The Netherlands in the Great Depression 1925-1934. A VAR Model Analysis of the Demand and Supply Shocks on the Price Level


Term Paper (Advanced seminar), 2016
13 Pages, Grade: 5
Anonymous

Excerpt

1 Introduction

In consequence of the Stock Market Crash in the Unites States of 1929 many countries have been hit by the so called Great Depression. In concrete the Netherlands economy declined gradually in the period in 1929-1931 and reached nadir in the period 1933-1936. The depression in the Netherlands was at its low point much later and therefore was affected by the depression significantly longer than other countries.

In this paper, we apply an empirical analysis to provide an answer to the Bullionist Controversy in Great Britain in the 18th century adopted to the Netherlands in the Great Depression. Therefore, we answer the question whether the price evolution in this period has been mostly driven by demand or supply shocks and whether remaining in the gold standard was a good decision for the economic development or not.

For our analysis we estimated a vector autoregressive model (VAR) and applied the Blanchard-Quah decomposition to identify the demand and sup- ply shocks on the output growth and inflation. Therefore, we use an impulse response and a Forecast Error Variance Decomposition to illustrate our re- sults.

We argue in this paper that the impact of the Great Depression on the economy of the Netherlands has been bigger because it stayed part of the Gold Bloc and therefore maintain convertibility. Thus, we bring forward the argument of the bullionist that the price shock has been a result of a demand shock. The gold standard as a consequence has led to an overvaluation of the Dutch currency (guilder). For a small open economy like the Nether- lands which is highly dependent of exports and has a big shipping sector the exchange rate plays a crucial role. Thus, the overvaluation resulted in a negative demand shock. Furthermore the persistent deflation and downward pressure on wages have led to even higher deflation expectations of the pop- ulation, what dampened the aggregate supply. Finally, the policy decisions of the government were incapable to reduce the problem and get out of the depression. Only after the suspension of the convertibility to the gold stan- dard and a devaluation of the currency the economy was able to recover. For this reason an earlier suspension would have had reduced the length and the intensity of the Great Depression for the economy of the Netherlands.

This paper is structured as follows. In Section 2 we outline the historical background of the political and economic situation of the Netherlands and their relation to the Gold Standard. Section 3 describes our Method. In Section 4 our empirical analysis will be discussed and section 5 concludes.

2 Historical Background

Due to its neutral status the Netherlands experienced a relatively economi- cally good development in the 1910s. The economy grew strongly, it had a low level of unemployment and a low inflation rate, while it was not highly indebted or damaged because of the war. But in the 1920s the Netherlands had to suffer under the consequences the war caused to the other countries. Since it is very dependent of the international trade, the lack of demand has brought the Netherlands into a strong depression until 1925. (Wikipedians, 2016, P.75-76)

After 1925 despite of the rising demand of Germany and the reentry to the Gold Standard the Netherlands were not able to end the depression. The shipping sector still suffered from the weak international trade and there were still strong trade restrictions and economic protectionisms from the period of war. (Wikipedians, 2016, P.75-76)

While in the beginning of the depression the prices of consumption good have fallen, after 1931 also wages have been cut and unemployment increased immensely what has led to a decrease in real income. Labor unions and gov- ernment subsidies were able to reduce poverty in the beginning of the depres- sion. But in advance of the depression these social benefits had to be cut. The cut in wages and the increasing poverty have led to strikes, protests and riots. In this time the Dutch national Socialist party increased its influence. (Wikipedians, 2016, P.76-78)

In the time between 1933 and 1939 the Netherlands was led by the states- man Colijn, which was a conservative, non-interventionist and international- ist. He pursued strictly the policy of a balanced budget of the government and refused to support the suffering industry with government demand by making debt. With a corn law in 1931 and several crisis laws to increase im- port, export and capital flow control by the government in 1932 they tried to subsidize the agriculture and the shipping sector. Nevertheless, the Nether- lands pursued a very conservative trade policy and did not increase trade barriers a lot before the failed World Economic Conference in 1933. The la- bor support like the in 1934 introduced Labor Fund failed to decrease poverty due to the balanced budget policy. (Wikipedians, 2016, P.78-79)

While most other countries left the Gold Standard and were able to re- cover in 1933-1934, the Netherlands maintained the Gold Standard and had to face price and wage cuts and increasing unemployment until 1936 when they finally left the Gold Standard. After this the devaluation of the Dutch currency has led to a recovery of the Dutch stock market as well as the in- ternational trade, while unemployment stopped increasing. (Wikipedians, 2016, P.78-79)

3 Method

For our calculations we estimate a vector autoregressive (VAR) model ∑

Abbildung in dieser Leseprobe nicht enthalten

where yt is a 2×1 vector containing growth of carried commodities and the growth of the wholesale price index.1 As proposed by (?, P.63) we create the matrix with lagged variables for OLS estimation of a VAR.

To identify supply and demand shocks we use the intuition of the AS- AD model and apply the Blanchard-Quah decomposition (Blanchard and Quah, 1989) and allow only the supply shocks to have a permanent impact on output in the limit. They argue, that since the two disturbances are un- correlated, we can interpret the one with temporary effect as demand effect and the one with permanent effect as supply effect, because we expect the long-run effects of demand shocks being relatively small. Furthermore, for their composition to be meaningful, demand shocks need to leave the rela- tion between the two variables mostly unaffected and the economy should be subject to only one, or at least one dominant demand shock. Moreover, they assume that the output variable is at the first difference stationary and the other variable, in our case the price index, stationary at its level, or at least this non-stationarity effect is of minimal importance.

To solve the identification problem we need to find the impact matrix S, which links the structural shocks in ϵt to the reduced form residuals in ut:

Abbildung in dieser Leseprobe nicht enthalten

The moving-average representation of the reduced-form VAR in equation (1) is

Abbildung in dieser Leseprobe nicht enthalten

and for the structural model, we have

Abbildung in dieser Leseprobe nicht enthalten

[...]


1 See e.g. Favero (2001, Chapter 6).

Excerpt out of 13 pages

Details

Title
The Netherlands in the Great Depression 1925-1934. A VAR Model Analysis of the Demand and Supply Shocks on the Price Level
College
University of Zurich
Grade
5
Year
2016
Pages
13
Catalog Number
V353297
ISBN (eBook)
9783668393448
ISBN (Book)
9783668393455
File size
548 KB
Language
English
Tags
netherlands, great, depression, model, analysis, demand, supply, shocks, price, level
Quote paper
Anonymous, 2016, The Netherlands in the Great Depression 1925-1934. A VAR Model Analysis of the Demand and Supply Shocks on the Price Level, Munich, GRIN Verlag, https://www.grin.com/document/353297

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