Accounting for the International Great Depression: Efficiency, Distortions and Factor Utilization during the Interwar Period

Abstract In this paper, we analyze the International Great Depression (IGD) in the U.S. and Western Europe by applying the business cycle accounting method to a dynamic stochastic general equilibrium model with time-varying production efficiency and factor market distortions. We measure the size of labor and capital market distortions with endogenous factor utilization and their relative importance in accounting for output fluctuation during the interwar period. Our main findings are that labor market distortions accounted for two-thirds of the output drops in both the U.S. and Western Europe, endogenous factor utilization amplified the negative effects of labor market distortions, and government spending played an important role in the recovery from the Great Depression in European countries who left the Gold Standard in the early 1930s.