Could A Monetary Base Rule Have Prevented the Great Depression?
Bennett T. McCallum
This paper continues an ongoing investigation of the properties of a
specific, quantitative, and operational rule for the conduct of monetary
policy, a rule that specifies settings of the monetary base that are designed
to keep nominal GNP growing smoothly at a noninflationary rate. Whereas
previous studies have examined the rule's performance in the context of United
States experience since World War II, the present paper is concerned with the
period 1923-1941. Counterfactual historical simulations are conducted with the
rule and a small model of nominal GNP determination, estimated with U.S.
quarterly data for 1922-1941. Residuals from the estimated relationships serve
as estimates of the behavioral shocks that occurred and accordingly are fed
into the simulation process quarter by quarter. The simulation results
indicate that nominal GNP would have been kept reasonably close to a steady 3
percent growth path over 1923-1941 if the rule had been in effect, in which
case it is highly unlikely that real output and employment could have collapsed
as they did during the 1930s.
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