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

Seminar paper from the year 2016 in the subject Business economics - Economic and Social History, grade: 5, University of Zurich, language: English, abstract: 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 supply shocks on the output growth and inflation. Therefore, we use an impulse response and a Forecast Error Variance Decomposition to illustrate our results.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. he gold standard as a consequence has led to an overvaluation of the Dutch currency (guilder). For a small open economy like the Netherlands 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 population, 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 standard 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.