Great Depression Flashcards
Three interpretations of the GD, how did it start?
Friedmand-Schwarz: says that it is money supply-driven. When banks collapse and money supply falls, prices falls too (deflation) and this causes frictions into the system and huge non-neutrality.
Peter Teller: says that it is demand-driven. Consumption starts to fall before everything else, but he does not provide an answer to why.
Roma - autonomous decline in consumption because of uncertainty. People are uncertain and stops investing in cars etc. This hits production and ultimately the real economy.
Did the banking crisis affect the downturn in the US economy in the GD?
Yes, Bernanke shows that regressing the output in the economy with bank failure and deposit failures actually has an effect. Furthermore, we can see that in Fed Reserve districts where they were much stricter in helping banks in distress, the downturn in the economy is much worse than in those districts where they were more generous and helping.
Why do Cole & Ohanian conclude that it cannot be the money supply (monetary non-neutrality) that drives the crisis into the real economy?
Because they look at how deflation affects output and compare between 21-22 crisis and 30-33 crisis and see that we had a lot of deflation in 21-22 as well but did not see this transmission into the real economy. And the effects on real interest rates was much worse in 21-22 than in the 30s.
What is Bernanke’s key argument regarding the GD?
That the banking failures and banking crisis made the downturn in the real economy much worse. The real economy would have been hit even if banks did not fail, but it made it all much worse.
How can we argue that states with better financial systems do better (grow more) than those with worse systems?
We can compare the growth rate distributions for states with a lot of external financial needs to those that can finance themselves internally. This shows that the curve for external financing needs shifts to the left, meaning that the downturn in economic activity was hit harder in those states. Furthermore this is linked to bank failures too because the difference increase when we look at settings with high vs low bank failure rates (banking crisis makes the downturn worse!!!)
Why is the interaction term of bonds maturing and banks failure so important compared to the variables alone?
Because if the bank does not fail, I can still get my financing needs satisfied by the bank. As soon as the bank fails, the effect of bonds maturing is magnified and gets worse. Why?? Because those are alternative sources of financing. As long as the bank is there, I can get the moeny somehow if I go to the bank when my bond matures.
Debt deflation mechanism
Your salary goes down, prices in the society goes down too and your real purchasing power is not affected, BUT the debt is written in yesterday’s dollar and wil therefore not change in terms of nominal numbers –> debt burden increases because of your lowered salary/income
Is the size of the banking sector important for whether you are hit harder by a crisis or not?
Yes, Grossman compares crisis and non-crisis countries and look into characteristics of the banking sectors and shows that crisis countries have on average much less branches per bank and smaller population/bank. This suggests that larger banking sectors are better suited to manage crises. For ex few branches means that the banks are less diversified.
Why do crisis countries have higher profits than non-crisis countries in the run-up to the GD? (2)
1) Higher profits can be linked to risky activities in the banking sector (not linked to leverage though bc leverage ratio are similar across countries). Countries that were very active and had a lot of borrowing probably engaged in unsustainable lending and made a lot of profits as long as the market was functioning, then when some little part goes wrong, everything collapses.
2) The other thing is unit branching - there where many banks with only one branch and who was the only bank in a city –> kind of monopoly that makes them able to charge higher interests and fees for the locals.
Termin effect =
When in crisis countries, bond yields go up a lot during crisis. Because people are desperate to borrow, but banks are shutting down and you need to seek alternative options elsewhere which bids up the bond yields.
Why do bills discounted in central bank portfolio increase in non-crisis countries?
Because discounting bills is a way for the CB to help/intervene in the banking system and provide liquidity. So, as the CB increased this activity in non-crisis countries, we can see it as a preferable way for them to intervene and help. It seems like it helped since they did not end up in crisis.
Is it more or less likely that you have a crisis if your currency value has gone up?
More likely. Appreciation makes it more likely to have a crisis.
Why is currency value affecting the likelihood of crisis in the GD? Hint: gold standard and import deficit
Because during the GD, almost all countries had the gold standard so that there was like a currency union across the globe. And if one country has an import deficit, they must literally ship gold to other countries. –> this leads to a problem because if the gold reserves decrease, people cannot go around with money in their pockets saying that “this is exchangeable for gold” –> need to decrease money supply in the society. And this pressures prices down. SO now our goods become more attractive (depreciation) and increase exports! SO we can solve the import deficit problem this way. The other country, here US, will see the opposite, they get gold and this appreciates their currency –> appreciation is positively related to likelihood of crisis.
Why did a deflationary bias in the gold standard emerge during WW1?
Because people realized that it is good to hold gold during wars, because you can pay for services to anyone from all countries. However, countries gaining gold did not increase their currency supply/money in circulation, BUT those losing gold take money out of circulation because they want to regain gold and become competitive on the world markets. So this leads to higher likelihood of deflation!! Because countries losing gold reduce money but those gaining gold does not print more money… –> More likely that prices go down
What is linking the gold standard to the Great Depression?
The deflationary bias is now of the things that links them. Because in a time of high debt burden and a labor market do not like to see the deflation mechanism on its long term contracts –> the deflationary bias created lots of problem and real burden of debt goes up and banks start to die.
