Monday, July 16, 2018

The best age for entrepreneurship

By Michael Taylor of The San Antonio Express News. Excerpts:
"A new research paper co-authored by researchers from MIT, Northwestern University, and the U.S. Census Bureau shows the surprising relationship between business startup success and the age of the founders."

"The researchers first discovered the average age of startup founders, which is a surprisingly non-youthful 41.9 years old."

"Their study zeroed-in on unusually “high-growth” companies, the type of company that creates an extraordinarily big economic impact. They calculated the average age of the founder of the top 0.1 percent of startups in terms of employment growth — in other words the best successes compared to 999 of its startup peers. Before I give the answer, want to guess the average age of founder for these companies?

The answer is 45."

"Beyond that average age for top performers, the researchers found that the probability of entrepreneurial success in general increased steadily with age.

Founders who were 50-something were almost twice as likely to succeed at the highest level than 30-something founders. Not only that, but business founders in their 20s were the least likely to succeed. All of this flies in the face of the popular image we get from financial media of Silicon Valley prodigies disrupting everything around them before they’ve been kicked off their parents’ health care plan."

"age and experience bring even more important advantages to bear. The three most important of these appear to be deep experience in a particular industry, access to financial resources, and harder-to-measure factors like managerial experience and social capital."

"young founders often seem to believe that their youth is an advantage, despite the data to the contrary. They self-perceive as “the next Mark Zuckerberg.” For better or worse, they have absorbed the media narrative around young disrupters, especially in technology."

Here is a short article by me called "Aging and Entrepreneurship." Article in the Encyclopedia of Financial Gerontology, Lois A. Vitt and Jurg K. Siegenthaler, Editors-in-Chief, Greenwood Press, 1996.
"ENTREPRENEURSHIP, the initiation and assumption of the financial risks of a business and its management. The decision to start a business is often complex.  Many factors, including the need for achievement, the need for control over one's destiny, the willingness to take risks, the loss of one's job, and other forms of displacement may prompt a person to start his or her own business. While some writers see no link between age and the decision to start a new business, others have found close links. When age is a significant factor, it is often for psychological reasons.

Entrepreneurial opportunities are most likely to be pursued by people with a college education who are in their late thirties and have established careers. Age is relevant to entrepreneurship, and entrepreneurship is important for the aged. Of those who are employed at age 65 or older, 27% are self-employed (Maddox 1985). It is useful to examine the relationship between entrepreneurship and aging through the internal or psychological aspects of a person's decision to become an entrepreneur.

The Entrepreneur and Hero Compared

Joseph Campbell believed that the entrepreneur was the real hero in our society. Although he never systematically compared the entrepreneur and the hero, it is interesting to do so. Heroes and entrepreneurs are called to take part in an adventure that is a simultaneous journey of self-discovery, spiritual growth, and the personal creativity they make possible. An entrepreneur's journey closely resembles the journey of the hero in mythology as outlined in Campbell's book, The Hero 'With a Thousand Faces (1968). There is a strong similarity between the journey that entrepreneurs take and the adventure of heroes. Entrepreneurs and heroes also have similar personality traits. Myths describe the universal human desires and conflicts we see played out in the lives of entrepreneurs. Ian MacMillan and Rita Gunther McGrath (Wall Street Journal 1992) of the Wharton School's entrepreneurial center found that entrepreneurs, no matter what country they call home, think alike. Campbell found that the basic pattern in the hero's journey is the same in every culture.

Heroes bring change. Campbell (1968) refers to the constant change in the universe as "The Cosmogonic Cycle" that "unrolls the great vision of the creation and destruction of the world which is vouchsafed as revelation to the successful hero." This recalls Joseph Schumpeter's theory of entrepreneurship as creative destruction. A successful entrepreneur simultaneously destroys and creates a new world, a new way of life. Henry Ford destroyed the horse and buggy age while creating the world of the automobile. Campbell's hero finds that the world "suffers from a symbolical deficiency" and "appears on the scene in various forms according to the changing needs of the race." Changing needs and deficiencies correspond to the changing market conditions or the changing desires for products. The entrepreneur is the first person to perceive changing needs. Campbell believed that people become creative when they engage in an activity, pursue a career or entrepreneurial venture, because it is what one loves to do and because it bestows on one a sense of personal importance and fulfillment. It is not the social system that dictates that it be done; rather, the drive comes from within. It is this courageous action that opens up doors and creative possibilities that did not previously exist.
Relationship of the Hero's Journey to Aging

The hero's goal is now to find a purpose in life. Campbell's and Erik Erikson's (1963) heroes are similar, because the hero's journey is a quest for personal identity that can be found in service to others or to society, or in finding and delivering a boon. During the generativity versus stagnation stage, which comes in the second half of life, in Erikson's eight ages of man, people become willing to take risks in order to be creative or make their mark upon society. Generativity involves establishing and guiding the next generation, but it also includes productivity and creativity, which, along with the willingness to take risks, are essential to entrepreneurship. For Campbell, the act of creating involves the willingness to take a risk and cross a boundary into a new domain of ideas. To be unwilling or afraid to do so is to be controlled by what he calls "the elder psychology," or the unwillingness to strike out on one's own and take risks.

The paradox, then, is that although entrepreneurship may be an important path for people to discover themselves and "do something meaningful for society" as they become older, they must resist this "elder psychology," which Campbell believes blocks risk taking, creativity, and entrepreneurship. When a person is able to champion things becoming, he or she can achieve generativity by making a significant and unique contribution to society. If one is able only to maintain the status quo, he or she will stagnate and will remain self-centered and unable to contribute to society. Almost by definition, entrepreneurs are champions of things becoming.

In counseling and advising the elderly in the area of entrepreneurial activity, it is useful to keep these insights from mythology and psychology in mind. They deal with the deepest of needs and forces in the human psyche. For an older person contemplating a new business venture, it will be helpful to recognize that it is not just the potential financial gains or losses involved that are important. The entrepreneurial act may be a life-defining and self-defining act, one with deep personal and perhaps even spiritual implications for the individual and his or her relationship with society. Entrepreneurs are often seen as having different attitudes toward risk: what a nonentrepreneur might view as a great financial risk, the entrepreneur may see as a cost of learning and adventuring. The venture is an end in itself, more than the profit. People who start new businesses in the second half of life may view risk in this way, because they feel such a strong need to define themselves and contribute to society.

Campbell, Joseph. 1968. The Hero With a Thousand Faces. Princeton. NJ: Princeton
University Press.

Erikson, Erik H. 1963. Childhood and Society. New York: W. W. Norton.

Jung, Carl G. 1956. Symbols of Transformation. New York: Harper TorchbookslBollingen Library.

Maddox, George L., et al. 1985. The Encyclopedia of Aging. New York: Springer.
Wall Street Journal. 1992. 6 February; A1."

Sunday, July 15, 2018

Can the right story increase your income or help the poor?

See Think Positive, Climb Out of Poverty? It Just Might Work by Seema Jayachandran in The NY Times. I have a blog that sometimes touches on issues like this called Dollars and Dragons A look at the intersection of economics and mythology. Even if these programs work, they raise an important question: if everyone gets the "right" story told to them, would we all become richer?

"In Kampala, Uganda, students who watched a feel-good movie about a chess prodigy improved their academic results. In Oaxaca, Mexico, clients of a microcredit organization were successfully trained to have greater aspirations for the future. And in Kolkata, India, sex workers in brothels were imbued with a sense of empowerment that helped them to take concrete steps to improve their lives."

"In Kampala, Uganda, for example, a study by Emma Riley, a graduate student at the University of Oxford in Britain, examined the effects on students of watching a movie, “Queen of Katwe,” starring Lupita Nyong’o and David Oyelowo. The Disney movie is based on the life of Phiona Mutesi, a girl from a poor township in Kampala, whose father died of AIDS when she was young.

Ms. Mutesi went on to become a champion chess player, representing Uganda in international competitions, an achievement that exceeded what many students in Uganda had expected for themselves or even thought possible.

To encourage them to aim higher, students preparing for their national exams were shown the movie. When they took the exams, they performed better than a control group that instead watched a Hollywood fantasy movie, “Miss Peregrine’s Home for Peculiar Children,” that did not feature an appropriate role model. Significantly more of the “Queen of Katwe” movie watchers had scores high enough to gain admission to a public university."

"The Kolkata, India, experiment, conducted by five scholars based in the United Kingdom and India, ran a short course on personal growth for 264 sex workers, who had often felt stigmatized and powerless. After participating, the women had measurably greater self-esteem and a stronger belief that they could determine the course of their lives. More concretely, they began saving more money and getting more frequent health checkups.

These successes suggest that even traditional anti-poverty programs work partly because they lift people up psychologically. For example, a program designed by a nonprofit in Bangladesh that has also been used in India, Ethiopia, Peru and other countries has given poor people livestock plus training on how to care for the animals.

This aid package has raised participants’ incomes more than might have been expected, based on the direct monetary value of the animals and the education. What helps to explain the outsize impact is that participants started working more hours."

Critics of anti-poverty aid have charged that it encourages laziness, but in this case, the opposite happened. The assistance motivated people to work harder. The extra work was partly a rational calculation: Productive assets like cows or goats magnified the payoff from labor. But it’s also true that participants’ mental health improved, which likely made them able to work more.

Better mental health is also one of the striking benefits of the cash grants that the American nonprofit, GiveDirectly, has given to poor households in Kenya."
"Hope isn’t a cure-all. In none of these examples can we be certain that it actually explains the gains in people’s income or education. And instilling hope without skills or financial resources is unlikely to be enough to lift people out of poverty."
"unrealistically high aspirations can be so discouraging that they are harmful. Repeatedly falling short can deplete motivation.

Still, it is welcome news that poverty-alleviation programs can amplify the good they do just by making a better life seem — and actually be — within reach."

Saturday, July 14, 2018

Student-Debt Forgiveness Is a Wonderful Boon, Until the IRS Comes Calling

Education analysts, student advocates warn of impending crisis from one-time tax bills individuals may not be prepared to pay off

See By Josh Mitchell of The WSJ. Excerpts:
"The tax bills are a feature of the “income-driven repayment plans” that have been offered by the Education Department since 2007. One version of these plans allows borrowers to set their monthly student-loan payments at 10% of their discretionary income. The balances often grow over time because the payments aren’t big enough to cover accruing interest.

Private-sector workers pay for 20 or 25 years. At the end of that period, any remaining balance would be forgiven. Under federal tax rules, that disappearing debt is considered part of a borrower’s income for that given year, and taxed as such.

Those delayed tax bills are piling up. There are now 7 million borrowers owing $389 billion in income-driven repayment, according to the Education Department. The first borrowers likely won’t have debt expunged until 2027. As enrollment surges, education analysts and student advocates are warning of a potential crisis facing borrowers and the government down the road: huge one-time tax bills that individuals aren’t prepared to pay off.

With the inflating tax bills, the plans for some borrowers resemble “balloon payment” plans offered by some mortgage lenders, under which borrowers make low monthly payments for a period and then are required to make a big, one-time payment to pay off the sum. Some policy makers have criticized balloon payments as a form of risky lending."

"Taken altogether, Americans could be on the hook for tens of billions of dollars of one-time taxes down the road."

"borrowers in income-driven repayment plans to have an average of $41,000 forgiven. For borrowers in the 25% tax bracket, that could mean a tax bill of more than $10,000."

"many student-loan borrowers are unaware they will face a big tax bill."

"The government already garnishes Social Security checks and wages for retirees who failed to repay student debt."

"For those borrowers who don’t have enough money to cover tax bills, taxpayers would be on the hook."
Related posts:

Who Is Most Likely To Default On Their Student Loans?

Student loan delinquency is higher than for other borrowing

The Diminishing Returns of a College Degree: In the mid-1970s, far less than 1% of taxi drivers were graduates. By 2010 more than 15% were

Friday, July 13, 2018

Unemployment Has Bottomed Out. So Where's the Wage Growth?

By Michael R. Strain. He director of economic policy studies at the American Enterprise Institute (AEI).
"There is “hidden slack” in the labor market because many people were driven out of the workforce by the severity of the Great Recession. The composition of the workforce is changing in ways that affect measured, economy-wide pay. Businesses are using levers other than wages to attract workers. Many of us are in for pay cuts that we should have received during the Great Recession but didn’t due to employers’ reluctance to reduce nominal pay. And maybe you’re reluctant to go to the boss and ask for a raise?"
There could be slack since the percentage of 25-54 year olds, although rising, has still not reached the pre-recession peak. See last week's post The percentage of 25-54 year olds employed rose in June.

See also Labor Market Dynamics and Monetary Policy by former Fed Chair Janet Yellen.
"the sluggish pace of nominal and real wage growth in recent years may reflect the phenomenon of "pent-up wage deflation."15 The evidence suggests that many firms faced significant constraints in lowering compensation during the recession and the earlier part of the recovery because of "downward nominal wage rigidity"--namely, an inability or unwillingness on the part of firms to cut nominal wages. To the extent that firms faced limits in reducing real and nominal wages when the labor market was exceptionally weak, they may find that now they do not need to raise wages to attract qualified workers. As a result, wages might rise relatively slowly as the labor market strengthens. If pent-up wage deflation is holding down wage growth, the current very moderate wage growth could be a misleading signal of the degree of remaining slack."
Here is a graph from today's WSJ:

Thursday, July 12, 2018

Chaos ensues when stuffed bears are given away (almost) free of charge

See Build-A-Bear shuts down 'Pay Your Age' deal after huge crowds mob stores. By Kate Taylor of Business Insider. Excerpts:
"On Thursday, Build-A-Bear was set to celebrate "Pay Your Age Day" in the US, Canada, and the UK. Customers had the chance to purchase a stuffed animal and pay only their age for the day. Kids were able to pay just a few dollars for stuffed bears, while adults' fees were capped at $29. The bears usually fall in the $20-$35 range.

However, the event had to be cut short after stores descended into "madness."

"Per local authorities, we cannot accept additional Guests at our locations due to crowds and safety concerns," Build-A-Bear posted on Facebook at 11 a.m. ET. "We have closed lines in our U.S. and Canada stores. We understand some Guests are disappointed and we will reach out directly as soon as possible.""
If a kid who was five years old could by one for $5 that normally costs $35, that is 86% off. Not quite free, but close to it. These bears are scarce. Give them away for (almost) free and you don't have enough to go around.

Update on July 13: Build-A-Bear CEO apologizes after crowds shut down promo event by Susan Heavey of Reuters.

Related posts about problems when thing are given away for free:

Domino's & T-Mobile discover there is no such thing as free pizza. Too many took advantage of offer. They ran out.

What happens if you give electricity away for free? (Tesla post)

Taco Bell Gives Away "Free" Tacos, Problems Arise.

IHOP Gives Away Free Pancakes And Gets Slammed.

There Is No Such Thing As Free Salt (Or Sand) .

Trees Are Scarce In San Antonio!

Free Can Be Deadly.

More Free Give Aways Lead to Trouble.

Josh Hamilton’s grand slam causes a flooring and countertop shortage

Wednesday, July 11, 2018

Jason Furman on how GDP is estimated

The official top-line figure for the first quarter is 2%. A more accurate measure puts the rate at 2.8%.

See The Economy Is Growing Faster Than the Government Says. He was chair of the Council of Economic Advisors under President Obama. Excerpts:
"GDP is not measured directly. Instead, the BEA sums up economy-wide expenditures from dozens of data sources, covering consumption, investment, government spending, net exports and more.

Last month’s figure was the BEA’s third estimate for the first quarter. Yet at this stage the statisticians have comprehensive data on only 38.5% of GDP. Most of the rest was inferred using direct or indirect indicators, such as by taking the number of housing starts as a proxy for dollars invested in new home construction. For 12% of GDP, the statisticians used “trend-based data,” which essentially amounts to extrapolation and guess work."

"Producing the most accurate statistics can be costly, complicated and fraught with these kinds of measurement problems. Despite the best efforts of the BEA’s excellent civil servants, the underlying data are noisy and incomplete, meaning that revisions to GDP growth estimates can be large and often confusing. The average absolute revision from 1993 through 2016 was 1.3 percentage point."

"the BEA separately gauges the size of the economy by adding up all the different sources of income, such as wages and profits. This figure is called gross domestic income, or GDI, and in the first quarter of 2018 it grew by an estimated 3.6%, annualized.

Ultimately, GDI should be identical to GDP, since all money spent is money earned. But in practice the published estimates differ because the data are subject to different errors and reflect different guesses. Research shows that a simple average of GDP and GDI is a nearly optimal way to combine the two sets of information. For the first quarter it averages to 2.8% growth. That is the best predictor of what the government will eventually estimate for GDP after several years of revisions."

"As the economy entered a tailspin at the end of 2008, the original report for the fourth quarter had GDP growth at minus 3.8%. That was eventually revised to minus 8.2%."

Related posts:

How Long Have Economists Known About The Shortcomings Of GDP?

Okun's Law (on the relationship between GDP and the unemployment rate)

Tuesday, July 10, 2018

Monetary Policy and the Great Crash of 1929: A Bursting Bubble or Collapsing Fundamentals?

By Timothy Cogley. He was then at the Federal Reserve Bank of San Francisco (1999). He is now at New York University.
"In recent years, a number of economists have expressed concern that the stock market is overvalued. Some have compared the situation with the 1920s, warning that the market may be headed for a similar collapse. Indeed, some suggest that lax monetary policy contributed to the Great Crash and have argued that current monetary policy is also dangerously lax. For example, an April 1998 Economist article stated:
In the late 1920s, the Fed was also reluctant to raise interest rates in response to soaring share prices, leaving rampant bank lending to push prices higher still. When the Fed did belatedly act, the bubble burst with a vengeance.
To avoid the same mistake, The Economist suggested that it would be better for the Fed to take deliberate, preemptive steps to deflate the bubble in share prices. It warned that the bubble could harm the economy if it were to burst suddenly, reducing the value of collateral assets and bringing on a recession. The article went on to say that “the longer that asset prices continue to be pumped up by easy money, the more inflated the bubble will become and the more painful the economic after-effects when it bursts,” and it concluded that “the Fed needs to raise interest rates.”

In this Economic Letter, I argue that The Economist has misinterpreted the lessons of the Great Crash. A closer examination of the events of the late 1920s suggests it is mistaken on at least four points. First, stock prices were not obviously overvalued at the end of 1927. Second, starting in 1928 the Fed shifted toward increasingly tight monetary policy, motivated in large part by a concern about speculation in the stock market. Third, tight monetary policy probably did contribute to a fall in share prices in 1929. And fourth, the depth of the contraction in economic activity probably had less to do with the magnitude of the crash and more to do with the fact that the Fed continued a tight money policy after the crash. Hence, rather than illustrating the dangers of standing on the sidelines, the events of 1928-1930 actually provide a case study of the risks associated with a deliberate attempt to puncture a speculative bubble.

Monetary Policy 1927-1930 

In 1927, there was a mild recession in the United States. In addition, Britain was threatened by a balance of payments crisis whose proximate cause was a demand by France to convert a large quantity of sterling reserves into gold. Thus, both domestic and international conditions inclined the Fed to shift toward easing. The resulting fall in interest rates helped damp the decline in domestic economic activity and facilitated an outflow of gold toward Britain and France.

Should the Fed have refrained from easing in 1927 because of concerns that the stock market might be overvalued? Measures of conventional valuation suggest the answer is no, for there was no obvious sign of an emerging bubble at that time. For example, Figure 1 illustrates the price-dividend ratio on the value-weighted New York Stock Exchange (NYSE) portfolio. At the end of 1927, the price-dividend ratio was around 23, which is actually a bit below its long-run average of 25. Although share prices had risen rapidly in the 1920s, so had dividends. Given that the price-dividend ratio was slightly below average, the Fed would have had little reason to refrain from easing in a recession year or to decline assistance to a gold standard partner in maintaining balance of payments equilibrium.

In any case, equity prices began to accelerate in January 1928, and they rose by 39% for the year. Dividend payments also grew rapidly that year, and the price-dividend ratio increased by 27%.
Motivated by a concern about speculation in the stock market, the Fed responded aggressively. Between January and July 1928 the Fed raised the discount rate from 3.5% to 5%. Because nominal prices were falling, the latter translated into a real discount rate of 6%, which is quite high in a year following a recession. At the same time, the Fed engaged in extensive open market operations to drain reserves from the banking system. Hamilton (1987) reports that it sold more than three-quarters of its total stock of government securities: “in terms of the magnitudes consciously controlled by the Federal Reserve, it would have been difficult to design a more contractionary policy.”

Furthermore, as Eichengreen (1992) has emphasized, monetary policy was tight not only in the U.S. but also throughout much of the rest of the world. By that time, roughly three dozen countries had returned to the gold standard, and when the Fed tightened, many countries faced a dilemma: Unless their central banks also tightened, lending from the U.S. would be disrupted and their balance of payments would move toward a deficit. In that case, they would either have to devalue or abandon the gold standard altogether. The former option was unattractive for countries with dollar-denominated debts, and the latter was virtually out of the question at the time, especially for countries where restoration of the gold standard had been painful and difficult.

The alternative was to conform with the Fed. By shifting toward more contractionary monetary policies, other gold standard countries could ensure that domestic interest rates would rise in parallel with those in the U.S. and would be able to maintain balance of payments equilibrium. This explains, for example, why the Bank of England shifted toward tighter policy in 1928, three years after Britain had entered a slump. It also explains why countries still rebuilding from WWI would adopt contractionary policies.

The implication is that monetary policy was far more restrictive than a purely domestic perspective might suggest. In 1928 there was a synchronized, global contraction of monetary policy, which occurred primarily because the Fed was concerned about stock prices. These actions had predictable effects on economic activity. By the second quarter of 1929 it was apparent that economic activity was slowing. The U.S. economy peaked in August and fell into a recession in September.

What were the effects on the stock market? At the beginning of 1929, it seemed that the contractionary measures taken in 1928 were working. The NYSE price-dividend ratio reached a local peak in January and then fell gradually through the first half of the year. Thus, it appeared that stock prices had stabilized. Furthermore, shares still were not obviously overvalued. The local peak was reached at 30.5, which is roughly 20% above the long-term average. Dividends had grown rapidly through 1928, and investors projecting similar growth rates forward may have been willing to settle for dividend yields somewhat below the long-run average.

Monetary policy was on hold during the first half of 1929, and some economists have argued that inaction in this period was responsible for the events that followed. But three observations are relevant here. First, as mentioned above, price-dividend ratios had stabilized and were falling gradually. To a contemporary observer, it would have appeared that the actions of 1928 were having the intended effects. Second, it was becoming increasingly apparent that general economic activity was slowing, and many other countries already had entered recessions. And third, while monetary policy was not becoming tighter, it was still quite tight. Short-term real interest rates were still around 6%, and there was no growth in the monetary base.

Price-dividend ratios continued to fall until July 1929, but then prices began to take off. In August, the Fed raised the discount rate by another percentage point to 6%. The stock market peaked in the first week of September. It is worth noting that at its peak the price-dividend ratio was 32.8, which is well below values reached in the 1960s or 1990s. Share prices declined in a more or less orderly fashion until the end of October, but then the market crashed. From its peak, the price-dividend ratio fell roughly 30%, to a level roughly similar to that prevailing at the beginning of 1928, when the Fed began to tighten.

In the immediate aftermath of the crash, the New York Fed took prompt and decisive action to ease credit conditions. When investors attempted to liquidate their equity holdings, many lenders also called their loans to securities brokers. With the encouragement of officials at the New York Fed, many of these brokers’ loans were taken over by New York banks, who were allowed to borrow freely at the discount window for this purpose. The New York Fed also bought government securities on its own account in order to inject reserves into the banking system. In this way, they were able to contain an incipient liquidity crisis and prevent the crash from spreading to money markets.

But this respite from tight money proved to be temporary. After the liquidity crisis had been contained, monetary policy once again resumed a contractionary stance. Throughout 1930, officials at the New York Fed repeatedly proposed that the System buy government securities on the open market, but they were systematically rebuffed. The reasons other members of the Federal Reserve gave for opposing monetary expansion are instructive. Several felt that much of the investment undertaken in the previous expansion was fundamentally unsound and that the economy could not recover until it was scrapped. Others felt that a monetary expansion would only ignite another round of speculative activity, perhaps even in the stock market. In any event, monetary policy remained contractionary; the monetary aggregates fell by 2% to 4%, and long- term real interest rates increased.

By maintaining a contractionary stance throughout 1930, after a recession had already begun, the Fed contributed to a further decline in economic activity and share prices. By the end of the year, the price-dividend ratio had fallen to 16.6, or roughly 34% below the long-run average. By then, there was a consensus that speculative activity had been eliminated!

Were the Fed’s actions stabilizing or destabilizing?

If one grants that a speculative bubble existed at the beginning of 1928, when the Fed began to tighten, then stocks must have still been overvalued in the aftermath of the crash. After all, price-dividend ratios were about the same in the dark days of November 1929 as at the beginning of 1928, and fundamentals must surely have taken a turn for the worse. If equities were still overvalued, it follows that a further dose of contractionary monetary policy was needed to purge speculative elements from the market. Perhaps this is what motivated the famous advice of Treasury Secretary Andrew Mellon to President Herbert Hoover, to “liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.” To argue that the actions of 1928-1930 were stabilizing, one must adopt the liquidationist position.

On the other hand, if one interprets the Great Crash as a bursting bubble, so that shares were more or less properly valued in the aftermath, then it follows that they were probably also not far from their fundamental values at the start of 1928, when the Fed began to tighten. Again, prices and price-dividend ratios were about the same after the crash, and fundamentals had surely become less favorable. According to this interpretation, the Fed’s initial actions may have been destabilizing, and the actions of 1930 certainly were.


In retrospect, it seems that the lesson of the Great Crash is more about the difficulty of identifying speculative bubbles and the risks associated with aggressive actions conditioned on noisy observations. In the critical years 1928 to 1930, the Fed did not stand on the sidelines and allow asset prices to soar unabated. On the contrary, its policy represented a striking example of The Economist’s recommendation: a deliberate, preemptive strike against an (apparent) bubble. The Fed succeeded in putting a halt to the rapid increase in share prices, but in doing so it may have contributed one of the main impulses for the Great Depression."