E¢ ciency, Distortions and Capital Utilization during the Interwar Period

Over the past 80 years, the source and mechanism of the International Great Depression (IGD) has been a heated topic of interest with little consensus on the horizon. In this paper, we compare the Great Depressions in the US and Western Europe using the business cycle accounting method a la Chari, Kehoe and McGrattan (CKM 2007). We extend the business cycle accounting model by including endogenous capital utilization in order to improve the measurement of production e¢ ciency during the interwar period. Our main …ndings are that distortions in the labor market are by far the most important source of the Western European Great Depression; distortions in production e¢ ciency, labor and investment markets all contributed to the Great Depression in the US; and unlike the …ndings of CKM (2007), distortions in the investment markets in both economies a¤ect output in both economies through the endogenous ‡uctuation in capital