Transcript Document 7729472

It’s Crunch Time, Ben!
The Financial Accelerator
EH 447, 2008/9
Week 4-2
Albrecht Ritschl
“The Great Depression is the Holy
Grail of Macroeconomics”
Ben Bernanke,
Essays on the Great Depression (2000)
Key economic concepts
 Yield differentials / credit spread :
interest rate differential between two bonds
of same maturity.
– This type of spread measures credit default risk
(if both bonds in same country and currency)
 Yield spread between corporate bonds and
Treasury bonds
Key economic concepts (cont’d)
 Cost of Credit Intermediation (CCI)
– Information asymmetries between
borrowers and lenders (Stiglitz & Weiss,
1981, extensive literature)
– “Bad” mimic “good” borrowers
– Credit rationing as an attempt to minimize
incentive problems
– CCI as result of monitoring, building long
term relationships, enforcement cost etc
Key economic concenpts (cont’d)
 Debt deflation, Irving Fisher (1933)
Debt contracts written in nominal units [$, £
etc., w/o price index clauses]
Price fall of underlying asset
 causes negative equity
 may cause firesale in case of debt default
 Feeds back on price declines of underlying
asset
Debt deflation (cont’d)
 But if nominal debt is so bad, then why
are such contracts written in the first
place (instead e.g. of a profit share)?
Gale and Hellwig (1985): because of high
cost of / difficulties in verifying debtor’s
true profits
 Even easier if debtor provides collateral
Bernanke (1983)
Great Depression aggravated by financial
market problems
 Debt deflation of values of collateral
(much like 2007-? housing slump)
Nominal debt contract more risky, CCI 
Resort to complicated risk sharing contracts
(then again, CCI ) or
Just reduce lending, even to solvent
customers, to reduce CCI
Baa Yield Spread Over Treasury Bonds
9
8
7
6
Bank of the
United
States
Collapse,
12/1930
5
4
3
2
1
1933:01
1932:07
1932:01
1931:07
1931:01
1930:07
1930:01
1929:07
1929:01
0
1933.01
1932.01
1931.01
1930.01
1929.01
1928.01
1927.01
1926.01
1925.01
1924.01
1923.01
1922.01
1921.01
mill. US $
Deposits in Failed Banks
(NBER m09039)
500
450
400
350
300
250
200
150
100
50
0
1933.01
1932.07
1932.01
1931.07
1931.01
1930.07
1930.01
1929.07
1929.01
1928.07
1928.01
1927.07
1927.01
1926.07
1926.01
1925.07
1925.01
1924.07
1924.01
1923.07
1923.01
1922.07
1922.01
1921.07
1921.01
Numbers of Business Failures
4000
3500
3000
2500
2000
1500
1000
500
0
0
1938.01
1937.01
1936.01
1935.01
1934.01
1933.01
1932.01
1931.01
1930.01
1929.01
1928.01
1927.01
1926.01
1925.01
1924.01
1923.01
1922.01
1921.01
Number of Business Failures
4000
3500
3000
2500
2000
1500
1000
500
1933.01
1932.01
1931.01
1930.01
1929.01
1928.01
1927.01
1926.01
1925.01
1924.01
1923.01
1922.01
1921.01
mill US $
Liabilities of Failed Businesses
120
100
80
60
40
20
0
Some finer points
 Financial channel is not about 1929
 Most banking problems not endogenous
to fall in output
 Instead caused by exogenous events
 This is most important for comparison
to 2008
 Output may be endogenous to banking
U.S. crisis 1929: a timeline
 Since 1928: NYSE stock market boom
 August 1929: Upswing in real investment
stops
 24 and 29 October 1929: stock market
crash
 Towards end of 1929:
– Decline in output, price levels
– Stock market quite resilient after initial shock
– Bold steps by Fed to lower interest rates
U.S. crisis 1930: a timeline
 Throughout 1930: further slide into
depression, very low interest rates
 June 1930: protectionist
Hawley/Smoot tariff
 December 1930: Bank of U.S. fails,
increased failures of rural banks
U.S. crisis 1931-32: a timeline
 Mid-1931: renewed banking panics
(banking troubles also in Ctrl Europe)
 Sept 1931: another wave of panic
(after UK’s departure from Gold Standard)
 Dec 1932: yet another panic
(after UK, F default on wartime credits, F
withdrawal of gold from NY)
U.S. crisis 1933: a timeline
 March 1933: Emergency Banking Act
(Bank Holidays, reopening of banks after
federal inspection)
 June 1933: (2nd) Glass-Steagall Act
(separation of deposit and investment
banking, federal deposit insurance, state
banking system, far-reaching regulation)
 Steep upswing sets in
International banking crisis 1931
 Austrian Creditanstalt crisis in May
 German banking crisis in July
– Bank run / bank holidays
– Forced merger of two of top 5 banks
– Part nationalisation of top 5 banks
– Run on currency / capital controls
– Hoover 1-year moratorium on reparations
and foreign debt
Consequences of 1931 banking crisis
 UK loans frozen in Austria, Germany
– Contributed to UK departure from Gold Standard
in September
 US loans frozen
 German reparations suspended
– Sent France, Belgium into depression
 1932: UK, F default on WW1 loans from US
– Causal for renewed U.S. banking crisis of early
1933
Conclusions on 1929/32
 Causes not so clear
 Catastrophic depression and deflation
 Banking crisis only towards the end of
depression
 Strong European element in banking
crisis
 Special features: Gold Standard,
reparations