Section A: Overview, Long Run Questions Flashcards
What did Bordo (2008) say about financial crises?
“Financial crises are an old problem. They go back to the origins of capitalism and beyond”
How many crisis did Kindleberger say there has been, and between what years?
38 from 1636 to 1997
Why were tulips valuable in 1636 in Holland?
Tulips, Asian wild flowers, cultivated for Dutch gardens to show wealth. 17th Century Holland was rich (nouveau riche) this fuelled demand. Very rare bulbs, with at times only 12 tulips in the whole of Holland. High demand and low supply increased prices.
What emerged to facilitate the purchase of tulips?
People bought tulips as an investment. Derivatives, forward contracts, borrowing etc all emerged to facilitate trade
How much was one tulip worth in 1637?
Same a luxury Amsterdam City House
When did the Tulipmania bubble burst?
February 1937, bubble bursts at an auction in Haarlem, prices decline dramatically in days!
What type of company did John Law set up and when?
Sets up a joint stock company (innovation in France) to exploit the riches of the Mississippi valley in 1719
Share prices of Law’s Mississippi company 1719/20?
1719: Shares at 500 livers. 1720: Shares at 18,000 livres
Why did the Mississippi bubble burst?
Bad news came back from the USA that the project was a failure, Law tried to stem to the news but the bubble burst in 1720.
Similarities between Mississippi bubble and Tulipmania?
- Exogenous event, highly profitable investment
- Commodity turned into an investment
- Over indebtedness and financial innovation
- Inexperienced investors
- Euphoria pushes up prices
- Innovations technical and difficult to understand
What did Kindleberger say about crashes?
“Whenever the outsiders go in, the insiders go out and the crash follows”
Definition of a bubble?
A financial asset exhibits a bubble when its price exceeds the present value of the future income (e.g. interest or dividends).
What is the problem with understanding bubbles?
hey appear to undermine key assumptions of economics, as the price should equal the PV
What did Greenspan, governor of the FED say about bubbles?
Cannot predict bubbles, CB can only clean up afterwards. PV, uses expectations and therefore bubbles can only be seen with hindsight
Why did Shiller suggest bubbles occur?
Irrational Exuberance: Stock markets are overvalued as psychologically driven volatility is an inherent characteristic of all markets. Predicted housing crash/tech bubble.
Possible solutions to the bubbles paradox?
- Give up rationality assumption
- Principal-agent relations/asymmetric info might explain bubbles
Why did Mill/Marx say bubbles occur?
Mill “Of the tendency of profits to a minimum”;
Marx “Law of the tendency for the rate of profit to fall”
What is Wallerstein’s theory to explain bubbles?
World Systems Theory, all have ups/downs but return moving equilibrium, this is not what it was before the crash. This equilibrium cannot be maintained, the system will collapse- structural crisis. Capitalism causes crises.
Why did people believe the market wouldn’t collapse in 2007?
Globalisation Tech Boom US Financial System Monetary policy Securitized debt
Who wrote the famous paper, “This time is different”?
Reinhart and Rogoff, 2009
What is a financial crisis?
Financial market volatility marked by serious illiquidity and insolvency amongst financial market participants
What is a banking crisis?
Financial distress resulting in erosion of most/all aggregate banking system capital
What is a currency crisis?
Forced change in parity, international rescue, abandonment of pegged exchange rate (IMF, a drop of 10%+ over 3 months is classified as a currency crisis)
What is a twin crisis?
When currency and banking crisis occur in the same or immediately adjoining years