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

In this paper, we analyze the International Great Depression 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 e¢ ciency 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 áuctuation during the interwar period. Our main Öndings are that labor market distortions accounted for two-thirds of the output drops in both the U.S. and Western Europe, endogenous factor utilization ampliÖed the negative e§ects 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.