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Accounting for the Great Depression

Quarterly Review 2721 | Spring 2003

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Accounting for the Great Depression

Abstract

Economists have offered many theories for the U.S. Great Depression, but no consensus has formed on the main forces behind it. Here we describe and demonstrate a simple methodology for determining which theories are the most promising. We show that a large class of models, including models with various frictions, are equivalent to a prototype growth model with time-varying efficiency, labor, and investment wedges that, at least on face value, look like time-varying productivity, labor taxes, and investment taxes. We use U.S. data to measure these wedges, feed them back into the prototype growth model, and assess the fraction of the fluctuations in 1929–39 that they account for. We find that the efficiency and labor wedges account for essentially all of the decline and subsequent recovery. Investment wedges play, at best, a minor role.


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This article is reprinted, with permission, from the _American Economic Review_ (May 2002, vol. 92, no. 2, pp. 22-27). Copyright 2002 by the American Economic Association. The article was edited for publication in the _Federal Reserve Bank of Minneapolis Quarterly Review_. https://doi.org/10.1257/000282802320188934
Related paper: [Staff Report 328, Business Cycle Accounting](https://doi.org/10.21034/sr.328)