Lecture 5 - The 1920s: Prelude to the Great Depression Flashcards
ROARING 20s
Consumption boom
Building boom
Financial boom
- Mortgage lending
- Equity market boom
- Credit growth
Real estate boom
- Mortgage credit funding
- US mortgage to debt ratio doubles
Household indebtedness
Equity price & dividends
- Decoupling of the two financed by credit stock purchases
Financial Instability Hypothesis
Alternations of financial euphoria and depressions led to large aggregate demand fluctuations
Euphoria phase
Initial shock gets investors excited: new tech (eg cars)
Credit boom (financial innovations - brokers loan)
Positive feedback loom: credit expansion <=> rising asset prices
=> AD increases
Minsky moment
once economy is highly leveraged, minor bad news can trigger financial crisis
Depression phase
Feedback loop reverses
Credit contraction <=> Falling asset prices
=> AD falls
Fed Minsky moment 1928/29
Debate about right measure to curtail speculation
Late 1920s: fed increases interest rates
Slowing economy
Stock market crash October 1929
Begin of US depression
Germany’s path into great depression
1918: foundation of weimar republic
Challenges:
1) Social demands & transmission of welfare
- Threefold increase in social expenditures (social care, housing construction, unemployment insurance)=
- Revenues raised through taxes
- Large deficits
2) War costs & reparations
- Reparations led to substantial increase in gvt expenditures
- Reparations large part of deficit
- Gvt. issues a lot of debt to finance it (net taxes politically impossible, reichsbank monetizes substantial part of debt)
- Inflastion only tax that was politically acceptable
3) Strong opposition to democracy
==> Fulfill 1 & 2 without threatening economic growth
Germanys path to Hyperinflation 1923
End of 1923: conflict about reparations
French troops occupy rhineland
Ruhr campaign: german government calls for general strike and passive resistance
=> Wages of 2 million workers paid for by gvt
=> Debt financed & monetized by Reichsbank
=> German hyperinflation begins
Price level depends on intra gvt relationship
1) Monety dominance: Monetary authority determines r, M, and fiscal authority has to plan budget accordingly
2) Fiscal dominance: Fiscal authority determines path for real gvt. surplus, monetary authority has to monetize any shortfall to avoid default
Germany inflation explanations
1) Official: reparations:
- Push down exchange rate
- Upward pressure on prices due to more expensive imports (money demand increases)
- Upward pressure on interest rate (possible liquidity shortage)
- CB avoids liquidity shortage, accommodates higher m demand
2) Confidential: gvt. debt
- Gvt fiscal policy dominates
- CB had to accomodate, default is not an option
- Fiscal policy dominates, but it is unable to achieve surplus consistent with price stability for political reasons
Monetary and fiscal reform Germany
Monetary reform: new currency and end of debt monetization
Fiscal reform: gvt. expenditure reduction
- 25% of public employees laid off
- Budget balanced, reparations rescheduled
- Dawes plan
=> Credible regime change
Dawes plan
Reparations become junior debt
Attracts private capital inflows
Germany recycles USD inflows for reparations
Effects of German hyperinflation
Distributional effects
1) Winners: debtors
2) Losers: owners & recipients of nominally fixed assets and incomes
3) Neutral: owners of real estate, workers
2) = Erosion of support for Weimar republic
Result:
- Limited economic policy space in subsequent depression
- Expansion of economic policies become a political no-go
Balance of payments problems Germany
Reichsbank intervention decreased stock prices
Berlin stock exchange begins to fall in 1927
US capital inflows fall
Balande of payment problems: how to get USD to pay for reparations
1929: Young plan replaces Dawes plan:
- Abolition of transfer protection
- Sudden stop of capital inflows
- End of credit financed reparations payments
- Trade surplus needed, thus government investment falls
- German Great Depression begins
