‘The Wizard of Oz’ is perhaps the most popular film ever made. Generations of families have enjoyed this classic tale of Dorothy’s struggle to return home from a faraway land. What is not well known, however, is that ‘The Wonderful Wizard of Oz,’ the 1900 book authored by L. Frank Baum (upon which the movie is based), is a thinly veiled economic and political commentary on the debate over ‘sound money’ at the end of the 1800s in the United States. What in the world could Baum’s happy fantasy have to do with monetary policy? This EconomicsMinute examines the historical relationship between the money supply and the price level. This analysis helps us to understand the effects of the current deflation in the Japanese economy as well as the length and severity of the Great Depression in the United States in the 1930s. This lesson points out why it is so important for a central bank to strike a balance between inflationary and deflationary concerns.
"The Wizard of Oz" is perhaps the most popular film ever made. Generations of families have enjoyed this classic tale of Dorothy’s struggle to return home from a faraway land. What is not well known, however, is that "The Wonderful Wizard of Oz," the 1900 book authored by L. Frank Baum (upon which the movie is based), is a thinly veiled economic and political commentary on the debate over "sound money" at the end of the 1800s in the United States. What in the world could Baum’s happy fantasy have to do with monetary policy?
This EconomicsMinute examines the historical relationship between the money supply and the price level. This analysis helps us to understand the effects of the current deflation in the Japanese economy as well as the length and severity of the Great Depression in the United States in the 1930s. This lesson points out why it is so important for a central bank to strike a balance between inflationary and deflationary concerns.
- Explain that deflation occurs when the average price level falls.
- Explain that deflation can be associated with a contraction of economic activity and heightened unemployment.
- Explain that inflation and deflation over long periods of time are primarily monetary phenomena.
Consumer Price Index 1913-: This Federal Reserve Bank of Minneapolis site contains the Consumer Price Index from 1913 to the present day.
Should We Worry About Deflation: This 2003 BBC Business article discusses if deflation is a legitimate concern.
The Case for Deflation: This 1998 Minnesota Public Radio article discusses some of the effects of deflation.
Deflation History: This Minnesota Public Radio article provides some deflation history from the past few centuries.
An Interview with Milton Friedman: This site provides an interesting interview with Nobe laureate Milton Friedman.
Are Money Growth and Inflation Still Related?: This Federal Reserve Bank of Atlanta PDF provides an article discussing the relationship between money growth and inflation.
What is Deflation?
The U.S. price level has increased continually for virtually the entire past half-century. Against this inflationary backdrop, it is hard to imagine that a number of respected observers are now concerned about deflation. Deflation refers to a decline in the average level of prices. See "https://www.minneapolisfed.org/community/financial-and-economic-education/cpi-calculator-information/consumer-price-index-and-inflation-rates-1913 .
In what years since 1913 did the United States experience deflation? [1921, 1922, 1927, 1928, 1930-1933, 1938, 1939, 1949, 1955.]
What happened to the price level during the Great Depression of the 1930s? [It declined in six out of ten years during the 1930s. The price level was lower at the end of the decade than it was at the beginning.]
- What recent trends can you identify regarding U.S. inflation? [The price level has continued to grow in the 1990s, but at a decreasing rate. Inflation has slowly declined to less than two percent.]
While lower prices for goods and services sounds desirable, this can lead to falling incomes and can force net debtors to repay loans in future dollars that have higher value (in terms of their ability to purchase lower-priced goods and services) than the dollars they borrowed in the first place. For any given nominal interest rate (these are the rates that are observed each day in financial markets), an expectation that the price level will continue to fall implies a higher real cost of making loan payments.
According to the author, when did deflation really hit? [During the global depression of the 1930s.]
What happened to the global economy during that time? Spending dropped sharply, leading to a general decline in prices.]
How did governments respond to the depression? [By adopting fiscal austerity programs, exactly the opposite of what they should have done.]
How does the depression of the 1930s compare to Japan's situation in the 1990s? [While Japan has not experienced economic problems of the magnitude of the 1930s global depression, the Japanese people have faced stagnant economic growth for most of the 1990s. Associated with this is a decline in many prices. Some observers feel that Japanese policy makers have not done enough to stimulate domestic demand.]
- Is the United States in danger of a wave of deflation on the order of that experienced in the 1930s? [Probably not. While commodity prices are falling and cheap Asian goods are forcing the United States to run a trade deficit with several countries in the Pacific Rim, a 1930s style period of deflation is unlikely because the Federal Reserve will not allow the U.S. money supply to contract as it did during the Great Depression.]
[NOTE: For another source of information on the effects of deflation, see "The Case for Deflation." Here you will find a discussion about the causes and consequences of deflation along with an eleven-minute Real Audio sound feature.]
We’re Off to See the Wizard
The final thirty years of the nineteenth century in the United States were characterized by deflation. The deflation had a particularly adverse impact on the agricultural sector. Many farmers faced mortgage obligations that they were unable to meet as a result of declining agricultural prices and falling farm incomes. Farmers (in concert with the Populists, a political movement that presumably reflected the interests of "common people") called for the U.S. monetary system to be expanded to include the convertibility of silver into U.S. dollars. At the time, the United States was on a gold standard. For various reasons, we experienced frequent reductions in our gold supply, leading to a contraction in the money supply and deflation. The call to permit the convertibility of silver was thus an attempt to expand the money supply, "reflate" the economy, and lower farmers’ (and others') burden of repaying mortgage debt. Note that those who opposed introducing silver into the monetary system argued, among other things, that this would prove inflationary (which the farmers probably would have found desirable) and could even lead to stagflation, the simultaneous occurrence of economic stagnation and accelerating inflation. Thus, for the most part, those opposed to silver had "good intentions."
In "The Wizard of Oz as a Monetary Allegory" (Journal of Political Economy, 1990, vol. 98, no. 1, pp. 739-60), economist Hugh Rockoff relates the characters in L. Frank Baum’s classic to various parties in turn-of-the-century America. According to Rockoff, Dorothy represents traditional American values; the Scarecrow represents farmers; the Tin Woodman represents industrial workers; the Cowardly lion represents William Jennings Bryan, the unsuccessful Democratic presidential candidate and the standard bearer for the silver movement; the Wicked Witch of the West represents President William McKinley; and the Wizard of Oz represents Marcus Alonzo Hanna, the chairman of the Republican party, depicted by Baum as a person who makes promises but ultimately cannot be trusted (recall the unkept promises made by the Wizard of Oz when Dorothy and her companions returned to Oz with the witch's broom.)
When Dorothy’s house falls on the Wicked Witch of the East, the silver (yes, Hollywood script writers changed the color of her slippers to ruby red) slippers are transferred to Dorothy’s feet. Dorothy then sets out on a journey to Emerald City (a green city meant to be the nation’s capital, that represents money) following a yellow brick road (this represents the gold standard) where the Wizard of Oz can help her find her way home. Dorothy, of course, ultimately discovers that the answers she seeks are not to be found in the Emerald City (Washington, DC) and that following the yellow brick road (the gold standard) is not the answer to her problems. After her journey, Dorothy discovers that she could have solved her problems all along by making a wish and clicking her (silver) slippers three times. [Baum is thus attempting to tell us that strict adherence to the gold standard is not the solution to the nation's problems. In his reference to the silver slippers, he is calling for the U.S. monetary system to be expanded to include the convertibility of silver to U.S. dollars.]
To find a discussion of "The Wizard of Oz" as it relates to turn-of-the century concerns over deflation in the United States, see "Deflation History."
[NOTE: In addition to the print material, you will find a nine minute Real Audio sound feature including the original voices of the cast of "The Wizard of Oz". If your computer capabilities allow for you to use this feature, it will add to the "mystique" of the lesson.]
How did the collapse of the railroad industry contribute to the economic despair experienced by farmers in the 1890s? [The effects of the collapse hit hardest in farm country, where farmers depended on railroads to transport agricultural commodities.]
How does the term "Oz" relate to the monetary system debate? ["Oz" is the abbreviation of ounce, the unit of gold that is used to express the value of gold in U.S. dollars.]
- What factor is identified as ultimately leading to an easing of deflation? [A steady flow of immigrants which created a new, cheaper source of labor and a vast new pool of consumers. That is, immigration led to a reduction in costs of production and an increase in aggregate demand.]
Money, Inflation, and Deflation
One of the most famous phrases in modern economics is that "inflation is always and everywhere a monetary phenomenon." This statement, made by Nobel laureate Milton Friedman, suggests that the principal factor influencing the movement of the price level over time is the growth rate of the money supply. [Note: For an interesting 1992 interview with Milton Friedman, see "https://www.minneapolisfed.org/publications/the-region/interview-with-milton-friedman."]
Consider the written passages and graphs in "https://www.atlantafed.org/-/media/Documents/research/publications/economic-review/1999/vol84no2_dwyer-hafer.pdf"
To answer the following questions: [NOTE: This exercise requires that you download the information into Adobe Acrobat.]
What is the international evidence on the relationship between M2 growth and inflation? [Over long periods of time, inflation is strongly associated with money growth in countries around the globe.]
What is the U.S. evidence on the relationship between M2 growth and inflation? [Over long periods of time, there appears to be a close association between inflation and money growth. Even though there remains a positive correlation between money growth and inflation over the short run, the relationship is not as strong.]
What is the Quantity Theory of Money? [It is the theory that predicts that, over long time periods, the primary factor determining inflation is the rate of money growth. It is the intellectual underpinning for Friedman’s statement that "inflation is always and everywhere a monetary phenomenon."]
- Can you think of some non-monetary events that can cause short run changes in the price level? [Answers will vary, but the possibilities include productivity shocks, changes in consumer and firm optimism that cause businesses and households to alter their spending plans, random shocks associated with weather, changes in the prices of productive inputs such as labor and energy, etc.]
The graphs referenced above appear to support the idea that over long periods of time, the quantity of money determines a country’s price level. This means, conversely, that deflation arises from a money supply that is either declining or growing very slowly.
A Return to Oz?
As the film closes, viewers discover that Dorothy’s adventures in the land of Oz are only a dream. As we have seen, however, a prolonged period of deflation can have real economic effects. Our experiences during the Great Depression are direct evidence of the human misery that can be caused by a continual decline in the price level. History now teaches us that inflation (and thus deflation) is indeed a monetary phenomenon. A country caught in a deflationary spiral will want to consider policies to expand money growth as well as to stimulate aggregate demand. This issue will be considered in the forthcoming EconomicsMinute titled "The Wizard of Oz Visits Japan."
[NOTE: Optional Extension Activity. Refer to "Inflation as a Monetary Phenomenon" procedures 6-12 in "Money, Interest, and Monetary Policy," Lesson 20 in Focus: High School Economics (Council for Economic Education: New York, 1997, pp. 187-197.) This activity involves increasing the quantity of money over three rounds to illustrate that the prices paid for the exact same items will increase when the money supply rises. To illustrate the effects of deflation, simply reverse the procedures. That is, start with a large money supply and then decrease it in successive rounds. This will confirm that the price level falls when the money supply declines.]
Additional funding for this lesson was provided by the Mortgage Bankers' Association of America