Several explanations for the depth of the Great Depression presume that the -30% deflation
of 1930-32 was unanticipated. For example, the debt-deflation hypothesis originally
put forth by Irving Fisher is based on the notion that unanticipated deflation increases the
burden of nominal debt, adversely affecting the banking system and the aggregate economy.
Other theories imply on ex ante real interest rates being low during the period, and so it is
essential that the deflation was unanticipated.
This paper measures inflationary expectations from data on prices, interest rates and
money growth in order to investigate whether the deflation could have been anticipated.
Current econometric techniques are used to compute expectations implied both by the
univariate time series properties of the price level, and by the information contained in
nominal interest rates. The major conclusion is that price changes were substantially serially
correlated, and so once the deflation began, people expected it to continue. This implies
both that the deflation was anticipated, and that real interest rates were very high during the initial phases of the Great Depression. These results call into question the validity of
theories that rely on contemporary agents' belief in reflation during the early 1930s, and
provide further support for the proposition that monetary contraction was the driving force behind the economic decline.
*Published:
American Economic Review, Vol. 82, No. 1, March 1992, pp. 141-156.
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