DSGE
VIP Member
- Dec 24, 2011
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It didn't happen because aggregate demand had been permanently increased.
how do you permanently increase demand when war demand was mostly for weapons that had no permanent use? You have described a bubble without realizing it.
You permanently increase it with a permanent monetary expansion. During the Depression the Fed doubled (I think. You'll have to check, but they increased it anyway) the monetary base. It wasn't expansionary though because of the gold standard; everybody knew that in the long run base money is constrained by the quantity of gold, so it'd have to be taken out. And temporary monetary injections aren't expansionary. What the war did was result in so much government debt that it had to be monetized. That created a permanent increase in the money base which resulted in a permanent increase in the price level and NGDP.
To be clear, I don't want the government to spend money or enter into excessive debt. I don't want demand increased through fiscal stimulus. I want monetary stimulus. So it would have had the same effect (actually it would have been much better) if there were no WWII which required government spending and instead they just devalued the exchange rate of gold.