Money, Sticky Wages, and the Great Depression

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

Introduction Motivation Great Depression and sticky wages

Introduction Motivation Great Depression and sticky wages Effect of Monetary Policy

Introduction Background Banking Crisis

Introduction Background Banking Crisis Federal Reserve Credit Supply

Introduction Background Banking Crisis Federal Reserve Credit Supply Remonetization

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

Model Model Overview New-Keynesian Model

Model Model Overview New-Keynesian Model Money

Model Model Overview New-Keynesian Model Money Foundations in Microeconomics

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

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

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

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

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

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

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

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

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

Model Evolution of money stock Source of monetary supply shocks

Model Evolution of money stock Source of monetary supply shocks Exogenous

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

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 )

Calibration and Estimation Key parameters

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

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

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)

IRFs Monetary policy shock Figure: Model prediction with sticky wages

Simulation Money Supply and Price Level

Simulation Price level and Real wages

Simulation Real wages and Labor hours

Simulation Labor hours and Output

Simulation Output and Consumption

Simulation Big Picture

Simulation Big Picture

Conclusion Big Picture Neo-Keynesian model

Conclusion Big Picture Neo-Keynesian model Monetary policy

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

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

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