Matthew Yglesias Challenges Milton Friedman’s Model of Business Cycles

Matthew reads Charles Morris confusing long-term growth with short-term business cycles:

Historians long attributed the turmoil to a “great depression of the 1870’s.” But recent detailed reconstructions of 19th-century data by economic historians show that there was no 1870’s depression: aside from a short recession in 1873, in fact, the decade saw possibly the fastest sustained growth in American history. Employment grew strongly, faster than the rate of immigration; consumption of food and other goods rose across the board. On a per capita basis, almost all output measures were up spectacularly. By the end of the decade, people were better housed, better clothed and lived on bigger farms. Department stores were popping up even in medium-sized cities. America was transforming into the world’s first mass consumer society. But why did people feel so miserable? Partly they were confused by prices, which were dropping sharply. Farmers thought falling grain prices meant they were getting poorer, without noticing that the price of everything else was falling too. Farmers’ terms of trade – the price differences between what they sold and what they bought – actually racked up solid gains in the 1870’s.

Matthew seems to recall that a recession did occur during the 1870’s, which is not inconsistent with high overall growth for the decade. We had two recessions during the 1950’s followed by one that began in 1960 – and yet the economy grew by 40% from 1950 to 1960. NBER also argues there was a recession that started in 1873.

Matthew continues:

One is that the author says people “were confused by prices, which were dropping sharply. Farmers thought falling grain prices meant they were getting poorer, without noticing that the price of everything else was falling too.” First off, I find it a little hard to believe that someone wouldn’t notice falling prices for the things they buy regularly. It seems like the kind of thing you would notice. But more to the point, how could prices have been falling in the context of rapid economic growth? As we all know, when the Fed decides it wants to reduce inflation (i.e., slow down the growth in prices) it raises interest rates to try and reduce economic growth. That’s because inflation is connected to growth – very fast growth leads to inflation. How could rapid growth have been paired with deflation? Perhaps there’s an answer.

Should we suggest that Matthew read Milton Friedman’s “The Role of Monetary Policy: Presidential Address to AEA”, American Economic Review (1968)? Actually, Matthew is challenging the entire premise of adaptive expectations as did the new classical types who emphasized rational expectations. I never bought into the premise of market clearing models of business cycles anyway. Just call me an old fashioned Keynesian.

But back the 1870’s – Matthew might enjoy The Crisis of 1873 by David Glasner as well as the other entries in Business Cycles and Depressions: An Encyclopedia.

Also note that Economic History Series provides a series that does indicate that real GDP in 1880 was 63% higher than it was in 1870 but they caution:

A central point to keep in mind is that the quality of the data deteriorates the farther back in time one goes. The reason for this is simple: GDP data were not collected or even defined before the 1930s and thus any measures for years before 1932 rely on sources that were not collected for the purpose of constructing national income and product accounts.