Grades 6-8, 9-12
How to Play the Fiscal Ship
‘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.
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 "Consumer Price Index, 1913- .
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.
[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.]
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 "An Interview with Milton Friedman."]
Consider the written passages and graphs in "Are Money Growth and Inflation Still Related?"
To answer the following questions: [NOTE: This exercise requires that you download the information into Adobe Acrobat.]
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
Grades 6-8, 9-12