“The Great Depression is the Holy Grail of Macroeconomics”
Ben Bernanke, Essays on the Great Depression
(2000)
Key economic concepts
Yield differentials / credit spread :interest rate differential between two bonds of same maturity. – This type of spread measures credit default
risk (if both bonds in same country and currency)
Yield spread between corporate bonds and Treasury bonds
Key economic concepts (cont’d)
Cost of Credit Intermediation (CCI)– Information asymmetries between
borrowers and lenders (Stiglitz & Weiss, 1981, extensive literature)
– “Bad” mimic “good” borrowers – Credit rationing as an attempt to
minimize incentive problems– CCI as result of monitoring, building
long term relationships, enforcement cost etc
Key economic concenpts (cont’d)
Debt deflation, Irving Fisher (1933)
Debt contracts written in nominal units [$, £ etc., w/o price index clauses]
Price fall of underlying asset causes negative equity may cause firesale in case of debt default Feeds back on price declines of
underlying asset
Debt deflation (cont’d)
But if nominal debt is so bad, then why are such contracts written in the first place (instead e.g. of a profit share)?
Gale and Hellwig (1985): because of high cost of / difficulties in verifying debtor’s true profits
Even easier if debtor provides collateral
Bernanke (1983)
Great Depression aggravated by financial market problems
Debt deflation of values of collateral(much like 2007-? housing slump)
Nominal debt contract more risky, CCI Resort to complicated risk sharing
contracts (then again, CCI ) orJust reduce lending, even to solvent
customers, to reduce CCI
Baa Yield Spread Over Treasury Bonds
0
1
2
3
4
5
6
7
8
919
29:0
1
1929
:07
1930
:01
1930
:07
1931
:01
1931
:07
1932
:01
1932
:07
1933
:01
Bank of the United States Collapse, 12/1930
Deposits in Failed Banks (NBER m09039)
0
50
100
150
200
250
300
350
400
450
500
19
21
.01
19
22
.01
19
23
.01
19
24
.01
19
25
.01
19
26
.01
19
27
.01
19
28
.01
19
29
.01
19
30
.01
19
31
.01
19
32
.01
19
33
.01
mill
. US
$
Numbers of Business Failures
0
500
1000
1500
2000
2500
3000
3500
4000
1921
.01
1921
.07
1922
.01
1922
.07
1923
.01
1923
.07
1924
.01
1924
.07
1925
.01
1925
.07
1926
.01
1926
.07
1927
.01
1927
.07
1928
.01
1928
.07
1929
.01
1929
.07
1930
.01
1930
.07
1931
.01
1931
.07
1932
.01
1932
.07
1933
.01
Number of Business Failures
0
500
1000
1500
2000
2500
3000
3500
4000
1921
.01
1922
.01
1923
.01
1924
.01
1925
.01
1926
.01
1927
.01
1928
.01
1929
.01
1930
.01
1931
.01
1932
.01
1933
.01
1934
.01
1935
.01
1936
.01
1937
.01
1938
.01
Liabilities of Failed Businesses
0
20
40
60
80
100
1201
92
1.0
1
19
22
.01
19
23
.01
19
24
.01
19
25
.01
19
26
.01
19
27
.01
19
28
.01
19
29
.01
19
30
.01
19
31
.01
19
32
.01
19
33
.01
mill
US
$
Some finer points
Financial channel is not about 1929 Most banking problems not
endogenous to fall in output Instead caused by exogenous events This is most important for
comparison to 2008
Output may be endogenous to banking
U.S. crisis 1929: a timeline
Since 1928: NYSE stock market boom August 1929: Upswing in real
investment stops 24 and 29 October 1929: stock
market crash Towards end of 1929:
– Decline in output, price levels– Stock market quite resilient after initial
shock– Bold steps by Fed to lower interest rates
U.S. crisis 1930: a timeline
Throughout 1930: further slide into depression, very low interest rates
June 1930: protectionist Hawley/Smoot tariff
December 1930: Bank of U.S. fails, increased failures of rural banks
U.S. crisis 1931-32: a timeline
Mid-1931: renewed banking panics(banking troubles also in Ctrl Europe)
Sept 1931: another wave of panic(after UK’s departure from Gold Standard)
Dec 1932: yet another panic(after UK, F default on wartime credits, F withdrawal of gold from NY)
U.S. crisis 1933: a timeline
March 1933: Emergency Banking Act(Bank Holidays, reopening of banks after federal inspection)
June 1933: (2nd) Glass-Steagall Act(separation of deposit and investment banking, federal deposit insurance, state banking system, far-reaching regulation)
Steep upswing sets in
International banking crisis 1931
Austrian Creditanstalt crisis in May German banking crisis in July
– Bank run / bank holidays– Forced merger of two of top 5 banks– Part nationalisation of top 5 banks– Run on currency / capital controls– Hoover 1-year moratorium on
reparations and foreign debt
Consequences of 1931 banking crisis
UK loans frozen in Austria, Germany– Contributed to UK departure from Gold
Standard in September
US loans frozen German reparations suspended
– Sent France, Belgium into depression
1932: UK, F default on WW1 loans from US– Causal for renewed U.S. banking crisis of early
1933
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