Inter-war period Flashcards
Why is the argument that the stock market crash in 1929 had nothing to do with the Great depression?
Because the linkages between stock market and real economy is too small. The rich investor will still be rich even if the market crash and the average people don’t invest and thus does not get affected.
In what type of consumption do we see largest decline in after the great crash?
In auto, durables and mail-order. But grocery stores are increasing.
What was falling first in the great depression, consumption or production?
Consumption. it was a consumption-led recession.
Why does uncertainty explain the fall in durable good purchases?
Because buying a car might mean that you must borrow and if you borrow you must be very confident in your economic situation and knowing that you can pay back in the future. When stock market prices are falling, you become uncertain about the future and postpone these purchases.
What is the fundamental value of the the capital the company has?
It is the flow of profits! The fundamental value of assets is simply what they produce/generate in terms of profits.
How do McGrattan & Prescott calculate the fundamental value of companies?
They set up the formula of flor of profits from tangible and intangible capital, then plugging in everything they know about taxes on profits, on distributions, the cost of intangible and tangible etc.
How much of the profits are left after accounting for what tangible capital yields? I.e. how much of Kt is the average stock of Ki.
0.61Kt. Which is a fairly large number.
Reasons for a CB to worry about bubbles? (3)
- misallocation of capital during the bubble period
- wealth effects during the bubble –> asset prices up –> overheating –> inflation
- sudden collapse and recession
Reasons for CB to NOT intervene when they think that there is a bubble? (3)
- Difficult to tell the diff between bubbles and asset price increases due to more productive economy
- Raising interest rates can make the consumer spending suffer.
- It can create volatility in both interest rates, output and inflation if the CB intervene
What can a CB do to intervene in a bubble period? (3)
- Put restrictions on access to credit and raising interest rates
- Open mouth operations - speculative statements made by the Federal Reserve to influence interest rates and inflation. “The market is overvalued”
- Surgical strike - attempt to limit lending to stock market alone
Why does HJ think that the intervention by the german CB was unecessary? Or why wasn’t it a bubble?
He thinks that the rise in the market was due to lower interest rates that lead people to discount the future earnings at a low rate. But that this rise was not a bubble.
Was the German 1927 recession led by consumption or fall in investment?
It was investment-led recession.
Link between stock market value and investment (direct and indirect)?
The direct link is that if my company want to invest and can sell my stocks at high price –> easy to raise capital.
Indirect - the stock market works as an indicator, and if people value capital high, my company has strong incentives to invest in physical capital.
Why did the German stock market collapse?
Because the CB required the banks to decrease their lending. And so they did. They reduced it by 25% and then further reductions. OF course it crashses!
Two lessons learned from the German CB intervention in 1927:
- Hard to tell the diff between a bubble and normal price increases.
- Surgical striker don’t work, and it might spill over to other asset markets and the real economy. Hard to limit the constraints only to the bubbly part.
