Topic 6 Flashcards
Minsky Model Boom
– The increase in demand presses against the capacity to produce goods. Market prices, profits and investment increase, national income increase.
– ‘euphoria’ developed: investors buy goods and securities to profit from capital gains. Speculation about increases in the prices of assets or commodities, overestimate of prospective returns
– The euphoria leads to an increase in optimism about the economic growth and rate of increase in corporate profit
– Speculation for capital gains leads away from normal, rational behaviour to ‘mania’ or ‘bubble’. The real estate and stocks are targeted.
Bubble refers to any deviation in the price of an asset or a security or a commodity that cannot be explained in terms of fundamentals.
Minky Model Bust
– Some borrowers, individuals and firms, realize that their indebtedness is too large relative to incomes. An uneasy period of ‘financial distress’ follows.
– A considerable segment of both firms and individual investors reduce holdings of real estate and stocks and to increase holdings of money. The prices of goods and securities fall sharply.
– Decline in prices continues, more and more investors realize prices are unlikely to increase and they should sell before prices decline further. Liquidation may degenerate into panic.
– Investors crowd to get through the door before it slams shut
– The panic feeds on itself until prices have declined so far and have become so low that investors are tempted to buy the less liquid assets. A lender of last resort may convince investors and restore confidence.
Internation Credit
(1) Direct cross‐border credit: non‐banks in a country can
borrow directly from non‐resident banks (foreign banks).
(2) Indirect cross‐border credit: banks located in a particular country may finance a large share of their locally extended credit to non‐banks.
(3) Foreign currency‐denominated credit to nonbanks
Credit in Asia, 2009-11
Small share of total bank credit. Rapid growth of such credit did not really contribute to overall credit growth
South Sea Bubble Lessons
New financial instruments to facilitate increase in sovereign debt (Sward Blade lottery, then ‘consolidations’ of debt via the SSC).
Expansion in the money stock (Sword Blade Bank – issuing money in competition with the Bank of England, which was thought to have a monopoly on the issuing of money).
Speculation because of unsustainable exuberance over the potential for share values to rise in response to:
– the SSC’s management of an increasing stock of public debt (i.e. ignoring the problem of whether the Crown has the capacity to repay the debt without adverse impact on the economy);
– potential for near monopoly profits from ‘South Sea’ trade;
– excesses (and possibly corrupt) behaviour.
Austrlia 1890’s depression Traditional Explination
Fall in Wool prices on London markets –
TRUE ‐ BUT prices had started falling much earlier and were worse in wheat than in wool. Increased quantity of wool exported tended to offset decreased prices.
Fall in overseas capital inflow. – after the collapse of the HOUSE OF BARING
TRUE – BUT Fall started PRIOR to Baring collapse in 1890 and Baring more concerned with Argentinean investment than Australian.
Australian 1890’s dpepression chain of eents
The long boom – after 1860
Land boom, emergence of NBFIs, increased number of
foreign depositors in the financial system.
Melbourne land prices turned down in 1888‐89 and
banks increase interest rates.
Reduction in domestic bank activity offset by external inflow, but increased exposure to international financial risks
1890: Bearing Bank collapse
1891: land prices collapse and many land investors
forced to liquidate.
1892‐93: there is a run on the banking system, including trading banks.
Lessons from history
– A 1890s lesson: WA economy is different to the other States: WA
economy may fare better
– A 1930s lesson: serious economic down turn is possible even with sound financial system (but with a quicker recovery)
– A joint 1890s & 1930s lesson: weak public finances reduces capacity to mitigate adverse real economic outcomes
More lessons from history (both SSC & Au 1890 crisis)
During and after the crisis:
Mania: speculation ends and infectious pessimism takes over, with share prices of bubble stocks plummeting.
Panic: stocks are sold, a financial institution is in serious trouble and there is credit tightening by lenders.
Crash: banks go out of business, rapid slow down in economic activity; macroeconomic down turn.
Fiscal Crisis + Reinhard & Rogoff
The progressive building up of public debt
In such circumstances, public domestic debt tracks
with the increase in public external debt
Inflation is correlated with the build up of external debt
The incidence of capital mobility is positively correlated with financial crisis
