Modern Economy1919-1930

US role in World Economy

• The result of US industrial expansion is US is over taking Great Britain as an economic power.

• US is leader in manufacturing in the world by 1913, Britain has fallen to third.

Manufactured goods become a larger percentage of exports and a smaller percentage of imports.

US role in World Economy

• US does not act like a world economic power• Foreign Policy is isolationist

– No interest in being involved in European power struggles – Limited interest in exerting influence in south America and

Caribbean

• Economic Policy is protectionist– Tariffs increase during Civil War– Remain high until 1900– Desire to protect US industry

Changes in US Economy

• US population is becoming more urban.

Changes in US economy

• More goods bought in market than produced at home

• Changes the way goods are sold– Product differentiation – Advertising

• As incomes increase, more spending on manufactured goods, less on food

Significant developments

• Increase in the size and functions of government. Result of populist movement is increase in regulation– Antitrust– Regulation of natural monopolies

• Grain elevators• Railroads, ICC• Electricity and Gas

– FDA

• Federal Reserve system is set up with the hope that the bank will intervene to stop panics– Not clear everyone agrees with this

• Income tax is established in 1913• WWI increases government intervention

WWI

• WWI begins in Europe in 1914– Assassination of Austrian Archduke Ferdinand by a

Serbian revolutionary in Sarajevo. – Russia, France and Britain vs Germany and

Austria-Hungarian empire– United States policy is isolationist

• does not enter war until 1917 in response to German U-boat attacks on merchant shipping

WWI

• Increase government regulation and spending during WWI– Draft– Wage and price controls

• Cost of WWI to US while small compared to cost to nations involved in Europe are still significant to US government.

Financing World War I, 1917–1919

Most the expenditures financed through borrowing.

Financing WWI

• Increase in demand for armaments produced in the United States– Not just for US troops, but also for other allies.– Paid for by loans made from US banks to allied

nations

Consequence of WWI

• At the end of WWI, US is clearly the dominant world power.– European nations on the continent suffer large

casualties and losses of capital.– German and Austria-Hungarian empire are

dismantled into large number of smaller countries– Britain’s Navy and merchant shipping suffers large

losses.

Gold Standard Problems

• Begins in period 1870-1914• Gold Standard functions like a pegged exchange

rate system• For this system to work, countries must let their

money supply change with gold flows– If exports>imports, gold flows in, Ms↑, P ↑– If imports>exports, gold flows out, Ms ↓, P↓

• Britain is dominate country, willing to do this• WWI all countries go off gold standard

WWI ends

• Britain is no longer dominant economy, US is unwilling to be the leader

• Treaty of Versailles – Requires Germany to repay large amount of money

• European countries are indebted to US, to pay loans must export more than they import, means US, Ms ↑, P ↑ but US will not do this

• Problems with the exchange rates when countries go back on the gold standard in 1925

Exchange rate problems

• Old rates do not reflect new reality– British pound is over valued by 10%

• British exports are more expensive, import less• British trade surplus which had been important source of foreign investment

declines

• Can only continue to do this if interest rates in US remain low.

Consequences of WWI

• Even though US is dominate power, both economically and militarily, it still does not act as if it is

• Foreign policy is still isolationist• Trade policy is protectionist• Immigration restrictions

– Consequence of union activity– Starts with restrictions like literacy and financial restrictions and ends

in 1921 with Emergency Immigration Act which restricts the number of people entering to 3% of the people of that nationality residing in US in 1910.

Immigration, 1910–1929

Economic Growth

• Some controversy about growth rate of real GDP during WWI– Christina Romer’s estimates suggest less growth than

official statistics

• Real GDP grows 4.7% per year between 1921-1929, unemployment is 4%– Recession 1920/21

• Almost half the world’s industrial output between 1925 and 1929 was produced in the US

year Real GDP GDP deflator Per capita GDP

1920 $687.7 12.85 $6,460

1921 $671.9 10.95 $6,191

1922 $709.3 10.35 $6,445

1923 $802.6 10.64 $7,170

1924 $827.4 10.51 $7,251

1925 $846.8 10.70 $7,311

1926 $902.1 10.75 $7,684

1927 $910.8 10.49 $7,652

1928 $921.3 10.57 $7,645

1929 $977.0 10.61 $8,016

Was this growth result of macroeconomic policy?

Federal Reserve Policy

• What was it? Not clear that it was to increase economic growth

• Federal Reserve Act 1913 gave Fed control of reserve rates and rediscount rates– rediscount rate is what the Fed will pay to by a

banknote due in the future now– Fed could originally only loan to banks by buying

short term loans

Federal Reserve Policy

• Fed increases the discount rate in 1920• Possible shift in 1924 to idea the Fed should

use open market operations to stimulate economy in rescession

• Not only were its goals unclear, Fed had limited information– No gdp estimates– No unemployment statistics

• Income distribution is more unequal– 1922 top 1% have 13.4 % of income– 1929 top 1 % have 14.5% of income

• Boom in building sectors– Value of new construction goes up from 6.7 billion

in 1920, 12.1 billion in 1925, 10.1 billion in 1929– Evidence of oversupply by mid 20s

• Automobiles and other consumer durables are booming, table shows percent of families with durables over time

Electric lights

Inside plumbing

Washing machines

Car

1900 3 15 <1 <1

1910 15 <1 1

1920 35 20 8 26

1930 68 51 24 60

Automobile Industry

• In 1899 56 cars were produced, by 1920 more than 25 % of US families own a car.

• Increase in ownership caused by decrease in price– Henry Ford’s use of assembly line– Price of a Ford car fell 80% from 1909-1929

Consumer Credit

• Along with increase in consumer durables, there was an increase in consumer credit

• Consumers could purchase an item by paying a down payment and making payments over time.

• These loans were secured (unlike general store credit) but still risky.

Goods Families Purchased on installment (1918–1919)

Labor Market Changes

Increase in education levels. Not clear to what extent this is a cause of economic growth or a consequence.

Continued difference between the South and the rest of the country.

Farm sector is depressed

• Farm price increased during WWI, then fell• Between 1920-1929, farm income dropped by

21%• Increase in costs, interest rates, taxes

– Taxes per acre increased 40%

• Farm output as a % of GDP went from 18% to 12.4%

Financial Sector

• Stock prices increased throughout this period

1920 100

1921 105

1922 129

1923 125

1924 150

1925 183

1926 188

1927 240

1928 320

1929 276

1930 192

• President Hoover and members of Federal Reserve felt stock price increase was a bubble

• Common to buy stocks on margin– Banks are loaning money to investors based on

assumption that prices will go up

• Fed sent letter on February 2, 1929 to Federal Reserve banks. :

The board has no disposition to assume authority to interfere with the loan practices of member banks so long as they do not involve the Federal reserve banks. It has, however, a grave responsibility whenever there is evidence that member banks are maintaining speculative security loans with the aid of Federal reserve credit. When such is the case the Federal reserve bank becomes either a contributing or a sustaining factor in the current volume of speculative security credit. This is not in harmony with the intent of the Federal Reserve Act, nor is it conducive to the wholesome operation of the banking and credit system of the country. (Board of Governors of the Federal Reserve 1929: 93–94, quoted from Cecchetti, 1998)

Fed Actions

• Attempts to stop speculation– Raises discount rate from 3 to 5 percent– Sells large quantity of securities

• This is a deflationary policy.• Rising interest rates make it difficult for

European countries who need to borrow.