These are the table and the figure used in the April 25 and 26 lectures.
We asked what might have acted as an impulse to the Great Depression.
Was it an AS or and AD shock? Probably AD, since P and Y went in the same direction (down!)
What moved the AD curve, an LM shock or an IS shock?
1. Evidence for LM is that interest rates shot up in 1929. The Fed tightened then because it feared that the high P/E ratios in the stock market at the time signaled that the stock market was overvalued. They felt that the inevitable fall in P/E would be produced by a fall in P, and they felt that the smaller the fall, the better. To them, this meant bringing down P sooner, before P rose a lot more and had to fall more. (Careful...here, P means the price of stock, while normally we use P to refer to a very different object, the dollar price of goods.) (Irving Fisher argued that the stock market was not overvalued. Writing in the 1920s and 1930s, he argued that the high P/E ratio in the 1920s reflected the relatively large fraction of startup firms, which tend to have low current earnings. So, his position was that the inevitable fall in P/E would be produced by a rise in E, as the startup firms started generating earnings. He thought the number of startup firms in the economy was unusually large because of a burst of inventive activity that began in 1919.)
Interestingly, the reason the Fed raised rates a lot in 1929 was similar to the reason the Bank of Japan raised rates in the late 1980s: to put an end to a stock market bubble that they thought was underway. In each case, what happened afterward was the same: the stock market crashed and the economy went through a period of weakness.
Whether the Fed or the Bank of Japan brought on the economic troubles that occurred after their tightening action, or whether even worse trouble would have occurred later if they had done nothing and let stocks rise more, is not known.
2. Evidence for IS can be seen in the extremely low investment that occurred during the Depression. That suggests our Ibar may have fallen at some point after the recession got under way. There probably was not a fall in our c0, since C/Y rose in the early 1930s.