I am Shocked, Shocked...

To read yet another disappointing Great Depression paper written by an economist. The Christina Romer paper I wrote about earlier, entitled "The Great Crash and the Onset of the Great Depression" turned out to be no better than the Bernanke paper. The new Chairperson of the Council of Economic Advisers writes that the fall in household wealth from the Great Crash was not large enough to cause the reduction in consumer spending that it did. This, as in many GD papers I've read, starts out with too many vague pronouncements and not enough hard facts. She (as does Temin) goes out of her way not to say how large the decline in the stock market was, or how large the decline in consumption was (in the beginning of her paper at least), and farms the evidence that the stock market crash couldn't explain the contraction in consumption to MIT's Peter Temin, who also goes out of his way not to say how much equities declined.

Now, I love Temin (or at least, usually I love Temin), but his Econometric results (in his 1976 book) indicating that a 100% reduction in wealth would only reduce consumption by 1.65% (or 1.52% for an alternative series) is somewhat less than completely credible. Most likely it is non-linear – in normal times, a 10% increase or decrease in my stock portfolio doesn’t have any effect on my spending (especially b/c I don’t watch the stock market every day); but once there is a crash and I become aware that my stock portfolio is down 55%, I start to cut back, and by much more than just .8%...

The contraction in consumption, it turns out, was just 5% between 1929 and 1930, whereas, in the initial crash, the stock market dropped about 33%. So, if you were trading on margin (and everyone was), then that could equate to a 50% loss in liquid real wealth. And, by the end of 1930, the market had dropped more than 50%... So is a 5% drop in consumption thus really a mystery that needs explaining? No, it is not.

And this woman is Chairperson of the CEA. Scary.