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Robert Teitelman

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Stiglitz Explains the Great Depression

Posted: 12/21/11 10:38 AM ET

By now seemingly everyone with access to a blog has contributed to the theory Joseph Stiglitz offers up in, of all places, the new Vanity Fair, about the causes not just of the Great Depression, but analogously, what he calls our own "Long Slump." For those who have been tree trimming or menorah lighting, Stiglitz cites research (apparently unpublished) with Columbia University colleague Bruce Greenwald that lays the blame of the Great Depression on a deficiency of aggregate demand caused by productivity increases in the still-sizable agricultural sector of the '20s and '30s. Accelerating productivity generated overproduction, he says, which drove down prices for farmers, which sent the banking system and the economy into a spiraling slump. He goes on to argue that the New Deal was inadequate to the task of supporting agriculture until structural adjustments could be made; that could occur only with the coming of World War II and the powerful Keynesian stimulus that moved "America, and particularly the South, decisively from agriculture to manufacturing."

Stiglitz goes on to insist that there are strong "parallels" to our current condition. Today manufacturing has been victimized by higher productivity gains. What's required is a similar level of government support, though as Brad DeLong comments in his post on the Stiglitz essay, it's a little hard to discern to what end. What's the next phase? After all, services have also been swept by information-technology-driven productivity gains. And the future, as ever, is uncertain.

All this has created a blogospheric scrum. Starting last week with Arnold Kling (here and with Nick Rowe here), moving to Ryan Avent at The Economist (here and here), to Scott Sumner (here) to DeLong to Matthew Yglesias in Slate (here), a fierce and often technical discussion of economic history and macroeconomic theory has broken out. Most of these bloggers reject Stiglitz's argument, either strongly or weakly, which after all appears in a glossy consumer magazine and that's written in Stiglitz's "public style" for an audience more accustomed to celebrities and scandal than discussions of deficient demand; Lady Gaga graces the cover. (To make matters worse, Stiglitz was recently thrashed in the blogosphere for writing a piece attacking the 1% in a magazine that endlessly celebrates wealth.) Stiglitz has also not wrestled with these tangled issues of economic history in the past, and his thesis runs against the conventional economic wisdom painfully forged over many decades by those who have -- including Federal Reserve Chairman Ben Bernanke. Stiglitz's own description of Bernanke's belief that the Great Depression was simply a matter of monetary errors -- too much monetary tightening -- caricatures the former Princeton professor's position and the general consensus of economic historians.

In characterizing all this as a theory of origins, Stiglitz has clearly struck a nerve in that borderland where macroeconomics and politics jostle. After all, if the Long Slump was kicked off by underlying macroeconomic and technological shifts, then some of the favorite bogeymen of the crisis -- bankers, Wall Streeters, regulators, deregulators, mortgage peddlers, derivatives whizzes -- drop down to a secondary or tertiary causation level. This is odd because less than a year ago Stiglitz himself was urging that many of these folks be tossed summarily into jail; and that even if there were no current laws to put them there, new laws should be written to insure accountability. He doesn't touch on that that issue here.

That said, I'm simply not equipped to wade into the technical debate, though it is fascinating and it does open up yet another window into the contingency and uncertainty of economics and economic history. DeLong, for instance, rises to argue that while he doesn't necessarily agree with Stiglitz, he does think the Nobel Prize winner makes a "coherent" argument -- a virtue other bloggers, like Sumner and Rowe, deny him entirely. (Carleton University's Rowe: "You just can't do macro like that. It all goes wrong from the very beginning.") DeLong himself tries to parse, with a discrete chuckle, the differences that exist by drawing distinctions between economic Wicksellians and Fisherians:

"I think it is because Stiglitz is at bottom a Wicksellian and Rowe is a Fisherian. A Wicksellian is a believer that the key equation in macro is the flow-of-funds equation S = I + (G-T), savings S equals planned investment I plus government borrowing (G-T), and that the money market exists to feed the flow-of-funds an interest rate that has a (limited) influence on planned investment I. A Fisherian is a believer that the key equation in macro is the money market's quantity theory equation PY = MV(i), and that the flow-of-funds exists to feed the quantity theory an interest rate that has a (limited) influence on velocity V.

"Thus they have a hard time communicating. From the Fisherian viewpoint, the Wicksellians are talking nonsense because they spend their time on things that have a minor impact on velocity while ignoring the obvious shortage of money. From the Wicksellian viewpoint, the Fisherians are talking nonsense by ignoring the obvious fact that movements in money induce offsetting effects in velocity unless they somehow alter the savings-investment balance.

"And it is we Hicksians, of course, synthesize both positions into a single unified and coherent whole..."

This is a DeLongian joke that's not really a joke. Economics has more schools and factions than Occupy Wall Street, and they fight like cats in heat. Many of these differences may be matters of style or perspective, but others are deeply fundamental. Consider this: Folks have been arguing over the origin of the Great Depression since about 1930. That debate, and various provisional conclusions, have often determined policy, good and bad. Generations of academic economists have dedicated careers to understanding how the economy suddenly imploded, including our own Fed chief. Various experts have poked into the structure of Wall Street and banking; have examined monetary policy; have blamed reparations in Europe, the Smoot-Hawley Tariff, the gold standard; recently, Republicans have pointed shivering fingers at the New Deal. Stiglitz targets the structural breakdown in agriculture while other gesture toward industrial overreach and overinvestment in the '20s, and still other point toward "financialization." At the risk of wading into a killing zone, I'd suggest that, history being history, the causes were complex, intertwined and multifactorial: some structural break, some policy errors, some scandal, some historical tragedies and, given the global nature of it all, some causes (like reparations but not necessarily agriculture) that were distinctively European -- or uniquely British, French, Italian, German or American. Stiglitz's Great Depression appears to be an isolated American phenomenon.

But think about it. Eighty-some years after the Great Depression, a Nobel Prize-winning economist with a distinguished business school colleague suddenly pops up and offers a coherent, if novel, explanation for a global cataclysm. It's like discovering that Hitler didn't make the decision to invade Poland, but that it was really a unilateral move by the German General Staff. It's possible, I guess, but is it probable? And if it does have explanatory power, what does that say about all the other folks that have looked into this? Are they stupid, deluded, compromised, or simply lacking information? And what does this say about all the arguments about accountability and cause in our current mess? (For a fine commentary that emphasizes the complexity and contingency of our own crisis, see Joe Nocera's column in today's New York Times on the Securities and Exchange Commission's charges against the former chiefs of Fannie Mae and Freddie Mac.)

The problem, of course, is that Stiglitz is writing for an audience that doesn't give a crap for the arguments of squabbling economists but that does care about the politics of the matter, while they're drooling over the ads. Of all the top-tier economists who feel compelled to man the public stage, he writes with perhaps the broadest stroke. He is not offering this theory to try to encourage academics to look into what may be an overlooked area. He is tossing it up, without the usual peer review, because he believes strongly in the need for a major government stimulus program. He may be exactly right about that policy. But in making that argument, Stiglitz is further eroding the authority of a profession that has already been severely bruised and battered. Maybe that's good in the long run, though I suspect Stiglitz never pauses to ponder the unintended consequence.