Money, Sticky Wages, and the Great Depression

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1 Money, Sticky Wages, and the Great Depression American Economic Review, 2000 Michael D. Bordo 1 Christopher J. Erceg 2 Charles L. Evans 3 1. Rutgers University, Department of Economics 2. Federal Reserve Bank of Washington D.C. 3. Federal Reserve Bank of Chicago Katie Lee and Jake Hochard April 12th, 2012

2 Introduction Motivation Great Depression and sticky wages

3 Introduction Motivation Great Depression and sticky wages Effect of Monetary Policy

4 Introduction Background Banking Crisis

5 Introduction Background Banking Crisis Federal Reserve Credit Supply

6 Introduction Background Banking Crisis Federal Reserve Credit Supply Remonetization

7 Introduction Background Banking Crisis Federal Reserve Credit Supply Remonetization National Industrial Recovery Act (NIRA)

8 Model Model Overview New-Keynesian Model

9 Model Model Overview New-Keynesian Model Money

10 Model Model Overview New-Keynesian Model Money Foundations in Microeconomics

11 Model Model Overview New-Keynesian Model Money Foundations in Microeconomics Three Sectors

12 Model Model Overview New-Keynesian Model Money Foundations in Microeconomics Three Sectors Households maximize utility

13 Model Model Overview New-Keynesian Model Money Foundations in Microeconomics Three Sectors Households maximize utility Firms maximize profit

14 Model Households Maximize Utility ( ) Max U = E 0 β t U C t, Mt C t,m t,b t,k t+1 P t t=0 β Discount Factor C Real Consumption M End-of-period nominal cash balances P Price level

15 Model Households Maximize Utility ( ) Max U = E 0 β t U C t, Mt C t,m t,b t,k t+1 P t Subject to t=0 Income {}}{ B t = B t 1+( R t 1B t 1 + W tl t + J tk t + π t + X t) Expenditures {}}{ (P tc t + P ti t + M t M t 1) K t+1 = (1 δ)k t + I t B Nominal bond holdings R Nominal interest rate L Total hours worked J Nominal rental price of capital π Nominal firm profits X Lump sum cash transfers from government

16 Model Firms Maximize Profit - No adjustment costs K = Capital Max π = K,L E0 t=0 ψ t[p tk θ t L 1 θ t W tl t J tk t] L = Labor W = Wage rate J = Capital rental rate ψ = Stochastic discount factor

17 Model Firms Maximize Profit - Adjustment costs K = Capital Max π = K,L E0 ψ t[p tkt θ t=0 ( L t ql 2 W tl t J tk t] (L t L t 1) 2 L t 1 ) 1 θ L = Labor W = Wage rate J = Capital rental rate ψ = Stochastic discount factor q L = Adjustment costs

18 Model Taylor wage contracts x t = Contract wage ln(x t) = φ 0ln(W t) + γ(l t L) φ 1ln(W t+1) + γ(l t+1 L) +E t +φ 2ln(W t+2) + γ(l t+2 L) +φ 3ln(W t+3) + γ(l t+3 L) W t = Average wage of all cohorts L t = Labor force L t = Natural rate of employment φ = Degree of forward looking behavior γ = Speed of wage adjustments

19 Model Taylor wage contracts x t = Contract wage ln(x t) = φ 0ln(W t) + γ(l t L) φ 1ln(W t+1) + γ(l t+1 L) +E t +φ 2ln(W t+2) + γ(l t+2 L) +φ 3ln(W t+3) + γ(l t+3 L) 4 Cohorts 4 Quarterly adjustments W t = Average wage of all cohorts L t = Labor force L t = Natural rate of employment φ = Degree of forward looking behavior γ = Speed of wage adjustments

20 Model Evolution of money stock Source of monetary supply shocks

21 Model Evolution of money stock Source of monetary supply shocks Exogenous

22 Model Evolution of money stock Source of monetary supply shocks Exogenous Determined by an AR(1), iid N(0, σ 2 g) process

23 Model Evolution of money stock Source of monetary supply shocks Exogenous Determined by an AR(1), iid N(0, σ 2 g) process g t+1 = g 0 + ρg t + ɛ t+1 g t = ln(m t ) ln(m t 1 )

24 Calibration and Estimation Key parameters

25 Calibration and Estimation Key parameters ρ = Monetary shocks Estimated from data

26 Calibration and Estimation Key parameters ρ = Monetary shocks Estimated from data q L = Adjustment costs Chosen (q L = 0.7)

27 Calibration and Estimation Key parameters ρ = Monetary shocks Estimated from data q L = Adjustment costs Chosen (q L = 0.7) γ = Wage contract sensitivity Backed out (chosen to minimize variance between model s simulation and data)

28 IRFs Monetary policy shock Figure: Model prediction with sticky wages

29 Simulation Money Supply and Price Level

30 Simulation Price level and Real wages

31 Simulation Real wages and Labor hours

32 Simulation Labor hours and Output

33 Simulation Output and Consumption

34 Simulation Big Picture

35 Simulation Big Picture

36 Conclusion Big Picture Neo-Keynesian model

37 Conclusion Big Picture Neo-Keynesian model Monetary policy

38 Conclusion Big Picture Neo-Keynesian model Monetary policy Test sticky wages in context of Great Depression

39 Conclusion Big Picture Neo-Keynesian model Monetary policy Test sticky wages in context of Great Depression Performance

40 Conclusion Big Picture Neo-Keynesian model Monetary policy Test sticky wages in context of Great Depression Performance Gold Standard, NIRA

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