THE BEHAVIOR (cid:18)(cid:19)

OF HOURS WORKED DURING MOST OF THE DOWNTURN PHASE OF THE ’REAT $EPRESSION(cid:14) (OWEVER(cid:12) THE MODEL SIGNI(cid:231)CANTLY UNDERPREDICTS THE CONTRACTION IN HOURS WORKED THAT OCCURRED BETWEEN EARLY (cid:17)(cid:25)(cid:19)(cid:18) AND EARLY (cid:17)(cid:25)(cid:19)(cid:19)(cid:14) 4HE MOST IMPORTANT FAILURE OF THE MODEL IS ITS IMPLICATION OF A RAPID RECOVERY IN HOURS WORKED FOLLOWING THE REMONETIZATION THAT BEGAN IN LATE (cid:17)(cid:25)(cid:19)(cid:19)(cid:14) !S WITH THE OUTPUT IMPLICATIONS(cid:12) THE MODEL PREDICTS THAT HOURS WORKED SHOULD HAVE RETURNED TO THEIR PRE(cid:13)$EPRESSION LEVEL BY MID(cid:13)(cid:17)(cid:25)(cid:19)(cid:20)(cid:14) (OWEVER(cid:12) ACTUAL HOURS WORKED RECOVERED VERY SLOWLY BETWEEN (cid:17)(cid:25)(cid:19)(cid:19) AND (cid:17)(cid:25)(cid:19)(cid:21)(cid:12) AND REMAINED ABOUT (cid:20)(cid:16) PERCENT BELOW ITS (cid:17)(cid:25)(cid:18)(cid:25)(cid:26)(cid:19) LEVEL AT THE END OF (cid:17)(cid:25)(cid:19)(cid:21)(cid:14) 4HE MODEL BASICALLY CAPTURES THE OBSERVED PATH OF CONSUMPTION (cid:8)&IGURE (cid:17)(cid:21)(cid:9)(cid:12) BOTH WITH RESPECT TO ITS TIMING AND MAGNITUDE(cid:14) (OWEVER(cid:12) IT UNDERPREDICTS THE MAGNITUDE OF THE DECLINE TO A MODEST DEGREE(cid:14) 4HE MODEL IMPLIES A DECLINE IN CONSUMPTION OF ABOUT (cid:17)(cid:21) PERCENT AT THE TROUGH(cid:12) COMPARED TO THE (cid:17)(cid:25) PERCENT DECLINE OBSERVED(cid:14) 2ELATIVE TO THE &ISCHER MODEL(cid:12) THE 4AYLOR MODEL(cid:218)S PREDICTION OF A MUCH MORE RAPID AND DEEP DECLINE IN CONSUMPTION OVER (cid:17)(cid:25)(cid:18)(cid:25)(cid:13)(cid:19)(cid:19) RE(cid:226)ECTS THE MORE PERSISTENT MONETARY NONNEUTRALITIES IN THIS CASE(cid:14) 4HE MODEL(cid:218)S ABILITY TO TRACK INVESTMENT (cid:213) SHOWN IN &IGURE (cid:17)(cid:22) (cid:213) IS SIMILAR TO ITS PERFOR(cid:13) MANCE IN ACCOUNTING FOR OUTPUT AND HOURS WORKED(cid:14) 4HE MODEL DOES WELL THROUGH EARLY (cid:17)(cid:25)(cid:19)(cid:18)(cid:12) BUT IMPLIES A SLIGHT RECOVERY OF INVESTMENT OVER THE SUBSEQUENT YEAR(cid:12) IN CONTRAST TO ACTUAL INVESTMENT SPENDING(cid:12) WHICH DECLINED SOMEWHAT FURTHER UNTIL REACHING A TROUGH IN (cid:17)(cid:25)(cid:19)(cid:19)(cid:26)(cid:17)(cid:14) !GAIN(cid:12) A MUCH MORE SERIOUS SHORTCOMING OF THE MODEL IS ITS PREDICTION OF A MAJOR BOOM IN INVESTMENT SPENDING IN THE SECOND HALF OF (cid:17)(cid:25)(cid:19)(cid:19)(cid:14) &IGURE (cid:17)(cid:23) INDICATES THAT OUR MODEL DOES WELL IN ACCOUNTING FOR THE OBSERVED DECLINE IN (cid:18)(cid:20)

THE PRICE LEVEL THROUGH THE EARLY PART OF (cid:17)(cid:25)(cid:19)(cid:18)(cid:12) THOUGH IT DOES UNDERSTATE THE CONTINUED SHARP PRICE LEVEL DECLINES THAT OCCURRED OVER THE FOLLOWING YEAR(cid:14) 4HE FAILURE OF OUR SIMPLE MODEL TO ACCOUNT FULLY FOR THE OBSERVED PRICE LEVEL DECLINE OVER THAT PERIOD MIGHT IN PART RE(cid:226)ECT SHOCKS TO THE MONEY DEMAND FUNCTION THAT CAUSED THE PRICE LEVEL TO DECLINE BY MORE THAN WOULD BE IMPLIED BY THE BEHAVIOR OF THE MONEY STOCK ALONE(cid:14) (cid:20)(cid:14)(cid:19)(cid:14) )NCORPORATING MONEY DEMAND SHOCKS INTO THE ANALYSIS ’IVEN THE CRUCIAL ROLE OF PRICE LEVEL CHANGES ON REAL ACTIVITY IN OUR MODEL(cid:12) IT SEEMS IMPORTANT TO INVESTIGATE WHETHER THE MODEL(cid:218)S FAILURE TO ACCOUNT FULLY FOR THE PRICE DECLINE MIGHT ALSO WEAKEN ITS ABILITY TO ACCOUNT FOR THE CONTINUED DOWNTURN IN MAJOR MACROAGGREGATES THAT OCCURRED BETWEEN EARLY (cid:17)(cid:25)(cid:19)(cid:18) AND EARLY TO MID(cid:13)(cid:17)(cid:25)(cid:19)(cid:19)(cid:14) !CCORDINGLY(cid:12) WE MODI(cid:231)ED THE MODEL SLIGHTLYTOALLOWFORMONEYDEMANDSHOCKS} ASWELL ASMONEYSUPPLYSHOCKS(cid:14) 4HEPREFERENCE S SPECI(cid:231)CATION (cid:8)(cid:18)(cid:14)(cid:18)(cid:9) WAS REFORMULATED AS(cid:26) , , 4(cid:7)B (cid:26) S(cid:8) (cid:28) P KMB (cid:10)(cid:7)(cid:16)‘P (cid:8)} KM(cid:7) S(cid:8) (cid:8)(cid:20)(cid:14)(cid:17)(cid:9) S / (cid:16) S (cid:16) S / S S &IGURES (cid:17)(cid:19)(cid:13)(cid:17)(cid:22) ALSO DISPLAY THE SIMULATIONS OF THE MODEL OVER THE SAMPLE PERIOD (cid:17)(cid:25)(cid:18)(cid:25)(cid:26)(cid:19)(cid:13) (cid:17)(cid:25)(cid:19)(cid:22)(cid:26)(cid:20) WHEN BOTH MONEY SUPPLY AND MONEY DEMAND SHOCKS ARE INPUT INTO THE STATE(cid:13)SPACE REPRESENTATION(cid:14) 4HE MONEY SUPPLY SHOCKS ARE THE SAME AS DISCUSSED ABOVE(cid:14) 4HE MONEY DEMAND SHOCKS ARE MEASURED TO MATCH EXACTLY THE MODEL(cid:218)S IMPLIED PRICE LEVEL PATH WITH THE ACTUAL PRICE LEVEL DATA(cid:14) 4HE SIMULATIONS LABELLED (cid:221)W(cid:15) MONEY DEMAND (cid:8)-$(cid:9) SHOCKS(cid:222) (cid:18)(cid:21)

CORRESPOND TO THIS CASE(cid:14)(cid:17)(cid:17) )TISEVIDENTFROMTHE(cid:231)GURESTHATALLOWINGFORMONEYDEMANDSHOCKSDOESACCOUNTSLIGHTLY BETTER FOR THE MAGNITUDE OF THE DOWNTURN IN MACROAGGREGATES(cid:12) PARTICULARLY IN THE EARLY (cid:17)(cid:25)(cid:19)(cid:18)(cid:13)EARLY (cid:17)(cid:25)(cid:19)(cid:19) PERIOD(cid:14) (OWEVER(cid:12) THE EdECTS OF THESE CHANGES IN THE SPECI(cid:231)CATION ARE NOT PARTICULARLY LARGE(cid:14) &OR EXAMPLE(cid:12) THE MODEL WITH MONEY DEMAND SHOCKS IMPLIES AN OUTPUT DECLINE OF ABOUT (cid:19)(cid:20) PERCENT IN (cid:17)(cid:25)(cid:19)(cid:19)(cid:26)1(cid:17) FROM ITS PRE(cid:13)$EPRESSION LEVEL(cid:12) COMPARED TO THE (cid:19)(cid:16) PERCENT DECLINE IMPLIED BY THE MODEL THAT DOES NOT ALLOW FOR MONEY DEMAND SHOCKS(cid:14) 3UMMARIZINGOUR RESULTS THUS FAR(cid:12) AND TEMPORARILY FOCUSING ON THE DOWNTURN PHASE OF THE $EPRESSION(cid:12) THE STICKY WAGE MODEL SEEMS TO PROVIDE A GOOD CHARACTERIZATION OF THE BEHAVIOR OF MAJOR MACROAGGREGATES THROUGH EARLY (cid:17)(cid:25)(cid:19)(cid:18)(cid:14) 4HE MODEL DOES(cid:12) HOWEVER(cid:12) SEEM TO UNDERSTATE THE SUBSEQUENT DECLINE IN REAL ACTIVITY THAT OCCURRED BETWEENEARLY (cid:17)(cid:25)(cid:19)(cid:18)AND EARLY (cid:17)(cid:25)(cid:19)(cid:19)(cid:12) EVEN IN OUR PREFERRED SPECI(cid:231)CATION THAT EXACTLY MATCHES THE PRICE LEVEL DECLINE(cid:14) 4HE INABILITY OF A PURELY MONETARY MODEL TO EXPLAIN THE DOWNTURN FULLY MAY RE(cid:226)ECT THE FACT THAT OTHER (cid:221)SUPPLY SIDE(cid:222) FACTORS(cid:12) INCLUDING THE EdECTS OF BANK PANICS AND DEBT DE(cid:226)ATION(cid:12) CONTRIBUTED NOTICEABLY TO THE OUTPUT DECLINE(cid:12) PARTICULARLY IN THE (cid:17)(cid:25)(cid:19)(cid:18)(cid:13)(cid:19)(cid:19) PERIOD(cid:14) (OWEVER(cid:12) IT IS STILL INTERESTING THAT THE STICKY WAGE MODEL APPEARS TO ACCOUNT FOR ROUGHLY THREE(cid:13)QUARTERS OF THE OBSERVED OUTPUT DECLINE OF (cid:20)(cid:20) PERCENT AT THE $EPRESSION TROUGH(cid:14) -OREOVER(cid:12) (cid:231)GURES (cid:17)(cid:24) AND (cid:17)(cid:25)(cid:12) WHICH EXAMINE (cid:17)(cid:17)4OIDENTIFYATIMESERIESFOR} (cid:12)WEASSUMETHAT} ISARANDOMWALKANDITSINNOVATIONSAREUNCORRELATED T T WITH THE INNOVATIONS IN THE MONEY GROWTH PROCESS(cid:14) 4HE MONEY DEMAND SHOCK INNOVATIONS ARE IDENTI(cid:231)ED BY COMPARING THE STATE SPACE REPRESENTATION FOR a0-ODEL AND THE ACTUAL DATA FOR a0$ATA(cid:14) )N PARTICULAR(cid:12) T T a0-ODEL‘a0$ATADEPENDSUPONCURRENTANDLAGGEDENDOGENOUSSTATEVARIABLES(cid:12)LAGGEDMONEYGROWTHRATES(cid:12) T T THE MONEY GROWTH INNOVATION(cid:12) AND THE MONEY DEMAND INNOVATION(cid:14) 3INCE WE HAVE ALREADY IDENTI(cid:231)ED A TIME SERIES FOR THE MONEY GROWTH INNOVATIONS(cid:12) THIS DETERMINES THE MONEY DEMAND INNOVATION(cid:14) 4HE ASSUMPTION THATTHEMONEYSUPPLYANDDEMANDINNOVATIONSAREUNCORRELATEDMAYAPPEAREXTREME(cid:14) "UTALLOWINGFOREVEN SIGNI(cid:231)CANT CROSS(cid:13)CORRELATION AND AUTOCORRELATION IN THE SHOCK PROCESSES (cid:8)E(cid:14)G(cid:14)(cid:12) ALLOWING MONEY SUPPLY SHOCKS TO ACCOMMODATE CHANGES IN MONEY DEMAND(cid:9) HAS VERY LITTLE EdECT ON THE BEHAVIOR OF THE REAL AND NOMINAL VARIABLES DEPICTED IN THE (cid:231)GURES(cid:14) (cid:18)(cid:22)

THE MODEL(cid:218)S IMPLICATIONS FOR REAL AND NOMINAL WAGES(cid:12) PROVIDE IMPORTANT EVIDENCE IN SUPPORT OF THE STICKY WAGE CHANNEL AS A CAUSE OF THE ’REAT $EPRESSION(cid:14) 4HE (cid:231)GURES SUGGEST THAT THE MECHANISM IN THE MODEL THAT ACCOUNTS FOR THE DOWNTURN IN THE MACROAGGREGATES (cid:213) NAMELY(cid:12) A RISE IN REAL WAGES AS NOMINAL WAGES FELL MORE SLOWLY THAN THE PRICE LEVEL (cid:213) IS BROADLY CONSISTENT WITH THE DATA (cid:8)AT LEAST OVER THE DOWNTURN PHASE OF THE $EPRESSION(cid:9)(cid:14)(cid:17)(cid:18) 4HE MODEL ACCOUNTS EXTREMELY WELL FOR THE RISE IN REAL WAGES THAT OCCURRED THROUGH MID(cid:13) (cid:17)(cid:25)(cid:19)(cid:18)(cid:12) AND THE MODEST DECLINE IN REAL WAGES OVER THE SUBSEQUENT YEAR(cid:14) 4HE MODEL(cid:218)S ABILITY TO ACCOUNT FOR PERSISTENT REAL EdECTS ON THE MACROAGGREGATES IS NOT ACHIEVED BY ASSUMING (cid:221)EXCESSIVELYSLUGGISH(cid:222)NOMINALWAGEBEHAVIOR(cid:14) /URPARAMETERIZATIONOFo (cid:28) ‘(cid:15)(cid:25)(cid:16)(cid:231)TSNOMINAL WAGES WELL OVER THE (cid:17)(cid:25)(cid:18)(cid:25)(cid:26)(cid:19)(cid:13)(cid:17)(cid:25)(cid:19)(cid:19)(cid:26)(cid:18) PERIOD(cid:12) AND IN FACT IS THE VALUE OF o THAT ALLOWS THE MODEL TO (cid:231)T OBSERVED NOMINAL WAGE BEHAVIOR AS CLOSELY AS POSSIBLE IN A LEAST(cid:13)SQUARES SENSE(cid:14) (cid:20)(cid:14)(cid:20)(cid:14) 4HE RECOVERY PHASE OF THE ’REAT $EPRESSION 4URNING TO THE RECOVERY PHASE OF THE $EPRESSION(cid:12) IT IS CLEAR THAT THE STICKY WAGE MODEL PROVIDES A POOR (cid:231)T(cid:14) 4HE MODEL IMPLIES THAT THE REMONETIZATION THAT BEGAN IN (cid:17)(cid:25)(cid:19)(cid:19) SHOULD HAVEGENERATEDAMUCHMORERAPIDRECOVERYTHANWHATACTUALLYOCCURRED(cid:14) )TISTEMPTINGTOTRY TOPROVIDEABETTER(cid:231)TOFTHERECOVERYPHASEOFTHE$EPRESSIONBYFORCINGMONETARYINNOVATIONS TO HAVE MORE PERSISTENT EdECTS ON REAL ACTIVITY(cid:14) 4HIS WOULD BE THE CASE IF NOMINAL WAGES RESPONDED EVEN LESS TO ECONOMIC ACTIVITY(cid:12) THROUGH LOWER ABSOLUTE VALUES OF o(cid:14) !S SHOWN IN (cid:17)(cid:18)&IGURES(cid:17)(cid:24)AND(cid:17)(cid:25)AREDERIVEDFROMTHE4AYLORMODELTHATINCLUDESMONEYDEMANDSHOCKS(cid:8)ANDHENCE(cid:231)TS THE PRICE LEVEL IN (cid:231)GURE (cid:17)(cid:23) EXACTLY(cid:9)(cid:14) 4HE VERSION OF THE MODEL THAT DOES NOT INCLUDE MONEY DEMAND SHOCKS HAS QUITE SIMILAR IMPLICATIONS FOR REAL WAGE BEHAVIOR AS IS SHOWN IN (cid:231)GURE (cid:17)(cid:24)(cid:14) 4HIS SIMILARITY ACCOUNTS FOR WHY THE TWO SPECI(cid:231)CATIONS HAVE SIMILAR IMPLICATIONS FOR OTHER REAL VARIABLES(cid:12) THOUGH THE MODEL WITH MONEY DEMAND SHOCKS (cid:231)TS OBSERVED REAL WAGE BEHAVIOR SLIGHTLY BETTER(cid:14) (cid:18)(cid:23)

(cid:231)GURE (cid:18)(cid:16)(cid:12) ASSUMING THAT o (cid:28) ‘(cid:15)(cid:25)(cid:15)(cid:18) ALLOWS THE MODEL TO PROVIDE A SOMEWHAT BETTER ACCOUNT OF THE BEHAVIOR OF OUTPUT DURING THE SLOW RECOVERY(cid:14) 4HE MODEL ALSO ACCOUNTS SOMEWHAT BETTER FOR THE DEPTH OF THE DOWNTURN IN (cid:17)(cid:25)(cid:19)(cid:18) AND EARLY (cid:17)(cid:25)(cid:19)(cid:19)(cid:14) #ORRESPONDING SIMULATIONS FOR CONSUMPTION(cid:12) HOURS(cid:12) AND INVESTMENT ALSO INDICATE A MODEST IMPROVEMENT IN (cid:231)T (cid:8)THESE RESULTS ARE NOT DISPLAYED(cid:9)(cid:14) "UT AN EXAMINATION OF WAGE BEHAVIOR OVER THE RECOVERY PHASE OF THE $EPRESSION SUGGESTS THAT IT IS NOT REASONABLE TO ATTEMPT TO RESCUE A STICKY WAGE EXPLANATION FOR THE RECOVERY BY CONSIDERING LOWER ABSOLUTE VALUES OF o(cid:14) 4HIS IS BECAUSE THE STICKY WAGE MODEL FAILS DRAMATICALLY ON TWO IMPORTANT FEATURES OF THE RECOVERY PHASE(cid:14) &IRST(cid:12) IN THE ABSENCE OF OTHER SHOCKS(cid:12) THE STICKY WAGE MODEL PREDICTS THAT THE RECOVERY SHOULD HAVE OCCURRED AS DECLINING REAL WAGES ENCOURAGED AN EXPANSION IN LABOR HOURS WORKED(cid:14) "UT AS (cid:231)GURE (cid:17)(cid:24) SHOWS(cid:12) REAL WAGES ROSE SHARPLY BEGINNING IN (cid:17)(cid:25)(cid:19)(cid:19)(cid:26)(cid:19)(cid:12) INCREASING BY (cid:18)(cid:16) PERCENT BETWEEN (cid:17)(cid:25)(cid:19)(cid:19)(cid:26)(cid:19) AND (cid:17)(cid:25)(cid:19)(cid:20)(cid:26)(cid:18)(cid:14) !SINDICATEDBYCOMPARING(cid:231)GURES(cid:17)(cid:23)AND(cid:17)(cid:25)(cid:12) REALWAGESROSEDESPITEAMARKEDINCREASEINTHE PRICE LEVEL ASSOCIATED WITH REMONETIZATION(cid:12) AS NOMINAL WAGES ROSE MUCH MORE SHARPLY THAN PRICES(cid:14) 3ECOND(cid:12) THE MODEL(cid:218)S IMPLICATION OF A STRONG RECOVERY IN HOURS WORKED LEADING THE RECOVERY IS ALSO INCONSISTENT WITH THE DATA(cid:14) 2ETURNING TO (cid:231)GURE (cid:17)(cid:20)(cid:12) OBSERVED HOURS WORKED RECOVERED MUCH MORE TEPIDLY THAN PREDICTED BY THE MODEL (cid:213) AND MUCH MORE SLOWLY THAN TOTAL OUTPUT(cid:12) AS SEEN BY THE BEHAVIOR OF ACTUAL OUTPUT AND HOURS WORKED IN (cid:231)GURES (cid:17)(cid:19) AND (cid:17)(cid:20)(cid:14) (OURS WORKED REMAINED (cid:19)(cid:21) PERCENT BELOW ITS PRE(cid:13)$EPRESSION LEVEL AS LATE AS THE END OF (cid:17)(cid:25)(cid:19)(cid:22)(cid:12) WHILE OUTPUT HAD RECOVERED TO WITHIN (cid:17)(cid:16) PERCENT OF ITS PRE(cid:13)$EPRESSION LEVEL(cid:14) 4HE BEHAVIOR OF REAL WAGESAND HOURS WORKED DURINGTHERECOVERY PHASE OF THE $EPRESSION (cid:18)(cid:24)

SUGGESTSTHATTHERAPIDRUN(cid:13)UPINWAGESBEGINNINGINMID(cid:13)(cid:17)(cid:25)(cid:19)(cid:19)PLAYEDAKEYROLEINDAMPENING THEPACEOFTHERECOVERY(cid:14) 4HERISEINWAGESISDIbCULTTOEXPLAINGIVENTHEHIGHUNEMPLOYMENT RATES OF THE PERIOD(cid:12) AS HAS BEEN NOTED BY OTHERS(cid:14) 4HE SHARP INCREASES IN NOMINAL WAGES SEEM TO BE ATTRIBUTABLE TO VARIOUS LEGISLATION(cid:12) PARTICULARLY THE .)2!(cid:12) THAT BECAME EdECTIVE IN MID(cid:13)(cid:17)(cid:25)(cid:19)(cid:19) (cid:8)7EINSTEIN (cid:17)(cid:25)(cid:24)(cid:17)(cid:9)(cid:14) 4HIS LEGISLATION ESSENTIALLY SET WAGE SCHEDULES FOR A BROAD SET OF INDUSTRIES(cid:14) 4HE FACT THAT MOST OF THE NOMINAL WAGE INCREASE OCCURRED OVER A THREE MONTH PERIOD IN (cid:17)(cid:25)(cid:19)(cid:19) (cid:213) NOMINAL WAGES ROSE BY (cid:17)(cid:25) PERCENT BETWEEN *ULY AND /CTOBER (cid:213) SUGGESTS THE (cid:231)AT NATURE OF THE WAGE JUMP(cid:12) THOUGH INCREASED UNION POWER BEGINNING IN THE EARLY (cid:17)(cid:25)(cid:19)(cid:16)S MAY HAVE ALSO CONTRIBUTED TO UPWARD PRESSURE ON NOMINAL WAGES(cid:14) /THER FACTORS IN ADDITION TO THE REAL WAGE HIKES PROBABLY DELAYED THE RECOVERY(cid:14) &OR EXAMPLE(cid:12) "ERNANKE (cid:8)(cid:17)(cid:25)(cid:24)(cid:19)(cid:9) HAS EMPHASIZED THAT WIDESPREAD BANK FAILURES DURING THE PERIOD MAY HAVE EXERTED A STRONG CONTRACTIONARY IMPACT(cid:12) BEYOND THEIR DIRECT EdECTS ON MONETARY AGGREGATES(cid:12) BY RAISING THE COST OF CREDIT INTERMEDIATION(cid:14) 4HUS(cid:12) WHILE THE SUSTAINED MONETARY EXPANSION THAT BEGAN IN (cid:17)(cid:25)(cid:19)(cid:19) UNDOUBTEDLY HELPED AMELIORATE SOME OF THE CONTRACTIONARY EdECTSOF THENOMINAL WAGE HIKES AND OTHERFACTORS(cid:12) WE CONCLUDE THAT THE MONETARY EXPANSION WAS NOT NEARLY STRONG ENOUGH TO EXPLAIN THE RECOVERY(cid:14) !LTHOUGH PROVIDING AN ACCOUNT OF THE KEY FACTORS THAT CONTRIBUTED TO THE RECOVERY IS BEYOND THE SCOPE OF THIS PAPER(cid:12) IT IS INTERESTING TO NOTE THAT RECENT LITERATURE HAS SUGGESTED THAT PRODUCTIVITY IMPROVEMENTS MAY HAVE PLAYED A SUBSTANTIAL ROLE IN THE RECOVERY(cid:14) 4HERE IS SOME INDUSTRY EVIDENCE THAT PRODUCTIVITY INCREASED MARKEDLY IN THE RECOVERY PHASE OF THE $EPRESSION BECAUSE OF SHAKE(cid:13)OUTS OF INEbCIENT PRODUCERS(cid:14) &OR EXAMPLE(cid:12) "RESNAHAN AND 2Ad (cid:18)(cid:25)

(cid:8)(cid:17)(cid:25)(cid:25)(cid:19)(cid:9) (cid:231)ND THAT AUTOMOBILE PRODUCTION BY (cid:17)(cid:25)(cid:19)(cid:21) HAD RETURNED TO ITS (cid:17)(cid:25)(cid:18)(cid:25) LEVEL(cid:12) ALTHOUGH THERE WAS A CONSIDERABLE CHANGE IN THE MIX OF PRODUCERS(cid:14) -OST OF THE INCREASE IN OUTPUT FROM VERY DEPRESSED LEVELS IN (cid:17)(cid:25)(cid:19)(cid:19) OCCURRED THROUGH AN EXPANSION OF ESTABLISHMENTS THAT HAD RELATIVELY HIGH PRODUCTIVITY LEVELS IN (cid:17)(cid:25)(cid:18)(cid:25)(cid:12) AND TO A LESSER EXTENT BY ENTRY OF NEW (cid:231)RMS THAT HAD A SIMILARLY HIGH LEVEL OF EbCIENCY (cid:8)MEASURED BY OUTPUT PER WORKER(cid:9)(cid:14) 4HIS INDUSTRY LEVEL EVIDENCE IS SUPPORTED AT A MORE AGGREGATE LEVEL IN RECENT WORK BY #ECCHETTI AND +ARRAS (cid:8)(cid:17)(cid:25)(cid:25)(cid:20)(cid:9)(cid:14) 4HESE AUTHORS(cid:12) USING VARIOUS SETS OF RESTRICTIONS TO IDENTIFY THEIR VECTOR AUTOREGRESSIONS(cid:12) (cid:231)ND THAT SUPPLY SHOCKS ACCOUNTED FOR A LARGE FRACTION OF OUTPUT GROWTH DURING THE RECOVERY PERIOD OF THE $EPRESSION(cid:14) 7HILE THIS EVIDENCE IS SUGGESTIVE THAT SUPPLYSHOCKSMAYHAVEPLAYEDANIMPORTANTROLEINOdSETTINGTHEOTHERCONTRACTIONARYEdECTS OF THE REAL WAGE HIKES(cid:12) PROVIDING A FULLER EXPLANATION FOR THE DELAYED ECONOMIC RECOVERY OF THE (cid:17)(cid:25)(cid:19)(cid:16)S CLEARLY REMAINS AN IMPORTANT TOPIC FOR FUTURE RESEARCH(cid:14) (cid:21)(cid:14) #ONTRASTING THE ’REAT $EPRESSION AND THE (cid:17)(cid:25)(cid:18)(cid:16)(cid:13)(cid:18)(cid:17) RECESSION /URRESULTSABOVESUGGESTTHATARELATIVELYSIMPLEMODELDRIVENBYMONETARYSHOCKSOPERATING THROUGH A STICKY WAGE CHANNEL CAN ACCOUNT SURPRISINGLY WELL FOR THE BEHAVIOR BOTH OF THE EXPENDITURE COMPONENTS OF ’$0 AND OF WAGES OVER THE DOWNTURN AND BOTTOMING OUT PHASES OF THE ’REAT $EPRESSION(cid:12) (cid:17)(cid:25)(cid:18)(cid:25)(cid:26)(cid:19)(cid:13)(cid:17)(cid:25)(cid:19)(cid:19)(cid:26)(cid:18)(cid:14) (OWEVER(cid:12) IT IS USEFUL TO DRAW ATTENTION TO TWO FACTORS THAT PLAY AN IMPORTANT ROLE IN THE MODEL(cid:218)S ABILITY TO ACCOUNT FOR THE SEVERITY OF THE $EPRESSION(cid:14) 4HESE FACTORS INCLUDE(cid:26) (cid:8)(cid:17)(cid:9) THE UNANTICIPATED NATURE OF THE PRICE LEVEL DECLINE(cid:12) AND(cid:8)(cid:18)(cid:9)SUbCIENTLYSLUGGISHWAGEADJUSTMENT THATALLOWS MONETARYSHOCKSTOEXERT EXTREMELY (cid:19)(cid:16)

PERSISTENT REAL EdECTS(cid:14) /UR ANALYSIS BELOW(cid:12) HOWEVER(cid:12) SUGGESTS THAT THESE TWO FACTORS WERE NOT AS IMPORTANT IN THE EARLY (cid:17)(cid:25)(cid:18)(cid:16)S(cid:14) (cid:21)(cid:14)(cid:17)(cid:14) (cid:17)(cid:25)(cid:18)(cid:25)(cid:13)(cid:19)(cid:19) /UR MODEL(cid:218)S IMPLICATION THAT THE PRICE LEVEL DECLINE WAS LARGELY UNANTICIPATED (cid:213) A FEATURE EVIDENT IN THE HIGHLY FRONT(cid:13)LOADED )2&S OF THE PRICE LEVEL FROM MONETARY SHOCKS (cid:213) TENDS TO MAXIMIZE THE REAL EdECTS OF A GIVEN(cid:13)SIZED DECLINE IN THE PRICE LEVEL(cid:14) 3PECI(cid:231)CATIONS IN WHICH A LARGER FRACTION OF THE PRICE DECLINE IS ANTICIPATED PRODUCE SMALLER REAL EdECTS(cid:14) &OR EXAMPLE(cid:12) IF A FUTURE PRICE DECLINE IS ANTICIPATED SEVERAL QUARTERS IN ADVANCE(cid:12) NOMINAL WAGES WOULD BEGIN ADJUSTINGDOWNWARDSOONERINRESPONSETOEXPECTEDFUTUREREDUCTIONSINTHEQUANTITYOF LABOR HOURS THAT (cid:231)RMS WILL DEMAND(cid:14) #ONSEQUENTLY(cid:12) REAL WAGES WILL NOT RISE AS MUCH WHEN THE PRICE LEVEL DECLINE IS ANTICIPATED(cid:14) 4O ASSESS THE QUANTITATIVE SIGNI(cid:231)CANCE OF THIS(cid:12) (cid:231)GURE (cid:18)(cid:17) COMPARES THE BEHAVIOR OF THE SIMULATEDPATHOFOUTPUTDERIVEDFROMTHE4AYLORMODELABOVE(cid:8)IN&IGURE(cid:17)(cid:19)(cid:9)WITHTHEOUTPUT PATH DERIVED UNDER THE ASSUMPTION THAT THE PRICE DECLINE WAS FULLY ANTICIPATED AS OF (cid:17)(cid:25)(cid:18)(cid:25)(cid:26)(cid:19)(cid:14) 4HE MODEL(cid:218)S IMPLICATIONS FROM THIS PERFECT FORESIGHT SIMULATION ARE OBTAINED BY SOLVING THE 4AYLOR CONTRACTS COMPONENT OF THE MODEL(cid:12) ASSUMING THAT AGENTS ALSO HAVE PERFECT FORESIGHT ABOUT THE ACTUAL PATH OF THE CAPITAL STOCK(cid:14) 3PECI(cid:231)CALLY(cid:12) THE AVERAGE WAGE 6 IS DE(cid:231)NED S BY EQUATION (cid:8)(cid:18)(cid:14)(cid:17)(cid:19)A(cid:9)(cid:12) AND IS A GEOMETRIC AVERAGE OF THE CONTRACT WAGES FW (cid:26)W (cid:26)W (cid:26)W G(cid:14) S S‘(cid:16) S‘(cid:17) S‘(cid:18) 3UBSTITUTING THE CONTRACT WAGES INTO (cid:8)(cid:18)(cid:14)(cid:25)(cid:9)(cid:12) AND LOG(cid:13)LINEARIZING YIELDS A LINEAR RELATIONSHIP BETWEEN THE LOGARITHMS OF W (cid:26)W (cid:26)W (cid:26)W (cid:26)/ (cid:26)* (cid:26)AND + (cid:14) 3OLVING THIS RELATIONSHIP FOR + (cid:12) S S‘(cid:16) S‘(cid:17) S‘(cid:18) S S S S (cid:19)(cid:17)

THE ONLY UNKNOWN VARIABLES ARE THE CONTRACT WAGES SINCE / AND * ARE ASSUMED TO BE KNOWN S S UNDER THE PERFECT FORESIGHT ASSUMPTIONS(cid:14) 3UBSTITUTING THIS SOLUTION FOR + INTO THE 4AYLOR S CONTRACTS EQUATION (cid:8)(cid:18)(cid:14)(cid:17)(cid:20)(cid:9) YIELDS A SINGLE DYNAMIC EQUATION FOR THE CONTRACT WAGE W IN TERMS S OF PAST AND FUTURE CONTRACT WAGES(cid:12) AS WELL AS CURRENT AND FUTURE PRICE LEVELS AND CAPITAL STOCKS(cid:14) ’IVEN THE SOLUTION FOR W (cid:12) THE AVERAGE WAGE 6 AND LABOR HOURS + ARE DETERMINED(cid:27) S S S THE PRODUCTION FUNCTION (cid:8)(cid:18)(cid:14)(cid:24)(cid:9) DETERMINES OUTPUT(cid:14)(cid:17)(cid:19) )T IS EVIDENT THAT THESE (cid:221)POLAR OPPOSITE(cid:222) ASSUMPTIONS(cid:12) ABOUT THE DEGREE TO WHICH THE $EPRESSION(cid:218)S PRICE DECLINE WAS ANTICIPATED(cid:12) LEAD TO SUBSTANTIAL DIdERENCES IN THE PREDICTED OUTPUTDECLINE(cid:14) 4HEMODELSUGGESTSTHATIFTHEFUTUREPRICELEVELDECLINEDURINGTHE$EPRESSION BECAME FULLY ANTICIPATED IN (cid:17)(cid:25)(cid:18)(cid:25)(cid:12) OUTPUT WOULD HAVE CONTRACTED ONLY ABOUT (cid:18)(cid:20) PERCENT EVEN IF THE CAPITAL STOCK DECLINED AS SHARPLY AS ACTUALLY OCCURRED(cid:12) COMPARED TO (cid:19)(cid:20) PERCENT IN THE MODEL IN WHICH THE PRICE DECLINE WAS UNANTICIPATED(cid:14)(cid:17)(cid:20) 4O THE EXTENT THAT PERFECT FORESIGHT ABOUT DE(cid:226)ATION WOULD HAVE TRULY AMELIORATED THE DATA(cid:218)S FALL IN THE CAPITAL STOCK(cid:12) THE OUTPUT DECLINE IMPLIED BY THE PERFECT FORESIGHT SIMULATIONS WOULD BE SOMEWHAT SMALLER(cid:14) 7E INTERPRET THE EXISTING EMPIRICAL EVIDENCE AS OdERING SUPPORT FOR THE HYPOTHESIS THAT AT LEAST A SUBSTANTIAL COMPONENT OF THE PRICE DECLINE DURING THE $EPRESSION WAS UNANTICI(cid:13) PATED(cid:14) )N PARTICULAR(cid:12) THE MAGNITUDE OF THE PRICE DECLINE WAS UNPRECEDENTED IN THE PEACETIME (cid:17)(cid:19)4O SIMULATE THE EVOLUTION OF X FROM A POINT IN TIME(cid:12) INITIAL VALUES OF THE PAST CONTRACT WAGES AND T FUTURE PATHS OF THE PRICE LEVEL AND CAPITAL STOCK ARE REQUIRED(cid:14) 7HEN WE SAY THAT THE PRICE DECLINE WAS FULLY ANTICIPATED AS OF (cid:17)(cid:25)(cid:18)(cid:25)(cid:26)(cid:19)(cid:12) WE ASSUME THAT(cid:26) (cid:8)(cid:17)(cid:9) THE INITIAL (cid:17)(cid:25)(cid:18)(cid:24)(cid:26)(cid:20)(cid:13)(cid:17)(cid:25)(cid:18)(cid:25)(cid:26)(cid:19) CONTRACT WAGES FX T (cid:27)X T‘(cid:17) (cid:27)X T‘(cid:18) (cid:27)X T‘(cid:19) G EQUAL THEIR STEADY STATE VALUES(cid:27) AND (cid:8)(cid:18)(cid:9) ANY IN(cid:231)NITE(cid:13)SUMS OF DISCOUNTED CURRENT AND FUTURE PRICE LEVELS AND CAPITALSTOCKSAREWELL(cid:13)APPROXIMATEDBYTHEIR(cid:231)VE(cid:13)YEAR(cid:231)NITEDISCOUNTEDSUMSOFFUTUREVALUES(cid:14) /NTHISLATTER ASSUMPTION(cid:12) OUR CALCULATIONS WERE QUALITATIVELY ROBUST TO TRUNCATING THE RELEVANT IN(cid:231)NITE SUMS AT THREE OR FOUR(cid:13)YEAR HORIZONS(cid:14) (cid:17)(cid:20)4HESE SIMULATIONS ARE CONDUCTED USING THE SAME WAGE ADJUSTMENT PARAMETER(cid:12) o (cid:29)‘(cid:16)(cid:26)(cid:17)(cid:14) (cid:19)(cid:18)

HISTORY OF THE 5NITED 3TATES(cid:12) AND IT FOLLOWED AN EIGHT YEAR PERIOD OF PRICE STABILITY (cid:8)&RIEDMAN AND 3CHWARTZ(cid:12) (cid:17)(cid:25)(cid:22)(cid:19)(cid:9)(cid:14) 4HIS SUGGESTS THAT A LARGE FRACTION OF THE DECLINE WAS UNANTICIPATED(cid:14) (AMILTON (cid:8)(cid:17)(cid:25)(cid:25)(cid:18)(cid:9) PROVIDES MORE FORMAL EVIDENCE THAT A LARGE COMPONENT OF THE DE(cid:226)ATION WAS UNANTICIPATED(cid:12) ESPECIALLY IN THE (cid:231)RST TWO YEARS OF THE DOWNTURN(cid:14) (AMILTON EXAMINES THE TIME SERIES BEHAVIOR OF COMMODITY FUTURES PRICES AND CONCLUDES THAT THE MARKET BELIEVED THAT PRICES WOULD REMAIN STABLE OR RISE DURING MOST OF THE $EPRESSION(cid:218)S DOWNTURN(cid:14)(cid:17)(cid:21) /F COURSE(cid:12) THE SPECI(cid:231)C IMPLICATION OF OUR MODEL THAT THE PRICE DECLINE WAS COMPLETELY UNANTICIPATED IS SUBJECT TO DEBATE (cid:8)SEE #ECCHETTI(cid:12) (cid:17)(cid:25)(cid:25)(cid:18)(cid:9)(cid:14) 3TILL(cid:12) THE IMPORTANT CONCLUSION TO BE DRAWN IS THAT THE REAL EdECTS OF THE PRICE DECLINE PREDICTED BY OUR MODEL DEPEND DIRECTLY ON THE EX(cid:13) TENT TO WHICH THE PRICE DECLINE WAS UNANTICIPATED(cid:14) 4HUS(cid:12) IF THE PRICE DECLINE WAS LARGELY UNANTICIPATED(cid:12) THE REAL EdECTS WOULD BE LARGE AND CLOSE TO THOSE SHOWN IN OUR SIMULATIONS(cid:14) (OWEVER(cid:12) IF THE PRICE DECLINE WERE LARGELY FORESEEN(cid:12) THE STICKY WAGE MODEL WOULD HAVE MUCH MORE DIbCULTY EXPLAINING THE MAGNITUDE OF THE DOWNTURN WITHOUT REFERENCE TO OTHER FACTORS(cid:14) ! SECOND IMPORTANT FACTOR IS THAT WAGE ADJUSTMENT IN THE MODEL MUST BE SUbCIENTLY SLUGGISH FOR MONETARY POLICY TO HAVE HIGHLY PERSISTENT EdECTS(cid:14) 4HIS IS EVIDENT FROM OUR COMPARISON OF THE &ISCHER AND 4AYLOR CONTRACT SPECI(cid:231)CATIONS ABOVE(cid:14) )N PARTICULAR(cid:12) IN ORDER TO ACCOUNT WELL FOR THE DEPTH OF THE DOWNTURN(cid:12) MONETARY SHOCKS MUST HAVE REAL EdECTS THAT ARE SOMEWHAT LONGER THAN THE ONE YEAR PERIOD IMPLIED BY OUR SPECI(cid:231)CATION OF THE &ISCHER CONTRACT MODEL(cid:14) 4HIS HOLDS DESPITE THE FACT THAT THE MODEL BASICALLY ALLOWS CONTRACTIONARY MONETARY SHOCKS TO EXERT MAXIMAL EdECTS ON OUTPUT FOR A GIVEN LEVEL OF WAGE SLUGGISHNESS (cid:17)(cid:21)!LSO SEE %VANS AND 7ACHTEL (cid:8)(cid:17)(cid:25)(cid:25)(cid:19)(cid:9) ON THIS POINT(cid:14) (cid:19)(cid:19)

(cid:8)AN IMPLICATION THAT THE PRICE LEVEL DECLINE WAS UNEXPECTED(cid:9)(cid:14) (OWEVER(cid:12) THE FACT THAT OUR PARAMETERIZATION OF WAGE ADJUSTMENT (cid:231)TS THE BEHAVIOR OF BOTH REAL AND NOMINAL WAGES QUITE WELL PROVIDES SUPPORT FOR OUR SPECI(cid:231)CATION(cid:14) (cid:21)(cid:14)(cid:18)(cid:14) (cid:17)(cid:25)(cid:18)(cid:16)(cid:13)(cid:18)(cid:17)(cid:26) A PUZZLING INTERPRETATION 7HILE THE UNANTICIPATED CHARACTER OF THE PRICE DECLINE AND SLUGGISH WAGE ADJUSTMENT APPEAR IMPORTANT IN ACCOUNTING FOR THE SEVERITY OF THE $EPRESSION(cid:12) THESE SAME FACTORS DO NOT APPEAR TO EXPLAIN WHY THE OUTPUT DECLINE DURING THE (cid:17)(cid:25)(cid:18)(cid:16)(cid:13)(cid:18)(cid:17) RECESSION WAS MUCH LESS SEVERE THAN DURING THE ’REAT $EPRESSION(cid:14) !FTER ALL(cid:12) PRICES DECLINED BY ROUGHLY THE SAME CUMULATIVE MAGNITUDE DURING THESE TWO EPISODES(cid:14) &IGURES (cid:18)(cid:18) AND (cid:18)(cid:19) COMPARE THE PRICE DECLINE THAT OCCURRED DURING THE (cid:17)(cid:25)(cid:18)(cid:16)(cid:13)(cid:18)(cid:17) PERIOD WITH THE DECLINE THAT OCCURRED DURING THE ’REAT $EPRESSION(cid:14) 4HE PRICE LEVEL IN THESE (cid:231)GURES IS REPRESENTED AS A PERCENTAGE DEVIATION FROM ITS (cid:17)(cid:25)(cid:17)(cid:25)(cid:26)(cid:17) AND (cid:17)(cid:25)(cid:18)(cid:25)(cid:26)(cid:19) LEVEL(cid:12) RESPECTIVELY(cid:14) 4HE MOST STRIKING FEATURE OF THE (cid:231)GURE IS THAT THE PRICE DECLINE DURING THE (cid:17)(cid:25)(cid:18)(cid:16)(cid:13)(cid:18)(cid:17) RECESSION WAS INITIALLY MUCH SHARPER THAN WHAT OCCURRED DURING THE EARLY DOWNTURN PHASE OF THE ’REAT $EPRESSION(cid:14) )N PARTICULAR(cid:12) THE PRICE LEVEL FELL (cid:18)(cid:20) PERCENT BETWEEN (cid:17)(cid:25)(cid:18)(cid:16)(cid:26)(cid:18) (cid:8)WHEN THE PRICE LEVEL REACHED AN INTERWAR PEAK(cid:9) AND (cid:17)(cid:25)(cid:18)(cid:17)(cid:26)(cid:18)(cid:14) "ETWEEN (cid:17)(cid:25)(cid:18)(cid:25)(cid:26)(cid:19) AND (cid:17)(cid:25)(cid:19)(cid:17)(cid:26)(cid:18) THE PRICE LEVEL FELL BY ONLY (cid:17)(cid:18) PERCENT(cid:14) &RIEDMAN AND 3CHWARTZ (cid:8)(cid:17)(cid:25)(cid:22)(cid:19)(cid:9) NOTE THAT THE PRICE DECLINE IN (cid:17)(cid:25)(cid:18)(cid:16)(cid:13)(cid:18)(cid:17) WAS THE STEEPEST PRICE DECLINE EXPERIENCED IN THE 5NITED 3TATES SINCE AT LEAST THE EARLY AFTERMATH OF THE #IVIL 7AR(cid:12) AND PERHAPS WAS THE LARGEST THAT EVER OCCURRED IN THE 5NITED 3TATES(cid:14) &IGURE (cid:18)(cid:18) INDICATES THAT OUTPUT CONTRACTED SHARPLY BEGINNING IN (cid:17)(cid:25)(cid:18)(cid:16)(cid:26)(cid:17)(cid:12) AND FELL BY (cid:17)(cid:23) (cid:19)(cid:20)

PERCENT OVER THE SUBSEQUENT YEAR (cid:213) SLIGHTLY LARGER THAN THE (cid:17)(cid:20) PERCENT DECLINE THAT OCCURRED DURING THE (cid:231)RST YEAR OF THE $EPRESSION (cid:8)(cid:231)GURE (cid:18)(cid:19)(cid:9)(cid:14) (OWEVER(cid:12) THE SUBSEQUENT BEHAVIOR OF OUTPUT SHOWS A MAJOR DIdERENCE BETWEEN THE TWO PERIODS(cid:14) /UTPUT REBOUNDED STRONGLY FROM ITS CYCLICAL TROUGH IN THE (cid:17)(cid:25)(cid:18)(cid:16)(cid:13)(cid:18)(cid:17) DOWNTURN BEGINNING IN (cid:17)(cid:25)(cid:18)(cid:17)(cid:26)(cid:18)(cid:12) REACHING ITS PRE(cid:13)RECESSION LEVEL BY MID(cid:13)(cid:17)(cid:25)(cid:18)(cid:19)(cid:12) IN STRONG CONTRAST TO THE PERSISTENT OUTPUT DECLINES THAT OCCURRED IN (cid:17)(cid:25)(cid:19)(cid:17)(cid:13)(cid:19)(cid:19)(cid:14) )F THE PRICE LEVEL DECLINE THAT OCCURRED IN (cid:17)(cid:25)(cid:18)(cid:16)(cid:13)(cid:18)(cid:17) WAS IN FACT LARGELY UNANTICIPATED(cid:12) AND WAGES ADJUSTED AS SLUGGISHLY AS IN OUR PARAMETERIZATION OF THE ’REAT $EPRESSION PERIOD(cid:12) THEN THE PRICE DECLINE OF (cid:17)(cid:25)(cid:18)(cid:16)(cid:13)(cid:18)(cid:17) (cid:213) BASED ON OUR EARLIER RESULTS (cid:213) SHOULD HAVE GENERATED A MASSIVE AND PERSISTENT DEPRESSION(cid:14) 4HIS INTUITION IS CON(cid:231)RMED IN &IGURE (cid:18)(cid:20)(cid:12) WHICH INDICATES THAT OUTPUT SHOULD HAVE CONTRACTED BY ALMOST (cid:21)(cid:16) PERCENT IN LOGARITHMIC TERMS (cid:8)OR BY ALMOST ONE(cid:13)THIRD FROM ITS LEVEL IN (cid:17)(cid:25)(cid:18)(cid:16)(cid:26)(cid:18)(cid:9)(cid:14) 4HE SIMULATION IN &IGURE (cid:18)(cid:20) IS DERIVED USING ESSENTIALLY THE SAME PARAMETERIZATION OF THE 4AYLOR CONTRACTS MODEL THAT WE CONSIDERED FOR THE (cid:17)(cid:25)(cid:18)(cid:25)(cid:13)(cid:19)(cid:22) PERIOD(cid:14) 4HE ONLY DIdERENCE IN SPECI(cid:231)CATION IS OUR INCLUSION OF BOTH MONEY SUPPLY AND MONEY DEMAND SHOCKS(cid:12) AND THESE SHOCKS WERE COMPUTED TO (cid:231)T THE OBSERVED BEHAVIOR OF MONEY AND THE PRICE LEVEL(cid:14)(cid:17)(cid:22) (cid:17)(cid:22)4HIS IS THE SAME PROCEDURE THAT UNDERLIES THE ANALYSIS RELATING TO &IGURE (cid:17)(cid:19)(cid:14) 7E ADD MONEY DEMAND INNOVATIONS BECAUSE THIS PERIOD WAS CHARACTERIZED BY A STRONG RISE IN MONEY VELOCITY(cid:12) I(cid:14)E(cid:14)(cid:12) THE OBSERVED -(cid:17) CONTRACTIONOFAROUND(cid:17)(cid:18)PERCENTOVERTHEPERIOD(cid:17)(cid:25)(cid:18)(cid:16)(cid:26)(cid:17)(cid:13)(cid:17)(cid:25)(cid:18)(cid:17)(cid:26)(cid:17)WASFARTOOSMALLTOACCOUNTFORTHE(cid:18)(cid:21)PERCENT PRICE DECLINE THAT OCCURRED OVER THIS PERIOD(cid:14) 4HE CONSTRUCTION OF THIS SIMULATION CONFORMS TO THE OBJECTIVE OF ASSESSING HOW THE PRICE DECLINE WOULD HAVE AdECTED REAL ACTIVITY IF IT HAD IN FACT BEEN UNANTICIPATED(cid:14) (cid:19)(cid:21)

(cid:21)(cid:14)(cid:19)(cid:14) #ONTRASTING (cid:17)(cid:25)(cid:18)(cid:16)(cid:13)(cid:18)(cid:17) WITH (cid:17)(cid:25)(cid:18)(cid:25)(cid:13)(cid:19)(cid:19) 4HERE IS EVIDENCE THAT THERE WERE CONSIDERABLE DIdERENCES BETWEEN THE TWO PERIODS(cid:26) IN THE EXTENT TO WHICH THE PRICE DECLINES WERE ANTICIPATED(cid:12) AND IN THE SENSITIVITY OF NOMINAL WAGES TO THE DOWNTURN IN ACTIVITY(cid:14) 4HESE FACTORS MAY HAVE PLAYED A LARGE ROLE IN ACCOUNTING FOR PRONOUNCED DIdERENCES IN THE BEHAVIOR OF REAL ACTIVITY(cid:14) &IRST(cid:12) IT SEEMS LIKELY THAT THE DISIN(cid:226)ATION EXPERIENCED IN (cid:17)(cid:25)(cid:18)(cid:16)(cid:13)(cid:18)(cid:17) HAD A MUCH LARGER ANTICIPATED COMPONENT(cid:14) 0REVIOUS MAJOR WARS(cid:12) INCLUDING THE 7AR OF (cid:17)(cid:24)(cid:17)(cid:18) AND THE #IVIL 7AR(cid:12) WERE FOLLOWED BY LARGE DE(cid:226)ATIONS(cid:14) 4HE MONETARY AUTHORITIES WERE COMMITTED TO A RETURN TO GOLD CONVERTIBILITY AT THE ORIGINAL PARITY FOLLOWING WARTIME SUSPENSIONS OF GOLD CONVERTIBILITY (cid:8)"ORDO AND +YDLAND (cid:17)(cid:25)(cid:25)(cid:21)(cid:9)(cid:14) 7ORLD 7AR ) SET THE STAGE FOR A SIMILAR EXPERIENCE DURING THIS PERIOD(cid:27) THE 5(cid:14)3(cid:14) PRICE LEVEL MORE THAN DOUBLED BETWEEN (cid:17)(cid:25)(cid:17)(cid:20) AND EARLY (cid:17)(cid:25)(cid:18)(cid:16)(cid:14) )T WAS CLEAR TO CONTEMPORARIES OF THE PERIOD THAT A LARGE DE(cid:226)ATION WAS REQUIRED TO RESTORE THE REAL PRICE OF GOLD TO ITS PREWAR LEVEL AT THE ORIGINAL PARITY(cid:14) )T ALSO SEEMS THAT MOST OBSERVERS WOULD HAVE EXPECTED (cid:8)CORRECTLY(cid:9) THAT THE 5NITED 3TATES HAD A STRONG COMMITMENT TO RESTORING THE PREWAR RELATIONSHIP BETWEEN PRICES AND THE PRICE OF GOLD(cid:14) !S NOTED BY &RIEDMAN AND 3CHWARTZ (cid:8)(cid:17)(cid:25)(cid:22)(cid:19)(cid:9)(cid:12) THE (cid:226)EXIBLE EXCHANGE RATES THAT PREVAILED DURING THE EARLY INTERWAR PERIOD (cid:221)WERE REGARDED AS A TRANSITORY EXPEDIENT PENDING A RETURN TO GOLD(cid:12) AND MONETARY AUTHORITIES EVERYWHERE SOUGHT TO FACILITATE A RETURN TO (cid:231)XED PARITIES(cid:14) (cid:8)P(cid:14) (cid:18)(cid:19)(cid:22)(cid:9)(cid:222) !CCORDINGLY(cid:12) THE MAJOR SOURCE OF UNCERTAINTY ABOUT THE DE(cid:226)ATION IN THE PERIOD IMMEDIATELY PRECEDING THE MONETARY TIGHTENING PROBABLY REGARDED ITS TIMING(cid:14) /NCE THE &EDERAL 2ESERVE RAISED THE DISCOUNT RATE BY (cid:18)(cid:16)(cid:16) BASIS POINTS BETWEEN .OVEMBER (cid:17)(cid:25)(cid:17)(cid:25) AND &EBRUARY (cid:17)(cid:25)(cid:18)(cid:16)(cid:12) THERE COULD HAVE BEEN LITTLE (cid:19)(cid:22)

DOUBT ABOUT THE &EDERAL 2ESERVE(cid:218)S COMMITMENT TO DE(cid:226)ATE(cid:12) OR THAT A LARGE DISIN(cid:226)ATION WOULD ENSUE(cid:14)(cid:17)(cid:23) ! SECOND CONSIDERATION THAT MAY ACCOUNT FOR THE LESS PERSISTENT REAL EdECTS OF THE PRICE DECLINEINTHE(cid:17)(cid:25)(cid:18)(cid:16)(cid:13)(cid:18)(cid:17)RECESSIONCOMPAREDTOTHE’REAT$EPRESSIONPERIODISTHATWAGESETTING APPEARS TO HAVE BEEN MUCH MORE RESPONSIVE TO THE DOWNTURN IN ECONOMIC CONDITIONS DURING THE EARLIER PERIOD(cid:14) %CONOMISTS WRITING DURING THE DEPRESSION PERIOD NOTED THE PRONOUNCED DIdERENCES IN WAGE ADJUSTMENT ACROSS THE TWO EPISODES(cid:12) A SUBJECT EXAMINED MORE RECENTLY IN WORK BY /(cid:218)"RIEN (cid:8)(cid:17)(cid:25)(cid:24)(cid:25)(cid:9)(cid:14) /(cid:218)"RIEN (cid:8)(cid:17)(cid:25)(cid:24)(cid:25)(cid:9) NOT ONLY PROVIDES STRONG EVIDENCE THAT WAGES BECAME LESS RESPONSIVE TO AGGREGATE DEMAND BETWEEN THE (cid:17)(cid:25)(cid:18)(cid:16)(cid:13)(cid:18)(cid:17) RECESSION AND THE LATE (cid:17)(cid:25)(cid:18)(cid:16)S(cid:12) BUT THAT THE CHANGE WAS RECOGNIZED BY CONTEMPORARIES OF THE PERIOD AND RE(cid:226)ECTED A CONSCIOUS CHANGE IN WAGE(cid:13)SETTING PRACTICES AT THE (cid:231)RM LEVEL DESIGNED TO MOLLIFY THE ADVERSE EdECTS OF WAGE DECLINES ON HOUSEHOLD PURCHASING POWER(cid:14) /(cid:218)"RIEN OBSERVES THAT THE VIEW BECAME WIDELY HELD DURING THE INTERWAR PERIOD THAT RAPID WAGE ADJUSTMENT DURING THE (cid:17)(cid:25)(cid:18)(cid:16)(cid:13) (cid:18)(cid:17) RECESSION CONTRIBUTED MARKEDLY TO THE RECESSION(cid:218)S SEVERITY(cid:14) (E ARGUES THAT THIS PHILOSOPHY ENCOURAGED COLLUSIVE BEHAVIOR ON THE PART OF MAJOR EMPLOYERS TO NOT CUT NOMINAL WAGES FOR A SIGNI(cid:231)CANT TIME PERIOD AFTER THE ONSET OF THE $EPRESSION(cid:14) /(cid:218)"RIEN NOTES THAT CERTAIN MAJOR EMPLOYERS(cid:12) SUCH AS ’ENERAL -OTORS AND )NTERNATIONAL (ARVESTER(cid:12) LEFT NOMINAL WAGE RATES UNCHANGED UNTIL THE FALL OF (cid:17)(cid:25)(cid:19)(cid:17)(cid:12) TWO YEARS INTO THE DOWNTURN(cid:14) &INALLY(cid:12) THE CONTEXT OF THE TWO PERIODS SUGGESTS A CHANGE IN WAGE SETTING BEHAVIOR(cid:14) 4HE EXTREME PRICE (cid:226)UCTUATIONS DURING THE (cid:17)(cid:25)(cid:18)(cid:16)(cid:13)(cid:18)(cid:17) PERIOD WOULD HAVE ENCOURAGED(cid:12) OR PERHAPS FORCED(cid:12) GREAT WAGE (cid:226)EXIBILITY(cid:14) (cid:17)(cid:23)4HE &EBRUARY(cid:17)(cid:25)(cid:18)(cid:16) INCREASEINTHEDISCOUNTRATEWASTHE(cid:221)SHARPEST SINGLE RISEINTHEENTIREHISTORYOF THE 3YSTEM(cid:14)(cid:222) &RIEDMAN AND 3CHWARTZ (cid:17)(cid:25)(cid:22)(cid:19)(cid:12) P(cid:14) (cid:18)(cid:19)(cid:16)(cid:14) (cid:19)(cid:23)

4HE ’REAT $EPRESSION(cid:12) HOWEVER(cid:12) FOLLOWED ALMOST A DECADE OF PRICE STABILITY(cid:14) (cid:21)(cid:14)(cid:20)(cid:14) (cid:17)(cid:25)(cid:18)(cid:16)(cid:13)(cid:18)(cid:17) REVISITED &IGURES (cid:18)(cid:21)AND (cid:18)(cid:22)ASSESS WHETHERALTERNATIVE ASSUMPTIONS ABOUT PRICE EXPECTATIONS ANDWAGE ADJUSTMENT DURING THE (cid:17)(cid:25)(cid:18)(cid:16)(cid:13)(cid:18)(cid:17) PERIOD MAY HELP ACCOUNT FOR THE MUCH SMALLER OUTPUT DECLINE THAT OCCURRED(cid:14) &IGURE (cid:18)(cid:21) PERFORMS A SIMULATION OF THE MODEL UNDER THE ASSUMPTION THAT THE PRICE DECLINE BECAME FULLY ANTICIPATED AS OF (cid:17)(cid:25)(cid:18)(cid:16)(cid:26)(cid:18)(cid:12) THAT IS(cid:12) THE QUARTER AFTER THE PRICE LEVEL PEAKED(cid:12) AND SHORTLY AFTER THE MONETARY TIGHTENING BEGAN(cid:14) !S IN THE CORRESPONDING PERFECT FORESIGHT SIMULATION RUN OVER THE $EPRESSION PERIOD IN &IGURE (cid:18)(cid:17)(cid:12) THE (cid:231)GURE IS BASED ON SIMULATING THE 4AYLOR WAGE SETTING COMPONENT OF THE MODEL ONLY(cid:12) TAKING THE CAPITAL STOCK(cid:218)S ACTUAL PATH AS KNOWN(cid:14) 4HE (cid:231)GURE INDICATES THAT IF THE PRICE DECLINE BECAME FULLY ANTICIPATED BY THE TIME PRICES ACTUALLY BEGAN TO FALL(cid:12) THE OUTPUT EdECTS WOULD HAVE ONLY BEEN ABOUT HALF AS LARGE AS IMPLIED BY THE SIMULATION IN (cid:231)GURE (cid:18)(cid:20) (cid:213) THOUGH STILL SOMEWHAT LARGER THAN WHAT ACTUALLY TOOK PLACE(cid:14) &IGURE (cid:18)(cid:22) REPEATS THE SIMULATION IN (cid:231)GURE (cid:18)(cid:21)(cid:12) EXCEPT THAT WAGE ADJUSTMENT IS ASSUMED TO OCCUR CONSIDERABLY MORE RAPIDLY THAN IN THE PARAMETERIZATION OF THE (cid:17)(cid:25)(cid:18)(cid:25)(cid:13)(cid:19)(cid:22) PERIOD(cid:14) )N PARTICULAR(cid:12) WE SET o (cid:28) ‘(cid:15)(cid:25)(cid:20)(cid:12) IMPLYING THAT THE EdECT OF PRICE LEVEL INNOVATIONS ON OUTPUT HAVE A HALF(cid:13)LIFE OF ABOUT HALF AS LONG AS IN OUR (cid:17)(cid:25)(cid:18)(cid:25)(cid:13)(cid:19)(cid:22) PARAMETERIZATION(cid:14) 4HE (cid:231)GURE IMPLIES THAT OUTPUT WOULD HAVE ONLY DECLINED BY ABOUT (cid:17)(cid:22)(cid:13)(cid:17)(cid:23) PERCENT (cid:8)GIVEN THE PRICE LEVEL DECLINE THAT ACTUALLY OCCURRED(cid:9)(cid:12) REASONABLY CLOSE TO THE MAGNITUDE OBSERVED(cid:14) 4HESE SIMULATIONS MAKE IT MORE APPARENT WHY A QUANTITATIVE GENERAL EQUILIBRIUM MODEL (cid:19)(cid:24)

IS USEFUL FOR EVALUATING THE STICKY WAGE HYPOTHESIS(cid:14) /UR RESULTS SUGGEST THAT IT IS NOT ENOUGH TO ARGUE THAT THE MASSIVE PRICE DECLINE THAT OCCURRED DURING THE ’REAT $EPRESSION PERIOD CAUSED THE DECLINE VIA A STICKY WAGE CHANNEL(cid:14) 2ATHER(cid:12) OUR RESULTS SUGGEST THAT THE UNANTICI(cid:13) PATED CHARACTER OF THE PRICE DECLINE PROBABLY PLAYED AN IMPORTANT ROLE IN EXPLAINING WHY THE DOWNTURN WAS SO LARGE(cid:14) &URTHERMORE(cid:12) IT IS EVIDENT THAT WHILE THIS HYPOTHESIS IS APPEALING INSOFAR AS IT CAN MATCH THE DOWNTURN IN MAJOR MACROAGGREGATES AND THE BEHAVIOR OF REAL WAGES(cid:12) IT DOES REQUIRE THAT MONETARY SHOCKS HAVE HIGHLY PERSISTENT OUTPUT EdECTS(cid:14) .EVERTHE(cid:13) LESS(cid:12) THIS DEGREE OF PERSISTENCE IS CONSISTENT WITH THE ENDOGENOUS BEHAVIOR OF WAGES DURING THE PERIOD(cid:14) &INALLY(cid:12) A COMPARISON WITH THE (cid:17)(cid:25)(cid:18)(cid:16)(cid:13)(cid:18)(cid:17) RECESSION FURTHER HIGHLIGHTS THE (cid:17)(cid:25)(cid:18)(cid:25)(cid:13)(cid:19)(cid:22) PERIOD AS AN OUTLIER EXPERIENCE(cid:26) A SIMILAR(cid:13)SIZED PRICE DECLINE HAD MUCH SMALLER OUTPUT EdECTS DURING THE EARLIER DOWNTURN(cid:12) PROBABLY BECAUSE A MUCH LARGER FRACTION OF THE PRICE DECLINE WAS ANTICIPATED IN (cid:17)(cid:25)(cid:18)(cid:16)(cid:13)(cid:18)(cid:17)(cid:14) (cid:22)(cid:14) #ONCLUSIONS /UR PAPER HAS FOCUSED ON THE ABILITY OF A PARTICULAR HYPOTHESIS ABOUT HOW MONETARY SHOCKS AdECTREALACTIVITY(cid:213)NAMELY(cid:12) THROUGHASTICKYWAGECHANNEL(cid:213)TOEXPLAINTHEMAGNITUDEAND PERSISTENCEOFTHE$EPRESSIONINTHE5NITED3TATES(cid:14) /URRESULTSSUGGEST THAT MONEYOPERATING THROUGH A STICKY WAGE CHANNEL PLAYED A QUANTITATIVELY SIGNI(cid:231)CANT ROLE IN ACCOUNTING FOR THE BEHAVIOR OF MAJOR MACROAGGREGATES OVER THE DOWNTURN PHASE OF THE $EPRESSION(cid:14) 4HE VERSION OF THE MODEL WITH 4AYLOR CONTRACTS IS SURPRISINGLY SUCCESSFUL IN ACCOUNTING FOR THE BEHAVIOR OF OUTPUT(cid:12) CONSUMPTION(cid:12) HOURS WORKED AND INVESTMENT(cid:14) )N ADDITION(cid:12) THE MECHANISM THROUGH (cid:19)(cid:25)

WHICH THE STICKY WAGE MODEL PREDICTS THAT A MONETARY DECLINE WOULD AdECT THESE VARIABLES SEEMS CONSISTENT WITH THE DATA(cid:14) 4HIS IS ESPECIALLY RE(cid:226)ECTED IN THE MODEL(cid:218)S ABILITY TO ACCOUNT FOR THE BEHAVIOR OF REAL WAGES OVER THE DOWNTURN(cid:14) 7HILE IT IS OF COURSE LIKELY THAT OTHER FACTORS DISCUSSED IN THE INTRODUCTION PLAYED A ROLE IN THE DOWNTURN(cid:12) THE QUANTITATIVE SUCCESS OF THE SIMPLE MODEL WE CONSIDER IS INTRIGUING(cid:14) -OREOVER(cid:12) THE STICKY WAGE MODEL(cid:218)S ABILITY TO ACCOUNT FOR THE RISE IN REAL WAGES(cid:12) IN ADDITION TO THEBEHAVIOROFTHEOTHERMACROAGGREGATES(cid:12)MAYPROVIDEANIMPORTANTBASISFORDISCRIMINATING BETWEEN ALTERNATIVE HYPOTHESES ABOUT THE CAUSES OF THE DOWNTURN(cid:14) 4HIS IS BECAUSE IT IS NOT APPARENT THAT OTHER HYPOTHESES WOULD YIELD PREDICTIONS CONSISTENT WITH OBSERVED REAL WAGE BEHAVIOR(cid:12) EVEN IF THEY COULD PROVIDE A SATISFACTORY ACCOUNT OF THE OTHER MACROAGGREGATES(cid:14) /UR MODEL SIMULATIONS AND SENSITIVITY ANALYSIS SUGGEST THAT BOTH THE ABSOLUTE SEVERITY OF THE ’REAT $EPRESSION(cid:218)S DOWNTURN AND ITS RELATIVE SEVERITY COMPARED TO THE (cid:17)(cid:25)(cid:18)(cid:16)(cid:13)(cid:18)(cid:17) RECESSION WERE IN LARGE PART ATTRIBUTABLE TO THE PRICE DECLINE HAVING A MUCH LARGER UNANTICIPATED COM(cid:13) PONENT DURING THE $EPRESSION(cid:12) AND ALSO TO MUCH LESS (cid:226)EXIBLE WAGE(cid:13)SETTING PRACTICES(cid:14) 4HESE RESULTS SEEM TO BE AN IMPORTANT RE(cid:231)NEMENT TO THE STICKY WAGE EXPLANATION FOR THE DOWNTURN(cid:14) 4HE (cid:231)NDINGS ARE IN LINE WITH BOTH (AMILTON(cid:218)S (cid:8)(cid:17)(cid:25)(cid:25)(cid:18)(cid:9) RESULTS THAT SHOW A SUBSTANTIAL COMPO(cid:13) NENT OF THE PRICE DECLINE TO BE UNANTICIPATED(cid:12) AND WITH /(cid:218)"RIEN(cid:218)S (cid:8)(cid:17)(cid:25)(cid:24)(cid:25)(cid:9) WORK THAT INDICATES WAGE(cid:13)SETTING BECAME MUCH LESS (cid:226)EXIBLE DURING THE COURSE OF THE (cid:17)(cid:25)(cid:18)(cid:16)S(cid:14) 7ITHIN THE CONTEXT OF OUR STICKY WAGE MODEL(cid:12) HOWEVER(cid:12) OUR RESULTS CAST SERIOUS DOUBTS ON EXPLANATIONS OF THE RECOVERY PHASE OF THE $EPRESSION WHICH RELY CRITICALLY ON THE SUBSTANTIAL REMONETIZATION THAT BEGAN IN (cid:17)(cid:25)(cid:19)(cid:19)(cid:14) 4HE MOST SERIOUS EVIDENCE AGAINST THIS EXPLANATION IS (cid:20)(cid:16)

ITS COUNTERFACTUAL PREDICTION THAT REMONETIZATION SHOULD HAVE REDUCED REAL WAGES(cid:12) STIMULATED LABOR DEMAND(cid:12) AND ALLOWED OUTPUT TO RECOVER(cid:14) "Y CONTRAST(cid:12) THE DATA INDICATE THAT REAL WAGES ROSE SUBSTANTIALLY BEGINNING IN MID(cid:13)(cid:17)(cid:25)(cid:19)(cid:19)(cid:12) AS NOMINAL WAGES ROSE EVEN MORE RAPIDLY THAN PRICES(cid:12) AND THAT HOURS WORKED RECOVERED MUCH MORE SLOWLY THAN OUTPUT(cid:14) 7HILE THERE IS SOME INDUSTRY AND AGGREGATE EVIDENCE THAT POSITIVE SUPPLY SHOCKS PLAYED A ROLE IN ALLOWING THE ECONOMY TO GRADUALLY RECOVER DESPITE SOME LARGE EXOGENOUS INCREASES IN REAL WAGES DUE TO LEGISLATIVE PROGRAMS(cid:12) PROVIDING A CONVINCING ACCOUNT OF THE FACTORS MOST RESPONSIBLE FOR THE RECOVERY CONTINUES TO BE AN IMPORTANT TOPIC FOR FURTHER RESEARCH(cid:14) (cid:20)(cid:17)

(cid:23)(cid:14) 2EFERENCES (cid:17)(cid:14) "ALKE(cid:12) .ATHAN 3(cid:14) AND 2OBERT *(cid:14) ’ORDON(cid:14) !PPENDIX "(cid:12) (ISTORICAL $ATA(cid:12) IN 2OBERT *(cid:14) ’ORDON(cid:12) ED(cid:14)(cid:12) 4HE !MERICAN "USINESS #YCLE(cid:26) #ONTINUITY AND #HANGE(cid:14) #HICAGO(cid:26) 5NIVERSITY OF #HICAGO 0RESS(cid:26) (cid:23)(cid:24)(cid:17)(cid:13)(cid:24)(cid:21)(cid:16) (cid:8)(cid:17)(cid:25)(cid:24)(cid:22)(cid:9)(cid:14) (cid:18)(cid:14) "ENEY(cid:12) -(cid:14) !DA(cid:14) 7AGES(cid:12) (OURS(cid:12) AND %MPLOYMENT IN THE 5NITED 3TATES (cid:17)(cid:25)(cid:17)(cid:20)(cid:13)(cid:19)(cid:22)(cid:14) .EW 9ORK(cid:26) .ATIONAL )NDUSTRIAL #ONFERENCE "OARD(cid:12) )NC(cid:14)(cid:12) (cid:17)(cid:25)(cid:19)(cid:22)(cid:14) (cid:19)(cid:14) "ERNANKE(cid:12) "EN(cid:14) (cid:221).ONMONETARY EdECTS OF THE &INANCIAL #RISIS IN THE 0ROPAGATION OF THE ’REAT $EPRESSION(cid:14)(cid:222) !MERICAN %CONOMIC 2EVIEW (cid:23)(cid:19) (cid:8)*UNE (cid:17)(cid:25)(cid:24)(cid:19)(cid:9)(cid:12) (cid:18)(cid:21)(cid:23)(cid:13)(cid:23)(cid:22)(cid:14) (cid:20)(cid:14) "ERNANKE(cid:12) "EN(cid:14) (cid:221)4HE -ACROECONOMICS OF THE ’REAT $EPRESSION(cid:26) ! #OMPARATIVE !P(cid:13) PROACH(cid:14)(cid:222) *OURNAL OF -ONEY(cid:12) #REDIT AND "ANKING (cid:18)(cid:23)(cid:26) (cid:17)(cid:13)(cid:18)(cid:24) (cid:8)(cid:17)(cid:25)(cid:25)(cid:21)(cid:9)(cid:14) (cid:21)(cid:14) "ERNANKE(cid:12) "EN (cid:12) AND +EVIN #AREY(cid:14) (cid:221).OMINAL 7AGE 3TICKINESS AND !GGREGATE SUPPLY IN THE ’REAT $EPRESSION(cid:14)(cid:222) 1UARTERLY *OURNAL OF %CONOMICS (cid:17)(cid:17)(cid:17)(cid:26) (cid:24)(cid:21)(cid:19)(cid:13)(cid:24)(cid:24)(cid:20) (cid:8)(cid:17)(cid:25)(cid:25)(cid:22)(cid:9)(cid:14) (cid:22)(cid:14) "LANCHARD(cid:12) /LIVIER*(cid:14)(cid:12) AND#HARLES +AHN(cid:12) (cid:221)4HE3OLUTIONOF ,INEAR$IdERENCE %QUATIONS 5NDER 2ATIONAL %XPECTATIONS(cid:12)(cid:222) %CONOMETRICA (cid:20)(cid:24)(cid:26) (cid:17)(cid:19)(cid:16)(cid:21)(cid:13)(cid:17)(cid:19)(cid:17)(cid:19) (cid:8)(cid:17)(cid:25)(cid:24)(cid:16)(cid:9)(cid:14) (cid:23)(cid:14) "ORDO(cid:12) -ICHAEL $(cid:14) (cid:221)4HE #ONTRIBUTION OF (cid:217)! -ONETARY (ISTORY OF THE 5NITED 3TATES(cid:12) (cid:17)(cid:24)(cid:22)(cid:23)(cid:13)(cid:17)(cid:25)(cid:22)(cid:16)(cid:218) TO -ONETARY (ISTORY(cid:12)(cid:222) IN -ONEY(cid:12) (ISTORY(cid:12) AND )NTERNATIONAL &INANCE(cid:26) %S(cid:13) SAYS IN (ONOR OF !NNA *(cid:14) 3CHWARTZ(cid:14) %DITED BY -(cid:14)$(cid:14) "ORDO(cid:12) #HICAGO(cid:26) 5NIVERSITY OF #HICAGO 0RESS(cid:12) (cid:17)(cid:25)(cid:24)(cid:25)(cid:12) (cid:17)(cid:21)(cid:13)(cid:23)(cid:16)(cid:14) (cid:20)(cid:18)

(cid:24)(cid:14) "ORDO(cid:12) -ICHAEL $(cid:14) AND &INN +YDLAND(cid:14) (cid:221)4HE ’OLD 3TANDARD AS A 2ULE(cid:26) !N %SSAY IN %XPLORATION(cid:14)(cid:222) %XPLORATIONS IN %CONOMIC (ISTORY (cid:19)(cid:18)(cid:26) (cid:20)(cid:18)(cid:19)(cid:13)(cid:20)(cid:22)(cid:20) (cid:8)(cid:17)(cid:25)(cid:25)(cid:21)(cid:9)(cid:14) (cid:25)(cid:14) "ORDO(cid:12) -ICHAEL $(cid:14)(cid:12) %HSAN #HOUDHRI AND !NNA *(cid:14) 3CHWARTZ(cid:14) (cid:221)#OULD 3TABLE -ONEY (AVE !VERTED THE ’REAT $EPRESSION(cid:14)(cid:222) %CONOMIC )NQUIRY(cid:12) (cid:19)(cid:19)(cid:26) (cid:20)(cid:24)(cid:20)(cid:13)(cid:21)(cid:16)(cid:21) (cid:8)(cid:17)(cid:25)(cid:25)(cid:21)(cid:9)(cid:14) (cid:17)(cid:16)(cid:14) "RESNAHAN(cid:12) 4IMOTHY &(cid:14) AND $ANIEL -(cid:14)’(cid:14) 2Ad(cid:14) (cid:221))NTERINDUSTRY (ETEROGENEITY AND THE ’REAT $EPRESSION(cid:26) 4HE !MERICAN -OTOR 6EHICLE )NDUSTRY(cid:12) (cid:17)(cid:25)(cid:18)(cid:25)(cid:13)(cid:19)(cid:21)(cid:14)(cid:222) *OURNAL OF %CO(cid:13) NOMIC (ISTORY (cid:23)(cid:26) (cid:22)(cid:17)(cid:13)(cid:24)(cid:21) (cid:8)(cid:17)(cid:25)(cid:25)(cid:19)(cid:9)(cid:14) (cid:17)(cid:17)(cid:14) #ALOMIRIS(cid:12) #HARLES(cid:14) (cid:221)&INANCIAL &ACTORS IN THE ’REAT $EPRESSION(cid:14)(cid:222) *OURNAL OF %CONOMIC 0ERSPECTIVES (cid:23) (cid:8)3PRING (cid:17)(cid:25)(cid:25)(cid:19)(cid:9)(cid:12) (cid:22)(cid:17)(cid:13)(cid:24)(cid:21)(cid:14) (cid:17)(cid:18)(cid:14) #ECCHETTI(cid:12) 3TEPHEN ’(cid:14) (cid:221)0RICES AND THE ’REAT $EPRESSION(cid:26) 7AS THE $E(cid:226)ATION OF (cid:17)(cid:25)(cid:19)(cid:16)(cid:13)(cid:19)(cid:18) 2EALLY 5NANTICIPATED(cid:31)(cid:222) !MERICAN %CONOMIC 2EVIEW (cid:24)(cid:18)(cid:26) (cid:17)(cid:20)(cid:17)(cid:13)(cid:17)(cid:21)(cid:22) (cid:8)(cid:17)(cid:25)(cid:25)(cid:18)(cid:9)(cid:14) (cid:17)(cid:19)(cid:14) #ECCHETTI(cid:12) 3TEPHEN ’(cid:14) AND ’EORGIOS +ARRAS(cid:14) (cid:221)3OURCES OF /UTPUT &LUCTUATIONS DURING THE )NTERWAR 0ERIOD(cid:26) &URTHER %VIDENCE ON #AUSES OF THE ’REAT $EPRESSION(cid:14)(cid:222) 2EVIEW OF %CONOMICS AND 3TATISTICS (cid:23)(cid:22)(cid:26) (cid:24)(cid:16)(cid:13)(cid:17)(cid:16)(cid:18) (cid:8)(cid:17)(cid:25)(cid:25)(cid:20)(cid:9)(cid:14) (cid:17)(cid:20)(cid:14) #HO(cid:12) *ANG(cid:13)/K AND ,OUIS 0HANEUF(cid:14) (cid:221)! "USINESS #YCLE -ODEL WITH .OMINAL 7AGE #ONTRACTSAND’OVERNMENT(cid:14)(cid:222) )NSTITUTEFOR%MPIRICAL-ACROECONOMICS$ISCUSSIONPAPER (cid:3)(cid:24)(cid:16)(cid:12) &EBRUARY (cid:17)(cid:25)(cid:25)(cid:19)(cid:14) (cid:17)(cid:21)(cid:14) #RUCINI(cid:12) -ARIO AND *AMES +AHN(cid:14) (cid:221)4ARIdS AND !GGREGATE %CONOMIC !CTIVITY(cid:26) ,ESSONS FROM THE ’REAT $EPRESSION(cid:14)(cid:222) *OURNAL OF -ONETARY %CONOMICS (cid:19)(cid:24)(cid:26) (cid:20)(cid:18)(cid:23)(cid:13)(cid:20)(cid:22)(cid:23) (cid:8)(cid:17)(cid:25)(cid:25)(cid:22)(cid:9)(cid:14) (cid:20)(cid:19)

(cid:17)(cid:22)(cid:14) %ICHENGREEN(cid:12) "ARRY(cid:14) ’OLDEN &ETTERS(cid:26) 4HE ’OLD 3TANDARD AND THE ’REAT $EPRESSION(cid:12) (cid:17)(cid:25)(cid:18)(cid:25)(cid:13)(cid:17)(cid:25)(cid:19)(cid:25)(cid:14) .EW 9ORK(cid:26) /XFORD 5NIVERSITY 0RESS(cid:12) (cid:17)(cid:25)(cid:25)(cid:18)A(cid:14) (cid:17)(cid:23)(cid:14) %ICHENGREEN(cid:12) "ARRY(cid:14) (cid:221)4HE /RIGINS AND .ATURE OF THE ’REAT 3LUMP 2EVISITED(cid:14)(cid:222) %CO(cid:13) NOMIC (ISTORY 2EVIEW (cid:8)-AY (cid:17)(cid:25)(cid:25)(cid:18)B(cid:9)(cid:12) (cid:18)(cid:17)(cid:19)(cid:13)(cid:19)(cid:25)(cid:14) (cid:17)(cid:24)(cid:14) %ICHENGREEN(cid:12) "ARRY AND *EdREY 3ACHS(cid:14) (cid:221)%XCHANGE 2ATES AND %CONOMIC 2ECOVERY IN THE (cid:17)(cid:25)(cid:19)(cid:16)S(cid:14)(cid:222) *OURNAL OF %CONOMIC (ISTORY (cid:20)(cid:21) (cid:8)(cid:17)(cid:25)(cid:24)(cid:21)(cid:9)(cid:12) (cid:25)(cid:18)(cid:21)(cid:13)(cid:20)(cid:22)(cid:14) (cid:17)(cid:25)(cid:14) %VANS(cid:12) -ARTIN AND 0AUL 7ACHTEL(cid:14) (cid:221)7ERE 0RICE #HANGES $URING THE ’REAT $EPRESSION !NTICIPATED(cid:31) %VIDENCEFROM.OMINAL)NTEREST2ATES(cid:14)(cid:222) *OURNAL OF -ONETARY %CONOMICS (cid:19)(cid:18)(cid:26) (cid:19)(cid:13)(cid:19)(cid:20) (cid:8)(cid:17)(cid:25)(cid:25)(cid:19)(cid:9)(cid:14) (cid:18)(cid:16)(cid:14) &ISCHER(cid:12)3TANLEY(cid:14) (cid:221),ONG(cid:13)TERM#ONTACTS(cid:12)2ATIONAL%XPECTATIONS(cid:12)ANDTHE/PTIMAL-ONEY 3UPPLY 2ULE(cid:14)(cid:222) *OURNAL OF 0OLITICAL %CONOMY (cid:24)(cid:21)(cid:12) (cid:17)(cid:25)(cid:17)(cid:13)(cid:18)(cid:16)(cid:21) (cid:8)(cid:17)(cid:25)(cid:23)(cid:23)(cid:9)(cid:14) (cid:18)(cid:17)(cid:14) &ISHER(cid:12) )RVING(cid:14) (cid:221)4HE $EBT $E(cid:226)ATION 4HEORY OF THE ’REAT $EPRESSION(cid:14)(cid:222) %CONOMETRICA (cid:17)(cid:26) (cid:19)(cid:19)(cid:23)(cid:13)(cid:19)(cid:21)(cid:23) (cid:8)(cid:17)(cid:25)(cid:19)(cid:19)(cid:9)(cid:14) (cid:18)(cid:18)(cid:14) &RIEDMAN(cid:12) -ILTON AND !NNA *(cid:14) 3CHWARTZ(cid:14) ! -ONETARY (ISTORY OF THE 5NITED 3TATES(cid:12) (cid:17)(cid:24)(cid:22)(cid:23)(cid:13)(cid:17)(cid:25)(cid:22)(cid:16)(cid:14) 0RINCETON(cid:26) 0RINCETON 5NIVERSITY 0RESS(cid:12) (cid:17)(cid:25)(cid:22)(cid:19)(cid:14) (cid:18)(cid:19)(cid:14) ’RAY(cid:12) *O !NNA(cid:14) (cid:221)7AGE )NDEXATION(cid:26) ! -ACROECONOMIC !PPROACH(cid:14)(cid:222) *OURNAL OF -ONE(cid:13) TARY %CONOMICS (cid:18)(cid:26) (cid:18)(cid:18)(cid:17)(cid:13)(cid:18)(cid:19)(cid:21) (cid:8)(cid:17)(cid:25)(cid:23)(cid:22)(cid:9)(cid:14) (cid:18)(cid:20)(cid:14) (AMILTON(cid:12) *AMES $(cid:14) (cid:221)7AS THE $E(cid:226)ATION $URING THE ’REAT $EPRESSION !NTICIPATED(cid:31) %VIDENCE FROM THE #OMMODITY &UTURES -ARKET(cid:14)(cid:222) !MERICAN %CONOMIC 2EVIEW (cid:24)(cid:18)(cid:26) (cid:20)(cid:20)

(cid:17)(cid:21)(cid:23)(cid:13)(cid:17)(cid:23)(cid:24) (cid:8)(cid:17)(cid:25)(cid:25)(cid:18)(cid:9)(cid:14) (cid:18)(cid:21)(cid:14) (ANES(cid:12) #HRISTOPHER(cid:14) (cid:221)"ARGAINING 0OWER AND .OMINAL 7AGE 2IGIDITY IN THE $OWNTURN OF (cid:17)(cid:24)(cid:25)(cid:19)(cid:12) (cid:17)(cid:25)(cid:18)(cid:25)(cid:12) AND (cid:17)(cid:25)(cid:24)(cid:17)(cid:14)(cid:222) 5NPUBLISHED MANUSCRIPT(cid:12) 5NIVERSITY OF 0ENNSYLVANIA(cid:12) (cid:17)(cid:25)(cid:25)(cid:21)A(cid:14) (cid:18)(cid:22)(cid:14) (ANES(cid:12) #HRISTOPHER(cid:14) (cid:221)#HANGES IN THE #YCLICAL "EHAVIOR OF 2EAL 7AGES(cid:12) (cid:17)(cid:24)(cid:23)(cid:16)(cid:13)(cid:17)(cid:25)(cid:25)(cid:16)(cid:14)(cid:222) 5NPUBLISHED MANUSCRIPT(cid:12) 5NIVERSITY OF 0ENNSYLVANIA(cid:12) (cid:17)(cid:25)(cid:25)(cid:21)B(cid:14) (cid:18)(cid:23)(cid:14) +ING(cid:12) 2OBERT ’(cid:14) (cid:221)-ONEY AND "USINESS #YCLES(cid:14)(cid:222) 5NPUBLISHED MANUSCRIPT(cid:12) (cid:17)(cid:25)(cid:25)(cid:16)(cid:14) (cid:18)(cid:24)(cid:14) -ELTZER(cid:12) !LLAN ((cid:14) (cid:221)-ONETARY AND /THER %XPLANATIONS OF THE 3TART OF THE ’REAT $E(cid:13) PRESSION(cid:14)(cid:222) *OURNAL OF -ONETARY %CONOMICS (cid:18) (cid:8)(cid:17)(cid:25)(cid:23)(cid:22)(cid:9)(cid:12) (cid:20)(cid:21)(cid:21)(cid:13)(cid:20)(cid:23)(cid:17)(cid:14) (cid:18)(cid:25)(cid:14) -ISHKIN(cid:12) &REDERIC 3(cid:14) (cid:221)4HE (OUSEHOLD "ALANCE 3HEET AND THE ’REAT $EPRESSION(cid:14)(cid:222) *OUR(cid:13) NAL OF %CONOMIC (ISTORY (cid:8)$ECEMBER (cid:17)(cid:25)(cid:23)(cid:24)(cid:9)(cid:12) (cid:25)(cid:17)(cid:24)(cid:13)(cid:19)(cid:23)(cid:14) (cid:19)(cid:16)(cid:14) /(cid:218)"RIEN(cid:12) !NTHONY 0(cid:14) (cid:221)! "EHAVIORAL %XPLANATION FOR .OMINAL 7AGE 2IGIDITY DURING THE ’REAT $EPRESSION(cid:14)(cid:222) 1UARTERLY *OURNAL OF %CONOMICS (cid:17)(cid:16)(cid:20)(cid:26) (cid:23)(cid:17)(cid:25)(cid:13)(cid:23)(cid:19)(cid:22) (cid:8)(cid:17)(cid:25)(cid:24)(cid:25)(cid:9)(cid:14) (cid:19)(cid:17)(cid:14) 2OMER(cid:12) #HRISTINA(cid:14) (cid:221)4HE ’REAT #RASH AND THE /NSET OF THE ’REAT $EPRESSION(cid:14)(cid:222) 1UAR(cid:13) TERLY *OURNAL OF %CONOMICS (cid:8)!UGUST (cid:17)(cid:25)(cid:25)(cid:16)(cid:9)(cid:12) (cid:21)(cid:25)(cid:23)(cid:13)(cid:22)(cid:18)(cid:20)(cid:14) (cid:19)(cid:18)(cid:14) 2OMER(cid:12) #HRISTINA(cid:14) (cid:221)7HAT%NDEDTHE’REAT$EPRESSION(cid:31)(cid:222) *OURNAL OF %CONOMIC (ISTORY (cid:21)(cid:18) (cid:8)(cid:17)(cid:25)(cid:25)(cid:18)(cid:9)(cid:12) (cid:23)(cid:21)(cid:23)(cid:13)(cid:24)(cid:20)(cid:14) (cid:19)(cid:19)(cid:14) 2OMER(cid:12) #HRISTINA(cid:14) (cid:221)4HE .ATION IN $EPRESSION(cid:14)(cid:222) *OURNAL OF %CONOMIC 0ERSPECTIVES (cid:23) (cid:8)3PRING (cid:17)(cid:25)(cid:25)(cid:19)(cid:9)(cid:12) (cid:17)(cid:25)(cid:13)(cid:20)(cid:16)(cid:14) (cid:20)(cid:21)

(cid:19)(cid:20)(cid:14) 4AYLOR(cid:12) *OHN "(cid:14) (cid:221)!GGREGATE $YNAMICS AND 3TAGGERED #ONTRACTS(cid:14)(cid:222) *OURNAL OF 0OLITICAL %CONOMY (cid:24)(cid:24)(cid:26) (cid:17)(cid:13)(cid:18)(cid:19) (cid:8)(cid:17)(cid:25)(cid:24)(cid:16)(cid:9)(cid:14) (cid:19)(cid:21)(cid:14) 4EMIN(cid:12) 0ETER(cid:14) $ID -ONETARY &ORCES #AUSE THE ’REAT $EPRESSION(cid:31) .EW 9ORK(cid:26) 7(cid:14)7(cid:14) .ORTON(cid:12) (cid:17)(cid:25)(cid:23)(cid:22)(cid:14) (cid:19)(cid:22)(cid:14) 4EMIN(cid:12) 0ETER(cid:14) ,ESSONS FROM THE ’REAT $EPRESSION(cid:14) #AMBRIDGE(cid:12) -!(cid:26) -)4 0RESS(cid:12) (cid:17)(cid:25)(cid:24)(cid:25)(cid:14) (cid:19)(cid:23)(cid:14) 5NITED 3TATES $EPARTMENT OF #OMMERCE(cid:12) "UREAU OF %CONOMIC !NALYSIS(cid:14) &IXED 2EPRO(cid:13) DUCIBLE 4ANGIBLE 7EALTH IN THE 5NITED 3TATES(cid:14) (cid:17)(cid:25)(cid:25)(cid:16)(cid:14) (cid:19)(cid:24)(cid:14) 7EINSTEIN(cid:12) -ICHAEL -(cid:14) (cid:221)3OME -ACROECONOMIC )MPACTS OF THE .ATIONAL )NDUSTRIAL 2E(cid:13) COVERY !CT(cid:12) (cid:17)(cid:25)(cid:19)(cid:19)(cid:13)(cid:17)(cid:25)(cid:19)(cid:21)(cid:14)(cid:222) )N +ARL "RUNNER (cid:8)ED(cid:14)(cid:9) 4HE ’REAT $EPRESSION 2EVISITED(cid:14) "OSTON(cid:26) -ARTINUS .IGHOd(cid:26) (cid:18)(cid:22)(cid:18)(cid:13)(cid:18)(cid:24)(cid:17) (cid:8)(cid:17)(cid:25)(cid:24)(cid:17)(cid:9)(cid:14) (cid:20)(cid:22)