The Great Depression in Canada Financial Crisis Thesis Statement

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Thesis Statement: Even though the great depression was the longest and most horrible financial crisis in Canadian history, it still can be predicted and minimized for losses.

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1.Cover page ( name, A number, profs name, subject, etc./)

2.Introduction: State the thesis again and briefly introduce about the great depression.( about 1 page)

3.Body paragraph 1: Why is it significant in the Canadian history: Show some economic results and Impacts.( unemployment, impact, facts, about 1.5 pages)

4.Body paragraph 2: What are some major causes and consequences for the great depression: Political, Social, Economic and Sheep-Flock effect. (about 2 pages)

5.Body paragraph 3: Summaries factors and trends foreshadowed the crisis and why people are not paying attention to them.(about 2 pages)

6.Conclusion (about 1 page)

7.Bibliography

Be 8 pages in length (double spaced, size 12 font, regular margins)

Include footnotes and a bibliography to cite all works (ideas and direct quotations)

Include an introduction, a clear thesis statement, and a conclusion

Draw on and cite at least five secondary sources including at least 3 scholarly books and 1 peer reviewed academic journal article.

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Review of Economic Dynamics 5, 45–72 (2002) doi:10.1006/redy.2001.0141, available online at http://www.idealibrary.com on The Great Depression in Canada and the United States: A Neoclassical Perspective1 Pedro S. Amaral Department of Economics, University of Minnesota, Minneapolis, Minnesota 55455 E-mail: pamaral@econ.umn.edu and James C. MacGee Department of Economics, University of Minnesota, Minneapolis, Minnesota 55455; and Research Department, Federal Reserve Bank of Minneapolis, Minneapolis, Minnesota 55480 E-mail: macgee@econ.umn.edu Received August 15, 2001 Canada suffered a major depression from 1929 to 1939. In terms of output it was similar to the Great Depression in the United States. However, total factor productivity (TFP) in Canada did not recover relative to trend, while in the United States TFP had recovered by 1937. We find that the neoclassical growth model, with TFP treated as exogenous, can account for over half of the decline in output relative to trend in Canada. In contrast, we find that conventional explanations for the Great Depression—monetary shocks, terms of trade shocks, and labor market and competition policies—do not work for Canada. Journal of Economic Literature Classification Numbers: E30, N12, N42.  2002 Elsevier Science Key Words: Great Depression; Canada; productivity; terms of trade; deflation. 1 We are especially grateful to Tim Kehoe, Ed Prescott, Lee Ohanian, and Hal Cole for their comments and suggestions. Comments by Ben Bridgman, Ron Leung, Igor Livshits, and Manuel Santos as well as seminar participants at the SED 2001 meeting in Stockholm and the Macro Workshop at the University of Minnesota are also much appreciated. Amaral acknowledges financial support from Fundação para a Ciência e Tecnologia. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System. 45 1094-2025/02 $35.00  2002 Elsevier Science All rights reserved. 46 amaral and macgee 1. INTRODUCTION Canada suffered a major depression from 1929 to 1939. In terms of output, it was similar in both timing and magnitude to the Great Depression in the United States. This has led some to conclude that the two episodes were essentially identical and share a common explanation (Betts et al., 1996; Siklos, 2000). The declines in output, productivity, and employment were very similar. However, the recoveries, though very similar in terms of output, were different in two important respects. In Canada, productivity did not return to trend as it did in the United States, while employment recovered more. The recovery in U.S. productivity led Cole and Ohanian (1999) to conclude that the slow recovery of output per adult in the United States was a puzzle. Cole and Ohanian (2000b) argue that cartelization and labor market policies can resolve this puzzle. However, in Canada there is no puzzle because productivity did not return to trend. We found that Canada did not follow the policies that Cole and Ohanian argue gave rise to the incomplete recovery in the United States. Our conclusion is that the main reason that Canadian output per adult was still 30% below trend in 1938 was that productivity failed to return to trend. Trade accounted for roughly half of Canadian output. A conventional view is that Canada imported the Great Depression via a collapse in its terms of trade. We find that this terms of trade shock has a negligible effect on output in standard models. A voluminous body of research has developed on the role of deflation in the Great Depression. We consider four standard transmission mechanisms that operate through either the credit market or the labor market. We find that these stories fail to account for the 10-year Canadian depression. These stories are not consistent with the 1920–1922 deflation, which was similar in magnitude to the 1929–1933 deflation. Also, these stories are inconsistent with the slow recovery. Given our findings we conclude that any successful theory of the Canadian 10-year depression should explain why productivity was so far below trend for so long. Any explanation should also be consistent with the fact that productivity recovered in the United States. 2. DATA ON THE GREAT DEPRESSION IN CANADA AND THE UNITED STATES This section presents some macroeconomic data on the Canadian and U.S. economies during the Great Depression. We establish two main points in this section. First, Canada experienced a decline in output between 1929 great depression in canada 47 and 1939 that was large and quantitatively very similar to that of the United States.2 Second, in contrast to the United States, Canadian total factor productivity (TFP) was well below trend throughout 1929–1939. We use the neoclassical growth model to organize the data. As a result, we look at per adult variables. Unless otherwise stated, all data are divided by the number of people older than 14 for Canada and older than 16 for the United States. We detrend all variables that grow at the same rate as output in a balanced growth path at a 2% yearly rate. This trend rate is close to the long-term average growth rate for both the United States and Canada. In detrending, we have taken the view that the growth in production efficiency due to increases in the stock of usable knowledge is smooth. Other things being equal, this gives rise to a yearly growth rate of GDP per adult of 2%.3 Real Data As we can see from Table I, the behavior of real output in the two countries was very similar. By 1933 both countries were roughly 40% below trend. The recovery was very protracted in both countries, with the United States recovering slightly faster than Canada. By the end of the decade, U.S. output was still 25% below trend while Canada’s was almost 30% below trend. Relative to trend, consumption fell more in Canada and remained below that of the United States throughout the 1930s. Investment in Canada fell to 15% of its trend value by 1933 and recovered very slowly in both countries (remaining roughly 50% below trend in 1939). Government purchases in the two countries followed a similar pattern during the downturn, before diverging in the late 1930s when U.S. government spending remained above trend, while in Canada it fluctuated about trend. Having looked at the product side, we now turn to the input side. We first calculate TFP, the part of output growth that cannot be attributed to input growth. We do this using the production function, Yt = At Ktθ Ht1−θ  (1) Henceforth, capital letters denote aggregate variables, while lowercase letters denote household variables. Y is aggregate output, K is aggregate capital, H are aggregate hours, and A is the TFP factor. 1939 Given values for Yt  Kt  Ht 1939 t=1929 and θ we can compute At t=1929 . The parameter θ is the share of product that accrues to factor payments 2 We look at 1929–1939; however, Canadian GDP per adult peaks in 1928. Average per capita GDP growth in Canada over the twentieth century is actually slightly higher than that in the United States. 3 48 amaral and macgee TABLE I Detrended Levels of Real Output and Its Components: 1929–1939 Year Can. GNP U.S. GNP Can. cons. U.S. cons. Can. inv. U.S. inv. 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 100 91.6 77.0 66.5 59.6 64.5 67.1 67.5 71.8 69.7 72.4 100 87.7 79.7 65.9 62.0 65.3 71.5 76.4 80.0 73.2 76.1 100 92.6 81.9 73.4 66.9 67.7 67.9 67.1 68.8 66.2 65.7 100 89.7 83.8 74.2 70.4 70.5 71.9 76.2 76.5 72.7 73.8 100 85 50.5 24.8 15.2 28.5 32.9 28.2 44 42.8 52 100 69.2 46.1 22.2 21.8 27.9 41.7 52.6 59.5 38.6 49 Year Can. govt. U.S. govt. Can. exp. U.S. exp. Can. imp. U.S. imp. 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 100 104.8 104.6 97 81 101 101.1 94.6 98.1 108.9 102.8 100 105.1 105.3 97.2 91.5 100.8 99.8 113.5 105.8 111.5 112.3 100 77 58.7 51.8 51.9 60.7 65.2 75.9 79.2 64.9 67.4 100 85.2 70.5 54.4 52.7 52.7 53.6 55 64.1 62.5 61.4 100 81.6 58.6 49 44.1 48 49.3 53.4 59.6 50.9 52.3 100 84.9 72.4 58 60.7 58.1 69.1 71.7 78 58.3 61.3 Note. Cons. is consumption, inv. is investment, govt. is government purchases, exp. is exports, and imp. is imports. The Canadian data are from Historical Statistics of Canada, Series F1-13. The U.S. data for GNP are from Kendrick (1961), and those for the different components are from Cole and Ohanian (1999). to capital. From both countries’ national accounts we get θCAN = 03 and θUS = 033. Table II presents the computed series.4 Notice that TFP in the United States (TFP U.S.) recovers much faster than TFP in Canada (TFP Can), and it is back to trend by the end of the decade. This pattern is the same for output per hour. Two questions emerge right away: Why did TFP fall so much in both countries, and why did it not recover in Canada? We return to these questions later in the paper. 4 Note that TFP is not detrended at a rate of 2% but at a rate equal to 1021−θ for each country, a trend that is close to the historical averages (excluding war periods). great depression in canada 49 TABLE II Detrended Inputs Year 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 TFP Can. 100 99.49 92.04 90.25 85.29 85.43 87.95 87.79 88.69 89.33 93.60 TFP U.S. 100 93.27 91.15 83.34 80.35 86.91 93.89 96.38 99.63 97.33 100.1 K Can. 100 96.93 92.43 86.68 80.95 76.21 72.38 68.87 66.2 63.85 62.04 K U.S. 100 98.55 96.16 92.23 87.27 82.64 79.26 76.61 74.97 73.11 71.05 H Can. 100 91.70 83.32 72.70 69.18 77.42 79.52 82.43 88.66 86.36 86.19 H U.S. 100 91.92 83.57 73.41 72.62 71.73 74.72 80.63 83.03 76.25 78.68 Note. Canadian capital data are from Brown (1965, p. 199, Series 5). The U.S. capital data are from Kendrick (1961, Table A-XV). The U.S. hours data are from Kendrick (1961, Table A-X). Canadian hours data are Series C-51 from Urquhart (1965) multiplied by average hours worked in non-agriculture, Series D-409. We used GDP from the National Income and Expenditure Accounts (1988). U.S. GDP is from Kendrick (1961). U.S. population is from U.S. Bureau of the Census (1965). We are aware that what is presented in Table II is not TFP, but measured TFP. There are a number of reasons why measured TFP may differ from the actual TFP. One major issue is factor mismeasurement. In terms of capital, there is the issue of capacity utilization. In terms of labor, there is evidence that the reduction in employment was much more severe for unskilled than for skilled workers. We used Ohanian’s (2001) estimates for the United States for the magnitude of these factors and recomputed TFP. We found that these two factors roughly cancel each other, so that measured TFP is almost unchanged. Another measurement question relates to what Bernanke and Parkinson (1991), among others, term labor hoarding. However, 10 years seems to be too long a period for this argument to make sense. Finally, there is the issue of sectoral compositional effects. We could only compute TFP for manufacturing. Manufacturing TFP is similar to aggregate TFP. The measured TFP is completely determined by the path of the inputs. So we now look at the inputs. Table II reports the capital stock for both countries (K Can and K U.S.). The most important feature regarding the capital stock is that it declines by more in Canada than it does in the United States. This result is not due to higher depreciation and is in contrast to the investment figures in Table I. Thus, there are problems with the capital stock data. Do they affect the qualitative results in terms of the measured TFP? We think they do not. If anything, Canada’s capital stock declined by less than the value reported in Table II. This suggests that adjusting for possible measurement errors 50 amaral and macgee in the capital stock would imply that TFP in Canada was even lower than reported. Table II also compares total hours worked for the two countries (H Can and H U.S.). Total hours are the product of the number of people employed and average hours worked. The series for Canada was computed using average hours for the nonagricultural sector, since a series for the whole economy (or for agriculture) was not available. This is likely to lead us to overestimate the fall in labor input in Canada, as agricultural hours in the United States (and most probably in Canada) fell by less than nonagricultural hours. The main difference in measured TFP lies in the employment data. During the recovery period, total hours in Canada recovered more than did total hours in the United States. The question about the lack of recovery of TFP in Canada relative to the United States can now be posed as: Why did total hours recover faster in Canada than in the United States? We now compare the private nonagricultural sectors in the two countries. This is an interesting disaggregation for several reasons. First, aggregate employment and output figures were influenced by different government policies toward public works and relief spending.5 Second, agriculture was hit by identifiable weather shocks in both countries. Also, the agricultural sector is a relatively small6 fraction of GDP. As Table I documents, U.S. government output increased more relative to trend than Canadian government output. A large part of the difference in government expenditure can be attributed to different government policies toward providing unemployment relief. In the United States, the government relied much more heavily upon make-work projects (government relief projects) than in Canada. The fraction of the workforce employed by the government doubled in the United States, while increasing by less than 50% in Canada. The increase in U.S. government employment was mainly due to public works, as nearly 7% of U.S. employment in the late 1930s was in relief projects. Relief workers were never more than 1.5% of the total number of employed people in Canada. (See Amaral and MacGee, 2001, for more details.) Table III reports TFP for the private nonagricultural sector. The calculation method and the shares used were the same as those for aggregate TFP. We also use the same series for capital as before. We assume that the private nonagricultural sector benefits from the services of government-owned capital. Total hours in Canada equal the product of employment in the 5 Government enterprises are included in the private sector. Agricultural GDP as a fraction of total GDP averaged 6.2% in the United States and 10.4% in Canada from 1929 to 1939. 6 great depression in canada 51 TABLE III Detrended Private Nonagricultural TFP Year 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 Can. 100 99.32 92.43 92.36 88.34 85.23 87.03 88.6 88.3 88.75 93.52 U.S. 100 93.56 88.72 82.17 79.79 87.75 90 97.43 94.59 94.26 96.49 private nonagricultural sector and average hours in nonagriculture. Total hours for the United States are from Kendrick (1961). In Canada, TFP in this sector is very similar to aggregate TFP. U.S. TFP in this sector behaved differently from aggregate TFP during the recovery period, since it stopped recovering in 1936, while aggregate TFP recovered continuously and was back to trend by 1937. This, we claim, is a major difference between the Canadian and U.S. experiences in the Great Depression. The comparison of the private nonagricultural sectors reinforces our earlier conclusion that the two countries look very similar during the downturn (1929–1933). However, this sectoral breakdown provides new insights into the recovery period. It suggests that in the United States, something happened around 1936 that induced a decrease in productivity. In Canada, the data reinforce the aggregate data—namely, that productivity did not recover relative to trend during the Great Depression. Nominal Data Given that much research on the Great Depression has focused on the role of monetary shocks, we present data on nominal variables that are central to monetary business cycle theory. As Tables IV and V show, the onset of the Great Depression coincided with a decline in money supply and price levels of approximately 20% in both Canada and the United States. This deflation was accompanied by a decline in nominal interest rates, although real ex post rates were high by historical standards. A cross-country comparison of interest rates is limited by the fact that a market in short-term government securities in Canada did not exist before 1934. The available data suggest that nominal interest rate spreads increased from 1930 to 1932, before narrowing. Short-term interest rates on government bonds did not fall as quickly as U.S. short-term rates did. This increase in the interest rate spread from 1930 to 1932 appears to be linked to differences in monetary policy. Canada was the first country to leave the gold standard, suspending gold shipments in January 1929 (Bordo and Redish, 1990). Despite the suspension of convertibility, the Canadian government took steps to prevent depreciation of the dollar, motivated in part by a wish to maintain access 52 amaral and macgee TABLE IV Nominal Money, Prices, and Interest Rates in 1929–1939 in Canada Year Monetary base 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 100 88.48 79.34 78.06 77.50 78.10 85.85 93.04 101.96 108.09 116.59 Price level M1 100 89.65 83.16 72.44 70.95 73.19 80.00 84.62 93.63 92.77 99.08 100 97.52 91.46 82.92 81.54 82.64 82.92 85.67 87.88 87.88 87.05 3-month T-bill Short-term dom. bonds Comm. paper — — — — — 2.83 1.249 0.753 0.763 0.676 0.808 5.34 4.87 4.43 5.08 4.15 2.91 2.29 1.61 1.93 — — 5.31 5.28 5.64 6.6 6.49 5.27 4.76 4.12 3.95 — — Note. The monetary data are from Metcalfe et al. (1996), and the GNE deflator (price level) is from Historical Statistics of Canada. The 3-month T-bill rate is from Historical Statistics of Canada (H588–603). The short-term Dominion bonds and the corporate paper rate are from Nixon (1937). to U.S. capital markets to refinance Dominion debt (Shearer and Clark, 1984). As a result, the government maintained the advance rate at its 1928 level throughout 1930, despite the fall in world rates. This policy was ultimately abandoned in 1931. Despite this, the Canadian dollar did depreciate relative to the U.S. dollar by approximately 15% between 1929 and 1931, before recovering to its 1929 level in 1935. TABLE V Nominal Money, Prices, and Interest Rates in 1929–1939 in the United States Year Monetary base 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 100 95.9 98.7 104.3 108.9 119.8 139.2 157.2 168.5 181.5 215.5 M1 Price level 100 94.4 85.6 74.5 69.9 78.0 91.0 102.1 102.9 102.2 113.7 100 97.0 88.1 78.4 76.7 83.2 84.8 85.2 89.4 87.2 86.6 Note. Data are from Cole and Ohanian (1999, Table 8). 3-month T-bill Comm. paper 4.4 2.2 1.2 0.8 0.3 0.3 0.2 0.1 0.5 0.1 0.0 6.1 4.3 2.6 2.7 1.7 2.0 0.8 0.8 0.9 0.8 0.8 great depression in canada 53 We suspect that the data reported dramatically overstate the difference in commercial paper rates in the late 1930s. Neufeld (1972) presents the commercial paper rate reported by Moody’s for Canada and the United States. His data suggest that while the spread between Canadian and U.S. corporate paper widened from 1930 to 1932; it then dramatically narrowed and remained under 1% from 1934 to 1939. The data suggest that while monetary shocks may help explain the 1929– 1933 downturn, it is unlikely that they played a significant role in the protracted recovery from 1934 to 1939. In both countries, the deflation ended by 1933 and both nominal and real interest rates remained low by historical standards. Summary We view the different behavior of TFP (together with the behavior of the labor input discussed below) as the main difference in the two countries’ experiences during the recovery period. Both Canadian and U.S. TFP fell roughly 20% relative to trend from 1929 to 1933, but unlike the U.S. TFP, Canadian TFP was not back to trend by the end of the decade. This contrasts with the similarities in per capita GNP. In both countries it fell 40% relative to trend from 1929 to 1933, and its recovery was very protracted. Finally, both prices and money aggregates fell considerably from 1929 to 1933 but had recovered by the end of the decade. In the remainder of the paper, we use theory and data to assess different explanations of the Great Depression in Canada. 3. HOW IMPORTANT WERE TFP SHOCKS? In this section, we ask how much of the Great Depression can be explained by measured TFP. In undertaking this experiment, we take measured productivity as exogenous and feed this series into the standard stochastic growth model. We conclude that the decline in measured TFP in Canada can account for over half of the decline and does a very good job of accounting for the protracted recovery. The TFP story can also account for 70% of the decline in U.S. per adult output, but cannot account for the slow recovery. Model The production function is Eq. (1). To complete the description of technology, the law of motion of capital is Kt+1 = 1 − δKt + Xt  (2) 54 amaral and macgee TABLE VI Calibration Parameters θ β χ δ γ η ψ σ Canada 0.3 0.96 1.7 0.05 0.02 0.02 0.9 0.017 U.S. 0.33 0.96 1.66 0.05 0.02 0.01 0.9 0.017 where δ is the depreciation rate and X is investment. The process for the stochastic technological shock is At+1 = 1 − ψ + ψAt + εt+1  (3) where the stochastic components are independently and identically distributed with mean zero and variance σ 2 . Preferences are defined over consumption and leisure and are represented by E0 ∞  t=0   βt 1 + ηt logct  + χ log1 − ht   (4) where h is time devoted to market activities and η is the population growth rate. We calibrate the model economy by choosing parameters in such a way that the balanced growth path of the model economy matches certain steady state features of the measured economies (see Cooley and Prescott, 1995). All parameter values are reported in Table VI. The depreciation rate is set to match an investment-to-capital ratio of 0.09 for Canada and 0.08 for the United States. β is chosen to match a capital–output ratio of 2.6 in Canada and 2.8 in the United States. We choose χ to match the fact that households dedicate one-third of their time to market activities. γ is the growth rate of real per capita output, which we take to be 2% for both countries. The population growth rate η is 2% for Canada and 1% for the United States. Given the long-run similarities between measured TFP in the two countries, we follow Cole and Ohanian (1999) and set ψCAN = ψUS = 09 and σCAN = σUS = 0017. The optimal decision functions are computed using a linear quadratic solution method. Given the capital stock in 1929, which we assume to be on a balanced growth path, we feed in the measured TFP series for each country from Table II and obtain paths for all the variables in the model. Findings The results are in Figs. 1 and 2. The fall in measured TFP can account for over half of the fall in output up to 1933 in Canada and approximately great depression in canada FIG. 1. 55 The effect of TFP shocks on Canadian output. 70% of that in the United States. The technology shock story qualitatively matches the Canadian experience. The model predicts a faster recovery in the United States than actually occurred. Given the fast recovery in TFP, the model predicts an equally fast recovery in inputs. In reality, this recovery in inputs is very protracted, as can be seen from Table II. The model also predicts a faster recovery for market hours in the United States than in Canada. From this section we obtain one finding and two puzzles. The finding is that measured TFP in Canada can account for over half of the decline and does a very good job of accounting for the protracted recovery. This leads FIG. 2. The effect of TFP shocks on U.S. output. 56 amaral and macgee us to conclude that any explanation for the Great Depression in Canada should be consistent with the TFP behavior. Two puzzles remain. The first puzzle is why did TFP decline so much in both countries? The second is why was there no recovery in TFP in Canada while it recovered in the United States? 4. HOW IMPORTANT WAS DEFLATION? Many economists have argued that money and banking shocks caused the Great Depression. In this section, we evaluate the effect of monetary shocks in Canada. We follow recent work by Cole and Ohanian (2000a) for the United States and focus our attention on four monetary transmission mechanisms. The first two are the most common stories of financial factors: (i) debt deflation and (ii) bank failures. The remaining two work via labor markets and are (iii) surprise deflation and (iv) imperfectly flexible wages. Our conclusion is that money and banking shocks can account for a small part of the downturn and play an insignificant role in the slow recovery. The insignificant role played by financial factors is not surprising, as Haubrich (1990) provides strong evidence that they did not matter. Our results lend further weight to his conclusion and provide some interesting parallels with the analysis of Cole and Ohanian (2000a) for the United States. We devote the greatest attention to the labor market transmission mechanisms, particularly the imperfectly flexible wages story, for two reasons. First, to our knowledge, this story has not been subjected to a careful evaluation for Canada. Second, this transmission mechanism has figured prominently in recent papers arguing that money and banking shocks played a key role in the Great Depression (i.e., Bordo et al., 1997; Bernanke, 1995). Our conclusion is that imperfectly flexible wages may play a small role in the downturn but play no role in explaining the slow recovery. A key argument against the money and banking stories that we emphasize is a consistency requirement. Cole and Ohanian (2000a) point out that monetary explanations of the Great Depression in the United States face the problem of explaining why the deflation of 1920–1922 was associated with a short depression. This leads them to argue that any transmission mechanism must be consistent with both the deflation of 1929–1933 and the (comparable) deflation of 1920–1922. Table VII shows that Canada and the United States experienced similar deflations in 1920–1922 and 1929–1933. In both countries, output fell much more between 1929 and 1933 than between 1920 and 1922. Paraphrasing Cole and Ohanian (2000a): If the 19% deflation caused the great depression in canada 57 TABLE VII Comparing 1920–1922 and 1929–1935 Year Y Can. P Can. Y U.S. P U.S. 1920 1921 1922 100 85.71 97.77 100 84.58 73.12 100 93.9 96.2 100 85.2 80.6 1929 1930 1931 1932 1933 100 91.6 77 66.5 59.6 100 97.5 91.5 82.9 81.5 100 86.9 77.6 64 60.9 100 97.5 88.5 79.5 77.5 Note. Y is GNP per capita, and P is the GNP deflator. The U.S. data are from Cole and Ohanian (2000a). The Canadian data are from Urquhart (1965, 1993). All real data are detrended. Great Depression in Canada, why didn’t the 27% deflation of 1920–1922 also cause a major depression?7 Credit Markets We consider two alternative channels via which deflation could have helped cause the Great Depression through credit market disruption. The first is debt deflation, and the second is a financial crisis that may have disrupted intermediation. The “debt deflation” view of the Great Depression asserts that deflation and high private debt levels contributed to the Great Depression by reducing borrower wealth and constraining lending. Haubrich (1990) argues that the debt crisis was much less severe in Canada than in the United States. He argues that there is little evidence to suggest that the debt crisis caused the Great Depression in Canada. Comparing the 1920s with the 1930s supports Haubrich’s (1990) conclusion. If Canada experienced a debt deflation crisis, then business failures should increase. Table VIII reports commercial failures in both countries. The Canadian series includes bankruptcies, insolvencies under provincial company acts, and proceedings such as bulk sales and tariff sales, which led to loss to creditors. The U.S. failure data include any business that was involved in court procedures or voluntary action, which probably ended in a loss to creditors. 7 The two depressions were also similar in that Canada faced deteriorating terms of trade and the Canadian dollar depreciated relative to the U.S. dollar by a similar amount during both depressions. 58 amaral and macgee TABLE VIII Commercial Failures Canada United States Year Number of failures Liability (thousands) Number of failures Liability (millions) 1920 1921 1922 1923 1924 1925 1078 2451 3695 3247 2474 2371 26,494 73,299 78,069 65,810 64,531 45,768 — 19,652 23,676 18,718 20,615 21,214 — 627 624 539 543 444 1929 1930 1931 1932 1933 1934 1935 2310 2741 2563 2938 2344 1627 1402 44,441 57,191 52,987 56,631 29,251 20,728 14,542 22,909 26,355 28,285 31,822 19,859 12,091 12,244 483 668 736 928 458 334 311 Note. The Canadian data are from Historical Statistics of Canada (Y215–216). The U.S. data are from U.S. Department of Commerce (1975), (V20–30). All liabilities are in current dollars. What is striking is that the number of commercial failures is not that high during the Great Depression. Indeed, while commercial failures in Canada more than tripled between 1920 and 1922, they increased by less than 20% between 1929 and 1932, before plunging to their lowest levels since 1920 in 1934. The U.S. data also show a similar pattern. However, failures in the United States increase more than those in Canada between 1929 and 1932. This suggests that the debt crisis story is not a good candidate to explain the Great Depression in Canada. A variation on the debt crisis story that may apply to Canada is the role of external debt. Canada had borrowed considerably from abroad prior to the Great Depression. There are two problems with this story. First, as noted above, there was a decline in failures during this period. Second, the risk premium on Dominion bonds sold abroad—primarily in the United States—did not significantly increase during the 1930s. This suggests that investors did not view Canada as likely to default and lends further credence to the view that there was no external debt crisis. A common view is that banking crises played a significant role in transforming the 1929 downturn into the Great Depression. For example, Bernanke (1983) states that “the financial crisis of 1930–33 affected the macroeconomy by reducing the quantity of financial services, primarily credit intermediation” (p. 262). As has been pointed out by numerous authors, however, Canada did not experience any bank failures. While great depression in canada 59 the number of branches did fall, Haubrich (1990) finds no evidence that this impacted the level of economic activity. Indeed, Haubrich (1990) concluded that if monetary shocks mattered in the United States, it must have been because of the financial crisis. Labor Markets We consider two alternative channels via which deflation could have helped cause the Great Depression through labor market disruption: the surprise deflation story and the sticky wage story. The surprise deflation story of Lucas and Rapping (1969) argues that the Great Depression was severe because it was unexpected. Cole and Ohanian (2000a) point out that for this story to work, we should observe low nominal interest rates in the 1920s and high nominal and ex post real interest rates in the 1930s. Interest rate data for both countries are reported in Table IX. Real interest rates are the nominal interest rates minus the percentage change in the annual GNP deflator. We report long-term Dominion bond yields as shortterm Treasury bill yields are not available until 1934. The Canadian data match the U.S. data—and suggest that the 1930s deflation was more predictable than the 1920s deflation. This leads us to conclude that the surprise deflation story cannot explain the Great Depression in Canada. The last monetary story we consider is that imperfectly flexible nominal wages and deflation led to high real wages. This story assumes that the short side of the labor market dominates, so that high real wages cause firms to lower their demand for labor, leading to lower employment and output. TABLE IX Nominal and ex-Post Real Interest Rates in Canada and the United States: 1920–1922 and 1930–1933 Years U.S. Treasury notes (nom.) U.S. Treasury bills (real) Long-term Dominion (nom.) Long-term Dominion (real) 1921 1922 Avg. 1930 1931 1932 1933 Avg. 4.83 3.47 4.35 2.23 1.15 0.78 0.26 1.10 19.63 8.87 14.25 4.73 10.38 10.95 2.78 7.21 5.99 5.41 5.7 4.73 4.55 5.12 4.6 4.75 15.36 7.23 10.76 14.46 6.26 9.68 16.01 14.7 Note. U.S. data are from Cole and Ohanian (2000a, Table 4). Canadian data are from Historical Statistics of Canada (H604–618). 60 amaral and macgee We find that high real wages can account for no more than a 7% decline in output and that predicted output is above trend by 1933. The imperfectly flexible wage story also has a consistency problem, as changes in measured real wages during the Great Depression are similar to changes during the 1920–1922 depression. There are a number of critical issues involved in this story. As McGrattan (1999, 2001) has pointed out, the relevant variable from the point of view of the firm is the ratio of the product price to the nominal wage rate. She finds that a key theoretical problem with standard sticky wage models is that the spread between the output price and the real wage does not vary much. McGrattan’s work also points to an important empirical question: the price index one uses to deflate wages matters. We use the GDP deflator. There were large changes in the relative prices of different types of goods. The prices of agricultural products and other commodities fell substantially relative to those of other goods. Both the wholesale price index and the consumer price index overweight commodities and agricultural products. This means that using either one as a deflator would overestimate the real wage. Figure 3 shows undetrended real wages for the industrial sector and agriculture. The nominal wage index for the industrial sector is based on the weighted average of eight nonagricultural industries (one of which is manufacturing). These nominal wage indices are for wage earners and are based on surveys conducted by the Dominion Bureau of Statistics of employers. Wage earners comprised approximately 70% of the workforce (with most of the remaining workers being farmers). The farm wage series is com- FIG. 3. Real wages in Canada. great depression in canada 61 puted using indices of farm wages reported in various issues of the Labour Gazette. The figure shows an important fact: real wages differed substantially across sectors of the economy. For the industrial workers the undetrended real wage increased by only 7% during the decline. The industrial real wage reported in Fig. 3 may be biased by compositional effects. The reduction in employment affected unskilled workers the most. Cole and Ohanian (2000a) argue that for the United States, compositional effects could cause the reported real wage to be overstated by up to 15%. Given the similarities between Canada and the United States, it could be argued that a similar figure also applies to Canada. This adjustment would imply that real wages were actually low during the Great Depression. The real wage story also faces a consistency problem. Nominal wage inflexibility in 1920–1922 appears very similar to that of 1929–1939. For the United States, this fact has been established by both Cole and Ohanian (2000a) and Dighe (1997). Table X reports detrended real wage movements in Canada and the United States. The real wage movements are very similar. Real wages in the nonagricultural sector increased slightly more over 1929–1931 than they did over the 1920–1922 period. Conversely, real wages in the farm sector fell more in the Great Depression than during the 1920s. Even if one rejects the arguments presented above, the imperfectly flexible nominal wage story is quantitatively unable to explain the Great Depression. To show this, we undertake the following experiment. We modify the model economy from Section 3 by assuming that the wage rate is determined exogenously and is given by the real wage in the industrial sector. The labor input is determined by the firms’ first-order condition. Since we are taking a real wage series for the industrial sector, we compare the predictions of the model to the nonagricultural sector. Figure 4 shows that the model fails to replicate the magnitude of the initial fall in output. It also completely fails to explain the lack of recovery as it predicts that output should be above trend by 1933. TABLE X Detrended Real Wages Year 1920 1921 1922 1929 1930 1931 1932 1933 Can. farm U.S. farm Can. manuf U.S. manuf. 100 100 100 100 85.7 71.9 103.3 101.5 81.3 73.1 100.1 101.2 100 100 100 100 89.9 93 101.1 102.1 71.9 76.8 103.7 106.8 58.9 64.7 105.4 106.5 55 60.2 100.6 104.2 Note. Date are from Cole and Ohanian (2000a), Historical Statistics of Canada (D1–11), and Labour Gazette. The wage series are deflated using a 1.4% linear trend. 62 amaral and macgee FIG. 4. The effect of imperfectly flexible nominal wages on Canadian output. We also repeated this experiment combining the drop in measured TFP for the nonagricultural sector and the reported real wage series. In this case, the model can account for most of the decline, but predicted output is back to trend by 1939. Comparing this to the experiment where we take only measured TFP as exogenous, we can explain 70% of the decline, as opposed to 60%. However, the predicted recovery is much faster. We conclude that the imperfectly flexible nominal wage story cannot explain the Great Depression in Canada. Indeed, given the questions about the data, it is an open question as to whether the real wage was actually “high” during the Great Depression. Summary Our conclusion is that money and banking shocks are unable to explain the Great Depression in Canada. Furthermore, none of these monetary explanations provides a direct channel for explaining either the observed drop in productivity or its lack of recovery. 5. HOW IMPORTANT WERE COMPETITION AND LABOR MARKET POLICIES? The role of government policies in the Great Depression—particularly U.S. “New Deal” policies—has long been a subject of debate among economists. Cole and Ohanian (2000b) present persuasive arguments that U.S. government competition and labor market policy play a key role in explaining the slow recovery from the Great Depression. In this section we great depression in canada 63 ask two questions: What were the labor market and competition policies in Canada during the Great Depression?8 What was their impact? What we find is surprising. Government policies were very different in Canada and the United States, particularly during the recovery period. The United States pursued a policy of reducing domestic competition and increasing wages (Cole and Ohanian, 2000b). There is no evidence to suggest that policies limiting competition were implemented in Canada. We also find important differences in labor market policies. Unlike the United States, Canada did not restrict hours worked or strengthen unions. Canadian policy consisted mainly of measures targeted at directly increasing wage rates. However, as we discussed in Section 4, high real wages can explain a very small part of the slow recovery in Canada. This leads us to conclude that neither competition nor labor market policies can explain the Great Depression in Canada. The Bennett “New Deal” From the legislative record, one would conclude that Canada introduced polices that were very similar to those put in place by the Roosevelt administration in the United States. The Bennett government introduced Canadian “New Deal” legislation in 1934 and 1935, which included the main features of both the Roosevelt New Deal and British Unemployment Insurance schemes. Unlike in the United States however, this legislation was not implemented before being struck down by the courts. These policies were not implemented because the Bennett government was defeated in 1935 by the Liberals, whose leader opposed these policies.9 Upon coming to power the Liberals referred the Bennett “New Deal” legislation to the courts. Most of the substantive elements of the New Deal legislation were ruled ultra vires. As a result these policies were never implemented. Competition Policy There is considerable evidence that Canadian competition policy was not relaxed during the 1930s. The number of cases dealt with under the Combines Investigation Act (the antitrust law in Canada) increased from approximately 50 during the 1923–1925 period to over 100 during each of the 1926–1930 and 1931–1933 periods. In contrast, the Roosevelt administration pursued an explicit policy of facilitating cartelization by 8 Amaral and MacGee (2001) provide a more detailed description of Canadian government policy. 9 King’s view is reflected in his quote that Roosevelt’s “mad desire to bring about State control and interference beyond all bounds made one shudder” (Struthers, 1983, p. 105). 64 amaral and macgee not enforcing antitrust laws. This is reflected in the nearly 50% fall from 1925–1929 to 1930–193410 in antitrust cases filed by the U.S. government. Price behavior during the 1930s also supports the view that competition policy differed across the two countries. Wholesale prices in Canada and the United States moved together during the interwar period, except for the 1933–1936 period, when U.S. prices rose much more quickly than Canadian prices. Romer (1999) attributes this rise in U.S. prices to the effects of the National Industrial Recovery Act (NIRA). This suggests that competition in Canada was less restrained by government policy during this period. Labor Market Policy In both countries, labor market policy attempted to increase wages. In Canada, these labor market policies primarily took the form of provincial governments’ minimum wage schedules. These governments put very few restrictions on hours worked per worker and did not significantly change labor legislation. In sharp contrast, the Roosevelt government both limited hours worked per worker and increased the bargaining position of unions relative to management. Most labor market intervention in Canada was done by provincial governments. They introduced minimum wage laws after the 1920–1922 depression. These laws initially applied solely to female workers in the nonagricultural sector. These minimum wage schedules were unchanged until being superseded by other legislation in the late 1930s. In 1934, these minimum wages were extended to male workers replacing female workers. From 1935 to 1937, legislation was passed which allowed provincial governments to set minimum wage schedules by industry. Although this legislation allowed for the regulation of hours, this provision was rarely used. Provincial government intervention probably increased nominal wages during the late 1930s. Did this policy have a large impact on the recovery? The answer is no. As we discussed in Section 4, high real wages are unable to account for the slow recovery. Since labor market policy only increased wages, it cannot explain the slow recovery. The contrast with U.S. labor market policy is substantial. U.S. government policy not only increased nominal wages, but also attempted to decrease hours worked. This policy was explicit under the NIRA (1933– 1935). After the NIRA was ruled unconstitutional in 1935, this policy was implicitly implemented through the National Labor Relations Act (NLRA), which strengthened the position of unions. The effect of this policy can be 10 The number of antitrust cases filed is contained in Cox (1981), who cites data compiled by Posner. great depression in canada 65 seen clearly in the rapid growth of union membership in the late 1930s. The fraction of unionized employees in nonagricultural jobs nearly doubled, increasing from 14% in 1936 to 27% in 1938. There was also an increase in strikes in the mid-1930s. Canadian government policy was very different. The influence of unions did not increase. This is reflected in the fact that the fraction of unionized workers did not increase (nor was there a large increase in labor unrest). The timing suggests that U.S. labor market policy may have slowed the recovery by adversely impacting productivity. The growth accounting exercise for the nonagricultural sector in Section 2 suggests that the recovery of TFP was abbreviated in 1936 in the United States, but continued unabated in Canada. This change in U.S. TFP coincided with the strengthening of the unions and the rise in the fraction of the unionized labor force. This conjecture is consistent with anecdotal evidence that the formation of unions in the 1930s lowered productivity (see Chap. 5 of Brecher, 1997). Summary Canadian government competition and labor market policy cannot account for the Great Depression. There is no evidence to suggest that Canadian governments undertook policies to reduce domestic competition. The main effect of labor market policies was to increase nominal wages, particularly during the late 1930s. However, high real wages cannot account for the slow recovery (see Section 4). Moreover, in Canada hours worked recovered to a much greater extent than those in the United States, which also suggests that labor market policies in Canada were less restrictive than those in the United States. Our analysis suggests that U.S. New Deal policies may have prolonged the Great Depression by halting the recovery in TFP. The productivity recovery in the private nonagricultural sector was arrested at precisely the time that U.S. labor legislation strengthened unions. This suggests another avenue via which the NLRA may have slowed the U.S. recovery. 6. HOW IMPORTANT WERE TERMS OF TRADE SHOCKS? In contrast to the United States, Canada had a very large trade sector with exports plus imports accounting for approximately 50% of GDP. In this section, we quantify the contribution of terms of trade shocks to the Great Depression in Canada. We first consider a simple partial equilibrium argument and then undertake a dynamic analysis using an open economy model. Our conclusion is surprising. Despite the fact that trade declined by 50% and only partially recovered (see Table I), we find that terms of trade shocks can account for less than 5% of the decline in GDP. 66 amaral and macgee FIG. 5. Terms of trade in Canada. Figure 511 shows that the onset of the Great Depression was associated with an adverse movement in Canada’s terms of trade. This can be attributed to several factors. First, Canada was a net exporter of commodities. In particular, Canada was a major exporter of wheat, which experienced a large decline in price relative to that of other goods during the early 1930s. Another factor was the large increase in tariffs both in Canada and abroad. Canada increased tariff rates by 50% on average in 1930 in retaliation to the Smoot–Hawley Act and imposed a number of nontariff trade barriers. These nontariff barriers were substantial, as the Ministry of National Revenue made extensive use of its power to assign artificial valuations to Canadian imports (Brecher, 1957). One feature of Fig. 5 worth noting is that there was a steeper fall in the terms of trade in 1920–1922, and this did not cause a protracted depression. This suggests that the terms of trade shock story faces a consistency problem. A simple back-of-the-envelope calculation suggests that trade cannot explain more than a third of the Great Depression in Canada. Suppose that a reduction in exports will lead to a one-for-one reduction in output. Exports were roughly 25% of the Canadian GNP in 1929. By 1932 they had fallen by slightly more than half their 1929 level. If factors used in the production of exports could not be reallocated, then this could account for a decline of 13.5% in output at most. This is roughly one-third of the actual decline in real GNP per capita. Moreover, the fall in output that can be 11 The terms of trade are the ratio of an index of Canadian prices of export goods divided by an index of Canadian prices of imported goods. great depression in canada 67 attributed to a decline in trade with the United States is less than half of this figure—less than 6%. This calculation also casts doubt on the common wisdom that the United States transmitted the Great Depression to Canada via trade (Safarian, 1970). While the United States was Canada’s largest trading partner in 1929 (having surpassed the United Kingdom in 1927), the United States received 35%–45% of Canadian exports. Furthermore, while total trade with the United States fell by more than half between 1929 and 1933, net exports to the United States increased. The above exercise, although illustrative, abstracts from important issues, namely the fact that domestic and imported goods can be imperfect substitutes. If this is the case, the domestic country is partially unable to substitute away from imports as their relative price increases. This will lower investment, which in turn will lead to a fall in output. We use a variation of the Backus et al. (1995) model to quantify the effects of terms of trade shocks. Canada is modeled as a small, open economy that takes terms of trade as given. For the sake of consistency with the Backus et al. language, we define the terms of trade as the price of imports divided by the price of exports. The economy is populated by an infinitely lived representative household whose preferences can be represented by Eq. (3). The home country, Canada, specializes in the production of a single good, which we call a. The rest of the world specializes in the production of a single good b. Canada produces a using a constant returns to scale production function that takes as inputs domestic labor and domestic capital, act + af t = Yc t = At Ktθ Ht1−θ  (5) where θ is capital’s share of product and A is total factor productivity. The process for At is the same as that defined in Section 3. Yc is GDP in Canada. This can be consumed either in Canada, ac , or exported abroad, af . Domestic consumption C and investment X are composites of the imports bc and the domestic good ac , Ct + Xt = Gac t  bc t  (6) where G is an aggregator given by 1−ρ 1−ρ Gac t  bc t  = ωac t + bc t 1 1−ρ  (7) where ω is the relative weight of domestic goods and the elasticity of substitution between foreign and domestic goods is given by σ = 1/ρ. Capital is a nontraded good, and its law of motion is given by Eq. (2). 68 amaral and macgee We assume that the world markets for both goods are perfectly competitive. The price of the foreign good is denoted by qf while for the domestic good we use qc . The trade balance is the value of exports minus the value of imports and is given by nxc t = qc t af t − qf t bc t  The terms of trade are given by pt = qf t qc f (8) , where the process for pt is pt+1 = ϕ + φpt + εt+1  (9) Trade is assumed to be balanced throughout, which implies that af t = pt bc t .12 In calibrating this model, all parameters common to the model in Section 3 have the same values as shown in Table VI. The parameter ω was calibrated to match a 25% steady state share of imports in GNP. The parameters defining the terms of trade process were estimated using ordinary least squares and are ϕ = 03 and φ = 066. Note that because we use a linear quadratic approximation, the standard deviation of the error term plays no role. We assume that the economy is on its balanced growth path in 1929. The 1929 capital stock is our initial capital stock in the model. We take the terms of trade from the data (the reciprocal of Fig. 5) and feed these into the computed decision functions. This gives us the predicted paths for all the variables in the economy. We report the results for two different values of the elasticity of substitution (recall that ρ is the reciprocal of the elasticity of substitution). The first case corresponds to an elasticity of substitution of 8 and the second case of 0.8. If the terms of trade are going to have any effect on output, it will be in the second case where the country cannot easily substitute away from imports. Figure 6 shows our results. The results indicate that terms of trade shocks are unable to account for the Great Depression. In both the elastic and inelastic cases, the model predicts a decline in output of around 3%. However, in the elastic case, the model predicts a slightly bigger fall in trade than actually occurred, while in the inelastic case trade falls very little. We have also repeated the above experiments using the TFP series from the data. We find that combining the two is not significantly different from using TFP shocks only. We conclude that adding terms of trade shocks to the business cycle model does not significantly add to its ability to explain the Great Depression. This result is subject to some caveats. Crucini and Kahn (1996) have 12 This is a reasonable approximation given the data. great depression in canada FIG. 6. 69 The effect of terms of trade shocks on Canadian output. emphasized that a substantial part of the interwar trade was in intermediate products. If the domestic and foreign intermediate products are imperfect substitutes in production, an increase in the relative price of the imported intermediate goods will affect capital accumulation and output. However, a problem with this story is that it does not provide a link between trade and the behavior of TFP, which we argue is key to understanding the Great Depression in Canada. 7. CONCLUSION Was the Great Depression in Canada similar to the Great Depression in the United States? While the downturn (1929–1933) was very similar in both countries, the recovery (1934–1939) was very different. In the United States, the recovery in output was very slow despite the rapid recovery of productivity. In Canada, productivity recovered much more slowly than in the United States, while output recovered almost as quickly. Any explanation of the Great Depression must be able to account for this difference. TFP shocks can account for a significant part of the Canadian 10-year depression. This leads us to conclude that any successful explanation of the Great Depression must be one that involves an initial decline and a very protracted recovery in measured productivity. However, since we do not have any theory for either the decline or the lack of recovery of TFP, we view this TFP behavior as an unresolved puzzle. Can the usual explanations of the Great Depression account for the Great Depression in Canada? Our answer to this question is no. As we show, money shocks, policy shocks, and terms of trade shocks cannot account for the 10-year depression. Explanations based on these shocks 70 amaral and macgee fail because their effects are quantitatively too small to explain the Great Depression. Our findings in this paper tell us where to go next. Future research into the Great Depression in Canada should focus on models in which changes in the level of trade affect the level of productivity. Such models are consistent with the fact that Canada’s TFP and trade both declined from 1929 to 1933. Beginning in 1934, trade began to slowly recover and so did TFP. This also matches the fact that the only large shock that hit Canada but not the United States was trade, while the main difference in macroperformance is the behavior of productivity. REFERENCES Amaral, P., and MacGee, J. 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Historical Statistics of the United States: Colonial Times to 1970, Part 2, Washington, DC: U.S. Govt. Printing Office. Journal of Monetary Economics 25 (1990) 223-252. North-Holland NONMONETARY EFFECTS OF FINANCIAL CRISES Lessons from the Great Depression in Canada Joseph G. HAUBRICH* University of Pennsylvania, Philadelphia, PA 19104, USA Received March 1988, final version received January 1990 This paper empirically examines the nonmonetary effects of financial crises. It exploits the special nature of the Great Depression in Canada to test propositions linking financial structure and aggregate economic activity. Canada’s large domestic debt and shrinking banking system had little impact on the course of the Depression. In comparison with results for the United States, this implicates bank failures as a prime factor in the real effects of financial crises. 1. Introduction Recent work examining the link between the financial system and macroeconomic activity maintains that bank failures and financial crises do not simply respond to a collapsing economy, but instead have direct aggregate effects beyond any impact on the money supply. This work [Bernanke (198311 has emphasized the nonmonetary causes, specifically bank crises, especially in the paradigm case of the Great Depression. It not only addresses contemporary concerns about bank safety but also has stimulated rigorous analytical development [Gertler (1988>]. Bernanke presents an important alternative to the traditional monetarist and Keynesian explanations of the Depression. Friedman and Schwartz (1983, p. 357) maintain that the wave of bank failures ‘would have been only a regrettable occurrence and not a catastrophe if it had not been accompanied by a major decline in the stock of money’. Temin (1976, pp. 9-lo), arguing the Keynesian position, claims that ‘the banking panics were a part of a larger process that started with the decline in autonomous spending.. . had they not taken place, the market would have been equilibrated in other ways but the overall story of the Depression would not have been much *Let me here thank the many people who have contributed to this paper, including Mike Bordo, Judith Farnbach, Eugene White, the Penn Macro Lunch Group, an anonymous referee, and Ronald Shearer and Nancy Leaman, who also shared some important data. Lillian Ng provided first-rate research assistance, and the University of Pennsylvania Research Foundation and PARSS seminar provided financial support. Any errors remain mine. 0304.3932/90/$3.50 0 1990, Elsevier Science Publishers B.V. (North-Holland) 224 J.G. Haubrich, Great Depression in Canada different’. According to Bernanke (1983, p. 2631, ‘the financial crises of 1930-33 affected the macroeconomy by reducing the quality of certain financial services, primarily credit intermediation’. That is, losing a large fraction of intermediaries produces real effects: the cost of credit rises and the ability to obtain funding to continue or establish businesses and farms falls. Extending Bernanke’s analysis to the Canadian Depression allows us a natural test of the cost of a credit model. In the U.S. - a unit banking system - over one fifth of all banks failed; with failures, voluntary liquidations, and mergers, one third of all banks disappeared. Although Canada’s branch banking system proved immune to runs and panics, the number of branches dropped from 4049 to 3640 between 1929 and 1933, loans and deposits fell, and bank-stock prices dropped. Thus, comparing Canada with the United States provides an experiment about the macroeconomics of financial organization. In particular, it allows us to isolate the separate components of actual bank failures and a shrinking banking sector. Studying Canada also eliminates the need to account for some of the extreme economic and political factors occurring in another natural comparison point, Europe. Hyperinflation, Fascism, and Communism were absent on a national scale in Canada. Likewise, it experienced real shocks similar to those in the United States. Chief among these was the agricultural crisis or ‘Dust Bowl’. The province of Saskatchewan, for example, produced 321 million bushels of wheat in 1928, but only 37 million in 1937 [Lower (1957)]. This takes on added significance because agricultural problems probably lay behind many American bank closings [Temin (19761, Friedman and Schwartz (196311. Finally, other authors have used comparisons with Canada to make their point about the U.S. Friedman and Schwartz maintain that ‘bank failures were important not primarily in their own right, but because of their indirect effect’ (p. 352) by pointing out that Canada had a large monetary contraction, no bank failures, and a depression almost as severe as that in the United States. Their student Morrison (1966) uses a similar comparison with Canada to show that panics induced American banks to increase their excess reserves during the Depression. Bernanke suggests that the severe Canadian debt crisis played a role similar to bank failures in the U.S., but does not acknowledge that this credit crunch may be a transmission mechanism of monetary policy. More precisely, considering the Canadian experience lets us test three hypotheses. First, it lets us test whether the decline in bank operations influenced the course of the Depression. A comparison with the American record can then differentiate between the macroeconomic consequences of a decline in operations and outright failures. Secondly, we test the importance of the nonbanking ‘debt crisis’ by looking at the effects of debt and commer- 225 J. G. Haubrich, Great Depression in Canada cial failures. Finally, we test for the effects of money and thus obtain some cross-country evidence on the monetarist explanation. This paper is organized as follows. I begin with a short description of the interwar financial system. Then to assess the role of the banking system in the Depression, I estimate several regressions following Bernanke’s techniques using data for the entire interwar period (1919-1939). A further section examines one aspect - domestic and international debt - that requires more detail. A final section draws some conclusions. 2. The Canadian economy between the wars Several features make the Canadian economy a natural testing ground for the real effects of financial crises.’ A depression occurred, with falling output, prices, and money supply, but in contrast to the U.S. no banks failed. On the other hand, several differences create a need for caution in interpreting results. The lack of a central bank, abandonment of the gold standard, and large external debt provide pitfalls in drawing comparisons with the U.S. The Canadian economy from 1919 to 1939 followed roughly the same course as the U.S. economy.* After a very inflationary boom during WWI, the economy steadily grew during the 1920’s, mostly due to growth in mining and manufacturing; agricultural income, though large, did not expand rapidly. After the peak in 1929 a severe depression set in, in part precipitated by a poor harvest and collapse of export prices and quantities. The cycle reached its trough in early 1933, with wheat and exports recovering before manufacturing. The recovery started rapidly, but then slowed down in early 1935, giving Canada overall a slower total recovery than that of the United States. 1938 saw Canada also enter a short but steep recession prior to the World War II driven recovery. Figs. 1, 2, and 3 show the course of output, money supply, and prices over the interwar period. The output measure, industrial production, distorts the picture somewhat in that it excludes agriculture. Income from agriculture accounted for almost a fifth of Canadian national income, and while national income fell by 50% in the Depression, farm-sector income fell by 80%. It also recovered more rapidly than investment or production. Unlike the unit banking system of the United States, the branch system of Canada proved relatively immune to runs or panics. The interwar period showed a trend towards fewer and larger banks. In 1920 Canada had 18 banks, but by 1929 the number had fallen to 10. Acquisitions and mergers accounted for most of the change. The only failure was that of the Home ‘This section Clark (1984). is based 2For more detail, on discussions consult Safarian in Beckhart (1959). (1929), McIvor (1958), and Shearer and 226 J.G. Haubrich, Great Depression in Canada CIP 130 - JJJJJJJJJJJJJJJJJJJJJJ AAAA~AAAAAA~AARAAAAAAA NNNNNNNNNNNNNNNNNNNNNN 1222222222233333333334 98123456789e123456789E DRTE Fig.1. Industrial production, Canada. Bank in 1923. By the Depression, numbers had settled down, with the only merger occurring in 1931 and the chartered banks making their presence felt by over 4000 branches throughout the Dominion. When failures did occur, losses to note holders and depositors were often small because bank stock carried double liability. Until 1935, Canada had no central bank. Despite this, the chartered banks were heavily regulated. The Bank Act specified (among other things) audits, capital requirements, directors’ qualifications, and loan restrictions, including a prohibition against holding mortgages. These were held by loan companies, which overall remained small relative to the chartered banks: in 1923 loan companies had assets of $188 million, compared with bank assets of $2.5 billion [Beckhart (192911. Regulations changed at regular intervals. Every ten years the Bank Act was (and still is) revised and all banks had to renew their charters. This was often the occasion for discussion, study, and debate about the system, and amendments frequently changed the regulations. Money in Canada took the form of chartered bank notes (asset-backed circulating notes of the banks), Dominion Notes put out by the government, and most importantly, deposits at the commercial banks. Banks did not have J.G. Haub~ch, a0 Great depression in Canada ~,,,,,,,,,,,,,,,,,,,,,,,,,‘,,,‘,1,,,1,1,,,1 227 r JJJJJJJJJJJJJJJJJJJJJJ AAARRRARAAAAARRRA~AAAB NNNNNNNNNNNNNNNNNNNNNN 1222222222233333333334 981234567B981234567B98 Fig. 2. Ml Canada. to hold reserves, but 40% of any reserves they chose to hold had to be Dominion Notes. Though lack of a central bank before 1935 left little room for discretionary monetary policy, the government issued money and established important rules for the moneta~ system. In theory, note issue (Dominion Notes) took the form of a fixed fiduciary issue, above which all notes were backed 100% by gold reserves. In practice this did not happen because the Finance Act of 1914 provided a major exception. Banks could obtain Dominion Notes against collateral, which could be anything from Canadian Treasury bills to feed stocks. The interest rate on this borrowing, known as the Advance Rate, was set by Parliament, so while it was at the discretion of the government, it changed only slowly. Banks requested a line of credit, above which they could not borrow, but this was never a binding constraint. Banks once used 39% of the line, but generally they used about 15% [Beckhart (19291, Shearer and Clarke t 198411. Other institutions somewhat compensated for the as yet nonexistent Bank of Canada. The Canadian Bankers’ Association, a private group recognized by the government, regulated clearing houses and created a fund to redeem the notes of failed banks. The Dominion used the Bank of Montreal as its 228 J.G. Haubrich, Great Depression in Canada PRICES 22E T 210 T 288 : 19u T 188 T 170 T 166 I 156 T 140 1 136 T 120 1 1lB T 100 1 90 1 se;,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,, JJJJJJJJJJJJJJJJJJJJJJ AAAAAAAAAAAAAAAAAAAAAA NNNNNNNNNNNNNNNNNNNNNN 1222222222233333333334 9812345678961234567898 DATE Fig. 3. Wholesale price index. fiscal agent. Canada also lacked a money market, but had easy access to New York. For most of the interwar period, except for July 1926 to January 1929, Canada was not part of the international gold standard. The rest of the time the Dominion was on either a de jure or de facto floating-exchange regime. For example, in 1929, when still officially on gold, Canada shifted the gold-shipping point from Montreal to Ottawa, exported only bullion and Canadian coins (which had to be assayed before being accepted in the U.S.), and instructed banks to charge prohibitive fees for handling gold. All pretense ended in 1931 when Canada left gold shortly after Britain. 3. Statistical tests This section tests the three competing hypotheses on the real effects of financial structure. It empirically examines whether financial crises, either in the banking system or in the broader debt market, help to explain the Depression after accounting for the effects of money and other factors. The first hypothesis is based on Bernanke (1983) who argues that, in the U.S., bank failures not only shrank the money supply, but also increased the cost of credit by making the transfer of funds from ultimate lenders to J. G. Haubtich, Great Depression in Canada 229 ultimate borrowers more difficult and more costly. Furthermore, the extensive bankruptcies among businesses made banks and others reluctant to lend which further depressed the economy. Bernanke supports these claims empirically by showing that deposits of failed banks and liabilities of failing businesses had large and statistically significant effects on industrial production, even after accounting for lagged values of income, unanticipated money, and unanticipated prices. The cost of credit hypothesis has two parts: increasing commercial failures crippled lending in the debt market and banking problems exacerbated the downturn. Since no banks failed in Canada, explicitly comparing the banking results requires a joint hypothesis: the decline in bank operations increases the cost of credit as do bank failures and a higher cost of credit has real effects. Rejecting the hypothesis may mean that bank failures have a different impact from declining operations. Empirically, we will look for significance of commercial failures and of the banking variable. The monetarist explanation also has a straightforward prediction. Namely, that the money supply will be significant. Furthermore, the effects of banks and debt should not be significant once money is accounted for in the regressions. BRANCHES 4800 I 4700 T 4600 1 4500 1 4400 1 4308 I 4200 T 4100 I 4600 1 3900 1 3900 T 3700 1 3600 1 3500 1 3466 1 3300 -/ , / , , ,, ,, /, , / , , , ,, , / , JJJJJJJJJJJJJJJJJJJJJJ AAAAAAAARAAAAAAAAAAAAA NNNNNNNNNNNNNNNNNNNNNN 1222222222233333333334 98123456789B1234567898 DATE Fig. 4. Number of branches. ,, , , , , , , , , , ;, 230 J.G. Haubrich, Great Depression in Canada INDEX 1.6 1.5 1.4 1.3 1.2 1.1 1.B 8.9 E.FJ 0.7 8.6 6.5 0.4 0.3 11.2 U.1 11.8 JJJJJJJJJJJJJJJJJJJJJJ AARRRARAARAAAAAAAAAAAA NNNNNNNNNNNNNNNNNNNNNN 1222222222233333333334 9012345678981234567899 DATE Fig. 5. Bank stock deflated by stock index. The Keynesian hypothesis favored by Temin suggests that banks and commercial failures merely reacted to the downturn and denies importance to money. It has other, more positive implications, but those will not be tested here, and the theory thus remains one interpretation of the null hypothesis: money, banks, and commercial failures had no effect on the course of the Depression. Without bank failures, I must use other proxies for the cost of credit. Counting branches measures one aspect of credit availability and financial services. Another aspect is bank-stock prices which measure the health and profitability of the Canadian banking sector. This measure has the flaw of being indirect, but the advantage of indicating the perceived value of the banks. Though neither measure is ideal, the two together should paint a better picture than either one alone. Figs. 4 and 5 plot the number of branches and an index of bank-stock prices. Without a single perfect variable or agreed-upon model of income determination, I must look at several different specifications of the problem. Along with using various proxies for the cost of bank credit, I include measures of the money supply and U.S. production to control for these important effects. Since this is a reduced-form study, I specify the regressions first in levels and 231 J. G. Haubrich, Great Depression in Canada then (following Bernanke more closely) in first differences. Later, Chow tests and vector autoregressions help check the robustness of the results with regard to stationarity and structural biases3x4 3.1. Regressions in level form The first set of regressions are variations on a theme in level form. Each regression, after controlling for the impact on industrial production of a time trend, the money supply, and the single bank failure. I use three proxies for the cost of credit: number of branches, price of bank stock, and spread between commercial and Dominion bond yields. A further variation adds U.S. industrial production to control for U.S. influence. Table 1 reports the results. The first regression regresses seasonally adjusted industrial production on a time trend, four lags of industrial production, money and four lags, a dummy for the Home Bank failure in August 1923, and the number of branches and four lags: 4 IP, = (Y + (YET+ C piIPt_i + 5 y;MOA’_i + diBANmAILt i=l + 5 i= 0 6,BR,_,. (1) i=O Serial correlation 3As might exponentially is not a problem, be expected, the R2’s differ detrended variables. measured substantially either between by the Durbin-Watson levels and rates of growth of 4The data come from various sources. The income measure is monthly values for industrial production, from Brecher and Riessman (1957). As mentioned above, these numbers unfortunately give a somewhat distorted view of the Great Depression in Canada because they exclude agricultural production [see Safarian (1959)]. Wholesale prices come from the same source. For the money supply I use Ml, which is deposits, Dominion Notes in circulation, and notes of other banks in circulation. The data were thoughtfully provided by Ronald Shearer, who extended the data beyond Curtis (1931), and from the Monthly Review of BusinessStatistics (assorted issues, 1931-39). The date for placing the dummy on the Home Bank failure in August 1923 comes from Beckhart (1929). The monthly data on branches are from Houston’s Monthly Bank Directory of Canada and Newfoundland. The three missing values were linearly interpolated. The stockprice index is an index of the 8 largest banks, and it and the market index of 130 firms come from various issues of the Dominion Bureau of Statistics’ Monthly Review of Business Statistics and its November 1931 supplement as do the data on real estate and mortgage loans. The data for liabilities of failed businesses come from the interwar editions of Dun’s Review. Data on interest rates and yields come from Nixon (1937) and bond ratings from Moody’s Manual of Investments, both Industrial Securities and Public UtilitySecurities. The regressions were run using SAS, with seasonally adjusted data. Those variables with a seasonal component were de-seasonalized using the SAS X11 procedure. 232 J.G. Haubrich, Great Depression in Canada statistic or by direct estimations of an autoregressive error process.5 Thus, even with lagged dependent variables, the least-squares estimates are consistent and asymptotically efficient [Theil (1971, sect. 8.711. Four lags of industrial production emerge as significant, as does the contemporaneous money supply. Also notice that the bank-failure dummy is insignificant. Furthermore, total branches and its first and third lags have the wrong sign. Only the second and fourth lags have the expected positive sign. I also compute F-statistics testing whether the sum of the coefficients equals zero. These do not always support the t-tests. The tests concur on industrial production: the sum of the coefficients is very significantly different from zero. However, the F-tests for money and branches conflict with the t-tests. The F-test on the sum of money coefficients shows them insignificantly different from zero. The branch sum differs from zero at the 5% level. Thus, the effects of both money and branches are of somewhat ambiguous significance. Still, since eq. (1) includes four lags of industrial production, money and branches do more than proxy for income. Causality is always difficult to determine, but the F-test on branches may indicate something beyond the normal pro-cyclical movement of the financial sector. Regression (21 adds lagged U.S. industrial production. This specification is IPt=a+a,T+wUSIP,~, + d,BANKEAIL, + ~ piZPI_I + ~ y,MON,-; i= I i=O + 5 &BR,_,. i=O (2) The U.S. index emerges as statistically and economically very significant. The branch coefficients remain insignificant, and the significant money terms remain, though with reduced significance. The sum of the money coefficients and the sum of the branch coefficients are not significantly different from zero. In a separate equation (not reported here), with 14 lags of money and 5 lags of U.S. industrial production, only the yearly (12th) lag on money was significant, and only U.S. industrial production was significant, so the results appear robust to the lag specifications. ‘Since the Durbin-Watson statistic means little when the regression contains lagged dependent variables, 1 report instead Durbin’s h [Durbin (1970)]. Because this indicated some autocorrelation, the equations were re-estimated using the AUTOREG procedure in SAS, which uses a two-step full-transform method of estimating serial correlation. The estimated coefficients and the standard errors changed little, and the estimates for the autoregressive parameters were small and insignificant. Those results are not reported here. Also, since the regressions in levels agree with the regressions in differences, the model is most likely correctly specified [Plosser and Schwert (1978)I. Table Regression Dependent variable Sample period Independent (1) IP 1919-39 TIME (2) IP 1919-39 (3) IP 1919-39 (4) IP 1929-37 variables USIPI CONST l9 16.6060’ (2.063) - 0.0086 (-0.867) 0.268gh (3.490) 0.2593 (3.515) 4.593 (0.535) 1.499 (0.238) 0.0129 (1.123) 0.0169’ (2.254) 0.0249 (0.8811 0.4903b (3.295) - 9.773 (0.577) IPI 0.5614h (8.609) 0.4877’ (7.269) 0.4623’ (6.933) 0.3449h (3.105) IP2 0.1213“ (1.702) 0.0882 (1.2561 0.1073 (1.543) 0.0729 (0.671) IP.? 0.3304b (4.694) 0.3149h (4.572) 0.3052’ (4.424) 0.3810h (3.587) IP4 -0.1127’ (1.770) - 0.0995 (1.597) - 0.0779 (1.243) -0.1198 (1.2301 MONO 0.0327” (2.195) 0.0281’ (1.923) 0.0190 (1.335) 0.0048 (0.250) MONI 0.0029 (0.154) 0.0010 (0.0551 0.0041 (0.224) 0.0152 (0.673) MON2 -0.0133 (0.6961 -0.0169 to.9031 -0.0173 (0.918) - 0.0383 (1.627) MON3 0.0148 (0.7851 0.0144 (0.7811 0.0135 (0.7271 0.0172 (0.736) MON4 -0.0241 (1.6171 - 0.0189 (1.287) - 0.0153 (I.0521 0.0115 to.0551 BA NKFAIL - 2.056 (0.470) -2.281 (0.5341 - 2.535 (0.6041 BRO - 0.0002 (0.006) BRI - 0.040 (0.988) - 0.0398 (1.003) ABSI 6.145 (0.748) SPRDl 1.768 (0.769) BR2 0.0592 (1.455) 0.0541 (1.361) ABS2 - 1.137 (0.138) SPRDZ - 1.133 (0.486) BR3 - 0.0501 (1.2381 -0.0516 (1.305) ABS3 2.063 (0.251) SPRD3 3.351 (1.454) BR4 0.027 (1.086) ABS4 5.517 (0.892) SPRD4 - 0.235 (0.127) Adj. R2 Durbin h 0.95 n.d.d 0.0118 CO.4461 0.024 1 (0.9931 0.95 n.d. ABS - 14.25” (2.394) 0.95 nd. SPRD - 1.402 (0.767) 0.94 n.d. “All data are monthly. IPn is the nth lag of seasonally adjusted Index of Industrial Production, Canada. MONn denotes seasonally adjusted MI and its lags. BANKFAIL is a dummy in the month of the Home Bank failure. BRn denotes the number of branches and its lags. ABSi is adjusted bank-stock price and lags. SPRDi is the interest rate spread and lags. Absolute values of I-statistics are given in parentheses. ‘Significant at 5% level. ‘Significant at 10% level. dNot defined. J.G. ~al~b~c~, Great Depression in Canada 234 Using the bank-stock price index broadly confirms these results. However, this measure does not indicate causality, since the stock market is a leading indicator of the business cycle, and bank-stock prices participate in this movement. To control for this, the regressions use the bank-stock index deflated by the DBS’s market index of 130 stocks obtained from the Monthly Review of Business Statistics. In fact fig. 5 shows that, when deflated by the market index, bank-stock prices appear counter-~clicai. Thus during a recession bank stocks (and thus perhaps banks) do well relative to other industries. The regressions took the form of IP, = LY + aT + wUSIP,_, + 5 piCIp,-i + i i=l + diBANKEAIL, Y;MON,-; i=O + ; G,ABS,_i. i=@ (3) This adjustment does differ from the previous resuhs. Though the contemporaneous adjusted stock price is significant, it has an unexpected negative sign. F-tests show neither stocks nor money significant. To more directly test the effects of a debt crisis or the nonbank aspects of a general financial crisis, regression (4) - not written out here - uses the yield spread between an index’ of commercia1 bonds and Dominion bonds as a measure of financial distress. Fig. 6 plots this spread for the avaiiable years 1929-1937. No financial or monetary indicators have any import, either singIy or jointly. 3.2. Regressions using rates of change Even tests that follow Bernanke more closely by using rates of change provide littIe for the cost of credit or monetarist hypotheses. This method also controIs for potential spurious correlation resulting from the time-series properties of the variables. The regressions run here for Canada differ from Bernanke’s in several ways. First, Bernanke uses deposits; I use differences of the number of branches and stock prices. Second, Bernanke uses unanticipated money and prices; I use growth rates for several reasons. (a) The equations predicting money growth did poorly; most money growth was unanticipated anyway. (b) Estimating and interpreting two-stage models involving expectations [see Mishkin (1983), Murphy and Topel (19851, Newey (198411 adds many complications. (c) The current framework allows easier comparison with other works not using the unanticipated-money hypothesis. ‘Nixon (1937) constructed this index. Moody’s (1929-37) rates these firms from Aaa to B. J.G. Haubrich, Great Depression in Canada 235 PERCENT 31 B_,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,, FEE38 NAY35 WC32 NOW29 FEE27 DATE Fig. 0. Spread between commercial and Dominion bonds. This is important since the money-surprise hypothesis has come under increasing attack [McCallum (1982), Cecchetti (198611.’ Third, my regressions also include the levels of commercial failures (liabilities of failed businesses), not the difference, because commercial failures are already a difference. Finally, the regressions were estimated separai.ely including the growth of industrial production in the United States. The regressions using rates follow regressions (l)-(4) in general form. The results are reported in tables 2 and 3. In the first specification, industrial production is regressed on two of its own lags, current U.S. industrial production and one lag, growth rate of money and three lags, bank branches and one lag, and contemporaneous commercial -failures and three lags: If’G, = i i=l CY,IPG,_, + 5 p,kG_; +i i=o i=o yiBRG,-; + i I hscF,-;. =o (5) ‘Earlier formulations not correct the standard than the following. of these regressions which used unanticipated money and prices but did errors, showed less influence of money and more influence of branches Table 2” Regression Dependent variable Sample period (5) IPG 1919-39 (6) IPG 1929-39 (7) IPG 1919-39 IPGl -0.316b (4.995) - 0.3246h (5.142) - 0.0532 (0.545) IPG2 -0.237h (3.759) -0.2198h (3.534) Independent variables - 0.0786 (0.821) MG 0.0029’ (2.129) 0.0021 (1.468) 0.0037h (2.463) MCI 0.0025’ (1.786) 0.0023 (1.584) 0.0015 (1.017) MG2 0.0025“ (1.753) 0.0026’ (1.823) 0.0021 (1.316) MC3 0.003 lh (2.168) 0.0027’ (1.903) 0.0039h (2.744) BRG 1.1217 (0.879) 0.0003 (1.245) 0.0005 (1.420) BRGI - 1.758 (1.481) SCF 0.0003 (1.318) SCFI - 0.0004’ (1.657) - 0.0004 (1.668) SCF2 0.0003 (1.295) 0.0003 (1.442) -0.0001 (0.330) SCF3 - 0.0001 (0.582) - 0.0001 (0.576) 0.0002 (0.757) - 0.0007h (1.985) LNG 0.0896 (0.313) LNGl 0.4452 (1.514) LNG2 * 0.649 (0.228) LNG3 0.0029 (0.010) RABS -0.2016h RABSI - 0.0991 (1.147) (2.412) Adj. R2 Durbin h 0.13 0.99 0.14 4.94 0.09 n.d.d “All data are monthly. IPGi denotes the ith lag of the Index of Industrial Production, growth rate of seasonally adjusted, exponentially detrended. MGi denotes money growth and its lags. LNGi is loan growth and its lags. SCFi is the value of commercial failures. BRGi denotes the rate of growth of branches. RABSi denotes the rate of growth of the adjusted bank-stock index. f-statistics are given in parentheses, ‘Significant at 10% level. ‘Significant at 5% level. “Not defined. J. G. Haubrich, Great Depression in Canada 237 Table 3” _~ Regression Dependent variable Sample period (6’) (5’) IPG 1919-39 IPG 1929-39 (7’) IPG 1919-39 IPGI - 0.3969h (6.174) - 0.4053h (6.399) -0.1195 (1.177) IPG2 - 0.2920h (4.676) - 0.27gh (4.592) Independent variables 0.0456 (0.476) USIPI 0.461 lh (4.113) 0.5044” (4.476) 0.1 998h (2.009) MG 0.0025’ (1.870) 0.0018 (1.304) 0.0032h (2.127) MGI 0.0013 (0.955) 0.0012 (0.881) 0.0007 (0.450) MC2 0.0010 (0.719) 0.0009 (0.659) 0.0009 (0.541) MG3 0.0024’ (1.724) 0.002 (1.440) 0.0034” cz.385) BRG 1.339 (1.084) RABS - 0.2032h (2.529) BRGI - 1.625 (1.415) RABSI - 0.0281 (0.332) SCF 0.0004’ (1.741) 0.0004 (1.619) 0.0005 (1.592) SCFl - 0.0003 (1.234) - o.ooll3 (1.147) - 0.0006c (1.808) SCF2 0.0003 (1.078) 0.0003 (1.215) - 0.0001 (0.417) SCF3 - 0.0003 (1.219) - 0.0003 (1.327) 0.0002 (0.493) LNG 0.1036 (0.368) LNGl 0.3749 (1.284) LNG2 0.0573 (0.204) LNG3 0.0189 (0.067) Adj. R’ Durbin h “See footnotes 0.23 n.d.d to table 2. USIPI is 1st lag of growth 0.20 0.77 rate of USIP. 0.1 I n.d. 238 J.G. Haubrich, Great Depression in Canada This reconfirms the earlier regressions. Money growth and its three lags appear significant. Branches and lagged branches are not significant, though they show the same sign pattern as before. Commercial failures appear insignificant except for the first lag. F-tests on the sum of the coefficients for branches and commercial failures cannot reject the null hypothesis that these sums are zero. Money growth has a significant sum, however. The second specification replaces branch growth with the bank-stock index adjusted by the market index: IPG, = ; a,IPGr_, i=l + i P,MG[_; i-o + i Y;SCF,_~ + i i= 0 G;RABS,_;. i=O (6) The basic results (including the results of the F-tests) hold. As before, the index is significant at the 5% level, and several lags of money and prices appear significant. The first lag of commercial failures is also significant at the 5% level when run with prices. Tests on the sum of coefficients again bear this out: the sum over bank stock differs significantly from zero, as do money and prices, but commercial failures do not. Regression (7) adds the growth in mortgages and real estate loans made in 1929- 1939: IPG,= &x,IPG,_,+ ,=I ;p,MG,_, i =o + &,SCF, i=o -; + ; y,LNG,_;. i=o (7) Adding this direct measure of debt has little impact on the results. Monetary variables remain significant, as does the first lag of commercial failures. The debt measure is not significant, and an F-test on both commercial failures and debt suggests joint insignificance. The regressions in level form showed appreciable changes when U.S. industrial production entered the equation. To account for the U.S. influence on the growth-rate equations, I added the growth rate of exponentially detrended U.S. industrial production in regression (5’1, (6’1, and (7’) (not written out to conserve space). As table 3 shows, the differences between regressions (5)-(7) and regressions (.5’)-(7’) echo but do not match the differences between level-form regressions (1) and (2). Though U.S. industrial production again dominates the equations, money remains significant. Regression (7’) has no individually significant monetary terms, but their sum differs from zero at the 10% level. In two of the three regressions, contempo- J. G. Haubrich, Great Depression in Canadu 239 raneous levels of commercial failures show significance. In no regression does the F-test on coefficient sums reject a zero value for stock prices, debt, or commercial failures. This extension of Bernanke’s analysis to Canada points to several conclusions. Most importantly, the cost of credit does not have a major impact on the course of depression. Neither bank variables nor debt variables emerge as significant. Less definitely, money also seems to have little impact on output. 3.3. Robustness tests The reduced-form time-series evidence presented here is subject to two serious complaints: that the regressions are not stable over time and that simultaneity problems confound any causality results. I examine these stationarity and structural issues with Chow tests and vector autoregressions, confirming the robustness of the above results. Some interpretations, particularly on the role of money, must be modified in light of structural questions, however. To test for coefficient stability, I performed Chow tests on the regressions. This was particularly important for the branch variable which declined in the 1920’s, a period of high growth. In particular, some authors feel the boom of the 1920’s led to many bank mergers. The former competitors then closed down rival branches in many towns. Since the merger process was largely complete by 1927, this might reverse the relation between branches and output. I checked for stability before and after January 1927.’ In the interests of space, those regressions are not reported here. The results varied. In general, the regressions in levels showed coefficient instability, while those in growth rates did not. Splitting the sample did not appreciably change the results so far reported, as the significance of branches, stock prices, and commercial failures did not change. In particular, the huge build-up and decline in branches following World War I thus does not explain the lack of correlation between branches and economic activity. Money tended to be more important in the 1927-1939 period than in 1919-1926 as regressions (6) and (6’) suggest. Like most work in this area, this paper relies heavily on reduced-form analysis. But a long tradition in economics makes us particularly suspicious about reduced-form results involving money or the international transmission of the business cycle. Neither the money supply nor U.S. industrial production is obviously exogenous in cl)-(7’). I test and find U.S. industrial produc- ‘F-tests showed that plausible the assumption lO)l. the split-sample regressions had the same error variance, making of homoscedasticity needed for the Chow test [see Maddala (1977, ch. J.G. Haubrich, 240 Great Depression in Canada Table 4 &anger causality Money and Industrial Specification: F-stat. F-stat. constant, all MON = 0 all IP = 0 U.S. and Canadian Specification: all CIP = 0 all USIP = 0 F-stat. F-stat. “Monthly constant. data, 1919-1939, tests.” Production time trend, four lags 2.50 2.03 Industrial Prob. F > 0 Prob. F > 0 0.04 0.09 Production time trend, 1.42 9.56 four lags Prob. F > 0 Prob. F > 0 0.23 0.0001 four lags used tion is exogenous, but the endogeneity of the money supply forces me to qualify my conclusions somewhat. An endogenous money supply probably lies behind the unexpectedly low significance of money. 1 attribute this to the monetary system. Without a central bank, the money supply was demand-determined, and high-powered money responded to banks’ advances under the Finance Act [Courchene (1969). Shearer and Clarke (198411. Table 4 supports this by reporting the results of a Granger causality test between money and income. The results show bi-directional causality, with both money and output influencing each other. The small effect of money, though interesting, should not be taken as a counterfactual. With the money supply demand-determined, money should not affect output. To make the point in a simpler context, consider the basic IS-LM model. If the government pegs the interest rate, resulting in a horizontal LM curve, all variations in output come from shifts in the IS curve. However, that does not imply money has no impact when a different regime starts shifting the LM curve. Although monetary policy may not have caused the Canadian depression, a counter-cyclical monetary policy might have prevented it. A different structural concern arises in an economy as open to the rest of the world as Canada’s. Accounting for foreign influences on the business cycle becomes both necessary and difficult. The ideal structural model would account for transmission via exports (tourism, forestry products), imports, investment, technology transfer, and what...
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Running head: GREAT DEPRESSION IN CANADA

Great Depression in Canada

Name
Institutional Affiliation
Date

1

GREAT DEPRESSION IN CANADA

2

Great Depression in Canada
The great depression was the worst experienced economic downturn in world history.
The great depression took place between 1929 to1939, and its impact was felt more in the
industrialized countries. The great depression was comprised of the decline in the value of shares
in the New York Stock Exchange market which wiped out many investors. It occurred after “the
Roaring Twenties" where economy performed exemplary well. The Roaring Twenties" was the
period between 1920s and 1929 where the nation's wealth grew more than two times. As the
economy was performing well, most people such as the tycoons, farmers and other business
people invested in the stock market hoping to make a profit1. However, during the 1929, the
economic growth stagnated and followed by a mild recession. At this, time, production began to
retract, and the unemployment rose thus leaving the value of the stock prices higher than their
actual value.
The agricultural sector was performing poor followed the drought and decline in the food
prices. The consumer debt was increasing at a higher rate, and the banks had huge loans which
could not be liquidated. During the period of great depression, the unsold goods began to
accumulate at this period, which slowed the factories production capacity.2 The wave of the
investor panic swept, and they began transacting the overpriced shares which led to selling of

1 Adolph,

Neal. "Doing What We Can: Governments and the Unemployed During the

Great Depression." Histoire sociale/Social History 47, no. 95 (2014): 775-780.
2

Amaral, Pedro S., and James C. MacGee. "The Great Depression in Canada and the

United States: a neoclassical perspective." Review of Economic Dynamics, 5.

GREAT DEPRESSION IN CANADA

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12.9 million and 16 million shares on Oct 24, 1929, and Oct 29, 1929, respectively3. This
rendered great loss to investors, and it was worse for those who used borrowed money to invest
on shares. The bank customers began withdrawing money in a large amount, and most banks
were closed. The factories production drastically declined which intensified the unemployment
rate. Ideally, the great depression negatively impacted not only the Canadian economy but also
other industrialized economies across the world.4 It led to an increase in poverty among middle
and lower classes who could not afford goods and services at the prevailing prices. Most, people
reduced the consumption due to the shortage of finances which weakened the economy even
more. Even though the great depression was the longest and most horrible financial crisis in
Canadian history, it still can be predicted and minimizes losses.
The Significance of The Great Depression in Canadian History
The great depression has significance in Canadian history. It was ushered in by the crash
of the stock market in late 1929. The depression lasted for ten ye...


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