Transmission of the Great Depression Flashcards
Schnabel 2004
The source of the German crisis in 1931 was simultaneous crises requiring different responses. Faced with a run on the currency (implying increased rates), as well as banking crises (implying increased credit lines, lower rates), all while constrained by the GS. Currency run also limits reserves and ability to bail out banks. CB pursued liquidity until reserves ran out.
Currency runs translate to bank runs if enough of a banks holdings are in foreign currencies, and vice versa if withdrawers want to convert. Data implies currency -> banking, due to bank exposure in increasing liabilities in terms of foreign currencies, and increased defaults of net-foreign liability firms.
Cause - recession, high unemployment, political turmoil drove a run on the banks, but also the currency. Political crisis (+background) -> currency crisis -> banking crisis.
Culminates in abandoning GS, capital injections to banks, and capital controls (to enable internal liquidity without a run on the currency).
Suggestion that moral hazard drives twin crises, with banks over-exposing themselves, making shocks far worse. Poor regulation.
Ritschl and Sarferaz 2014
The US and GER had the strongest GD crises, and were correlated. Why/which way was the causation?
Argument is GER -> US, driven by financial channels and debt defaults, rather than the monetary channel. Little direct transmission US -> GER; theoretically drives the global GD, but not really. Debt defaults drove financial trouble in the US.
The US held German debt totalling 15% of GDP in 1931 (bonds, bills, war debt), as well as Allied debt fed by German debt. German crises (Schnabel) in 1931 meant this was all lost 1931-33. German debt was ~100% GDP when it unravelled, and mostly underwritten by the US. Repayment of debts was driven by capital flows (eg Ponzi scheme)
The US held many GER bonds as part of its postwar success story. This held the banks/US hostage not to let GER default (don’t push them on reparations). Worry by 1928, with banks shifting assets to smaller firms. GER unable to control or slow down borrowing. Moratorium on debt announced in July 1931, bond prices fell 50% by the end of 1931. NY banks were diverse, but London banks hit hard. US losses constitute 15% GDP, but Fed/banks coordinate to avoid full crisis, with early write-downs.
Financial (eg banking) shocks transmitted from GER to US, contributing to shocks in real activity, interest rates, and market conditions. US also weakened by crises of AUS. Monetary channel insignificant.
Accominotti 2012
The 1931 Sterling Crisis was driven by European (German, Austrian) crises, which gutted London merchant banks holding European commercial bonds, spiralling into asset devaluation and sell-offs. Drove a collapse in the £, and GB leaving the GS, which then led to the Fed tightening its MP to avoid a run on the $. Long chain of international transmission.
Timing: German crisis, German capital controls, (July 1931), followed by gold outflows in GB - 20% of the BoE reserves in 2w.
“Direct” channel is weak - that GER panic affected GB banks balance sheets, impairing the £.
Merchant banks guaranteed European commercial bills of exchange, and under capital controls they were liable to pay out (in £, or whatever) but did not receive payment from Germans (in £). Forced sell-off to meet liabilities, driving down asset values, impairing other bank positions and driving them to sell too.
Strong correlation between level of exposure to bills and level of deposit decline. On average of the largest banks, they had 47% of their acceptances frozen. Those with >50% of capital in European acceptances reduced liquid assets by 50%.
Small banks, but key to the system and drove a general crisis/chain reaction (LIBOR rates were almost the same as the BoE rate at the time of crises, usually far lower). Crisis drives outflows since investors expect loose MP to come (ie, devaluation). This is what happened, with GB also leaving the GS due to restrictions and weak reserves.
Schularick and Taylor 2012
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Dimand 2003
Hummel 2011
F-S H - the causal mechanism was changes in the money stock and so the equilibrium price level. Panics collapsed the money stock, as well as velocity. This contracted output, as a result of the shock to AD. Bank failures and panic are attributed to inept Fed policy.
Bernanke emphasises that it was the failure of banks, disrupting abilities to save and accumulate capital, that made the contraction so long and thorough. Bank panics contribute to the collapse in output/prices through nonmonetary mechanisms.
But still emphasises AD over AS - the disruption of the credit channel induces a preference to hold money rather than spend/invest. Essentially, also a negative velocity shock. Not mutually exclusive to F-S H.
Under F-S’ view, the policy response is a general injection of liquidity into the financial system, to avoid a fall in AD and prices, due to a collapse in the money supply due to bank panic.
Under B’s view, the policy response is targeted bailouts, since the danger from bank panics is the choking of credit which reduces AD and/or AS. General stabilisation does nothing with major institutions insolvent. This is played out in Bernanke’s policy and reasoning at the time of the crisis.
Mathy and Meissner 2011
Co-movement during the GD correlates with greater bilateral trade and the GS in common. Co-movement falls after 1932, due to the rise in protectionism/trade blocs.
Provides evidence of the GS being a transmission mechanism of the GD. Temin 1993 - the GS required a deflationary response to negative foreign monetary shocks.
During the war, prices rose by ~100% for the US and UK, and ~900% for FR. Nations tried to return to the GS at pre-war parity, but many struggled to get price levels down to match these EXR. since deflation was hard to sell politically.
GS co-movement found after the 1928 shock of US interest rate spike (cut US demand for exports, encouraged other hikes). Countries not on the GS avoided this shock (eg China). Also found during the 1931 banking crisis, sparking runs on various countries (GB leaves, GER enacts capital controls).
How do we distinguish co-movement from shared shocks from that due to trade/GS. Trade ambiguous - if goods are substitutable domestically, trade may correlate with low co-movement.
The role of the GS/trade in co-movement falls in the GD, since the common shock is explanatory.
