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FEDS Notes

August 30, 2016

Inflation Expectations in the Recovery from the Great Depression

Andrew Jalil and Gisela Rua

One way to successfully stimulate an economy when nominal interest rates have hit the zero lower bound (ZLB) is to increase inflation expectations, thereby reducing the real rates of interest that presumably affect business and household spending decisions. While the literature has provided ample support for managing inflation expectations as a central part of monetary policy at the ZLB, less is known about what policies can actually affect these expectations and whether they can bring recovery. In this note, we draw on our recent research on the role of inflation expectations in the recovery from the Great Depression of the 1930s (Jalil and Rua, 2016a and 2016b) to provide insights into the actions that can successfully shift inflation expectations and stimulate economic recovery.

In the spring of 1933, after four years of deflation and economic depression, Franklin Roosevelt was elected President of the United States. While his election campaign was marked by optimism and commitment to recovery, he did not present a detailed economic plan for taking the country out of the Depression. As a result, it was generally believed that his policies would not be substantially different from President Hoover's. However, beginning in April 1933, President Roosevelt implemented a new inflationary macroeconomic policy regime. This new regime represented a radical break with previous policies (Temin and Wigmore (1990), Eggertsson (2008), Romer (2013)).

Did inflation expectations shift?
Did this new regime change inflation expectations? An obstacle in answering this question is that the data used today to derive estimates of inflation expectations--such as Treasury Inflation-Protected Securities (TIPS), the Michigan Survey of Consumers, or the Survey of Professional Forecasters--did not exist for the 1930s. As such, we gather new evidence from the narrative record on market participants' inflation expectations. We examine three types of narrative evidence.

First, news coverage of inflation surged in April 1933. Across five major daily newspapers, the number of news articles containing the terms inflation or inflationary more than tripled from January to April. The rise is even more dramatic if compared with 1932. In April 1933, the daily average number of news articles containing the terms inflation or inflationary was seven times higher than the 1932 daily average. This evidence indicates a surge in public discussion about inflation in the spring of 1933.

Second, the reports of contemporary observers contained in two historical news sources Business Week and the Economist show a shift in expectations of inflation in the second quarter of 1933. We find a dramatic change in public perception about the likelihood of inflation after the exit from the gold standard--the critical turning point. Business Week wrote, "Inflation has begun"1 and concluded that "the long debate as to whether we are or are not going to attempt inflation is over--the Administration is committed."2 The Economist concurred in this assessment, affirming that a key reason for the abandonment of the gold standard was "to give an impetus to a rise of prices in America."3 In addition, several subsequent actions and statements further established the new policy regime: Congress passed the Thomas Inflation Amendment, granting Roosevelt broad powers to inflate; the Federal Reserve, at the behest of the Roosevelt Administration, engaged in open-market purchases of government securities to increase the money supply; and the Federal Reserve Bank of New York reduced its rediscount rate to encourage bank lending. Moreover, Roosevelt repeatedly pledged to raise prices to their pre-Depression levels, nullified the gold clause, and declared to the rest of the world, in a message to the World Economic Conference, that his Administration rejected the measures for currency stabilization being discussed and would not be deterred from its program to raise prices in the United States. Together, these events created the general notion that prices were going to rise. For example, on May 10, an advertisement appeared in Business Week with the headline "Inflation Will Catch You IF YOU DON'T WATCH OUT."

Third, the forecasts of contemporary business analysts moved toward inflation during the second quarter of 1933. The Magazine of Wall Street, Moody's Investment Survey, Standard Statistics Company's Standard Trade and Securities, Business Week, the Harvard Economic Society's Review of Economics and Statistics, and Irving Fisher's Trade and Money Index published real-time forecasts of prospective macroeconomic developments, as a component of the investment advice offered to their readers. Despite some variation in the timing and magnitude of their inflation forecasts, all six forecasters expected inflation at some point during the second quarter of 1933. Moreover, Roosevelt's policies, actions, and statements caused the forecasters to predict inflation.

What were the key events that shifted inflation expectations?
The above evidence shows that inflation expectations increased in the second quarter of 1933. What were the events that played a key role in this shift in expectations? Based on evidence we gather from two daily newspapers, the New York Times and the Wall Street Journal, we identify five inflationary news shocks--events that increased the likelihood of inflation in the eyes of contemporary observers--between April 1 and July 31: (1) the abandonment of the gold standard, combined with a pledge by Roosevelt to raise prices (April 19), (2) the passage of the Thomas Inflation Amendment in the Senate (April 28), (3) the announcement of open-market operations (May 24), (4) the announcement of the government's decision to repeal the gold clause, alongside overnight news of a reduction in the rediscount rate of the Federal Reserve Bank of New York (May 26), and (5) Roosevelt's rejection of a plan to stabilize the value of the dollar at the World Economic Conference (June 19). Using the dates of these events, together with daily stock price and exchange rate data, we find in an event-study analysis that these inflationary events had significant effects on financial markets. On average, an inflationary event was associated with a 5-percent increase in stock prices and a 2-percent depreciation of the dollar by the close of the market on the day of the event. Further, in a similar event-study analysis using weekly data on durable and nondurable industry stock prices, we find that inflationary news shocks are associated with larger increases in the stock prices of durables, than of nondurables.

Did the shift in inflation expectations stimulate the recovery?
Given that inflation expectations shifted, the next crucial question is whether the increase in inflation expectations stimulated real economic recovery. The narrative accounts indicate that the shift in inflation expectations had large immediate effects on spending and production because Roosevelt's pledge to raise prices to their pre-Depression levels--in essence, a form of price-level targeting--induced market participants to believe that inflation was imminent and, thus, that they needed to act quickly. Since nominal interest rates were so low in early 1933, this shift to higher inflation expectations stimulated consumption and investment by lowering ex ante real interest rates (Romer (1992, p. 775)).

Specifically, the narrative accounts we have identified noted that consumers rushed to buy goods in expectation of higher future prices and firms raised production in anticipation of growing consumer demand and higher input costs:

The depreciation of the dollar gave rise to fear--or hope--of inflation, which made people anxious to transfer their money into goods. (Economist, July 8, 1933)

It is already being appreciated that the remarkable expansion in industrial activity is partly in anticipation of a rise in working costs and partly a gamble on a sustained increase in consumption. (Economist, July 15, 1933)

The data corroborate these reports: retail sales and industrial production surged in the second quarter of 1933. Firms also started to build up inventories; manufacturers' inventories began to rise in July 1933 and increased through the rest of the year.

In addition, higher inflation expectations stimulated aggregate spending by raising expectations of future growth and consumer and business confidence. Four years of deflation and depression led many contemporaries to associate deflation with depression and inflation with recovery. As such, the Economist talked about the psychological optimism and renewed confidence that gripped the nation after Roosevelt pledged to a platform of deliberate inflation:

There is a sense, both at Washington and throughout the country, of confidence, almost amounting to elation, that action will be taken to grapple with the forces that have brought about the depression. (Economist, May 27, 1933)

American business men began to regain their lost confidence as soon as President Roosevelt indicated his intention to stop the deflation which has been dragging prices and business down. . . . Confidence began to return as soon as it became certain that currency deflation was to be succeeded by currency reflation. (Trade and Money Index, May 8, 1933)

Finally, higher expected inflation had expansionary effects on the economy by breaking Fisher's debt-deflation vicious cycle (Fisher, 1933). Indeed, the narrative evidence suggests that the increase in inflation expectations stimulated the recovery through various mechanisms.

The setback in the fall of 1933
After four months of rapid growth between April and July, the recovery experienced a setback between August and November. Our narrative evidence indicates that inflation expectations moderated suddenly in August as a result of a backpedalling from Roosevelt in his commitment to an inflationary regime. (The Roosevelt Administration revealed that it planned to use the newly implemented National Industrial Recovery Act, rather than inflation, to sustain the recovery.) Not only did the forecasters stop predicting inflation, but after July, there was also a sharp rise in the share of news shocks that were perceived to decrease the prospects of inflation. This sudden reversal of inflation expectations, alongside a few other forces (see, for example, Taylor and Neumann (2016)), played a role in the setback. Nonetheless, the Great Contraction had ended and, with the exception of 193637, the recovery continued through World War II.

To summarize, our findings indicate that inflation expectations changed radically during the second quarter of 1933. We also gather new evidence linking inflation expectations with both the turnaround recovery in the spring of 1933 and setback in the fall. More broadly, our research suggests that, under the right set of conditions, a combination of bold measures and ample public communication of policy objectives can dramatically shift expectations and set a recovery in motion.

Eggertsson, Gauti B. 2008. "Great Expectations and the End of the Depression." American Economic Review, vol. 98(4): pp. 1476516.

Fisher, Irving. 1933. "The Debt-Deflation Theory of Great Depressions." Econometrica, 1(4): pp. 337357.

Jalil, Andrew J. and Gisela Rua. 2016a. "Inflation Expectations and Recovery in Spring 1933." Explorations in Economic History, forthcoming.

Jalil, Andrew J. and Gisela Rua. 2016b. "Inflation Expectations in Fall 1933." Working paper.

Romer, Christina D. 1992. "What Ended the Great Depression?" Journal of Economic History, vol. 52(4): pp. 75784.

Romer, Christina D. 2013. "It Takes a Regime Shift: Recent Developments in Japanese Monetary Policy Through the Lens of the Great Depression." In NBER Macroeconomics Annual, ed. Jonathan A. Parker and Michael Woodford. Cambridge, Mass.: MIT Press, pp. 383400.

Taylor, Jason E. and Todd C. Neumann. 2016. "Recovery Spring, Faltering Fall: March to November 1933." Explorations in Economic History, vol. 61: pp. 5467.

Temin, Peter and Barrie A. Wigmore. 1990. "The End of One Big Deflation." Explorations in Economic History, vol. 27(4): pp. 483502.

1. "Inflation Begins," Business Week, April 26, 1933. Return to text

2. "We Start," Business Week, April 26, 1933. Return to text

3. "The Fall of the Dollar," Economist, April 22, 1933. Return to text

Please cite as:
Jalil, Andrew J., and Gisela Rua (2016). "Inflation Expectations in the Recovery from the Great Depression," FEDS Notes. Washington: Board of Governors of the Federal Reserve System, August 30, 2016,

Disclaimer: FEDS Notes are articles in which Board economists offer their own views and present analysis on a range of topics in economics and finance. These articles are shorter and less technically oriented than FEDS Working Papers.

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Last update: August 30, 2016