Download bimetallism

Banking/financial crises


Long history: 1819, 1838, 1857, 1893, 1907
Bank runs



fractional reserve
Suspension of payments
No federal level deposit insurance
A new Central Bank

We had


First bank of the United States, 1791-1811
Second bank of the US, 1816-1836


Charter renewal vetoed by President Jackson in 1832
New one: the Federal Reserve



Permanent charter
12 districts
Board of Governors
What does the central bank do?

Modern days



Lender of last resort
Monetary policy
Regulation of banks
Money stock/interest rate

How does the central bank control money
supply?





Open market operation
Buy/sell bonds
Demand/supply of bonds
That changes interest rate
Other factors:

How much currency do people hold?
Money creation

Money is not just cash in your pocket
(currency)



Includes demand deposits, traveler’s checks
Saving deposits, small time deposits, money
market mutual funds, etc
Currency to deposit: creates extra money in
the banking system

Through money multiplier
Gold standard


1900, Gold Standard Act
Globally, it means a fixed exchange rate



Everything is tied to gold
Benefits?
Costs?


Inflexibility in money supply
Fluctuations outside of economic force
Transmission mechanism






US productivity increase
Same amount of money, more goods
Prices fall
US goods cheaper
Britain buys more US goods
Gold inflow for US, outflow for Britain
Trade imbalances





US running a trade surplus, Britain deficit
Gold inflow for US, outflow for Britain
US price level goes up, Britain down
US goods more expensive, Britain goods
cheaper
US buys more British goods

Built-in mechanism to balance trade
Gold Standard: Summary



Money supply tied to gold
In general, expect deflation
Built-in mechanism to balance trade



Relies on inflation when gold flows in
A country has no control over price level
fluctuations
International forces will create business cycles

On top of domestic factors
Interest rate



With free flow of capital, money goes where
the return is high
If interest rate is high, capital flows in
If interest rate is low, capital flows out
Stock Market Crash of 1929



Similar to South Sea Bubble
10/24/1929, 10/29/1929, black Thu/Tue
But has some “fundamentals”



Stock price and fundamental factors?
Fundamentals? Profitability, dividend
How are they related?


Future profitability
Booming economies of 1920’s
Was there “bubble”?

No



Booming economy
New Federal Reserve System, confidence
Yes



Economic boom might have initiated the bubble
but not sustainable
Dividend growth not as high
Speculation
What caused the crash?


Increased supply of new stocks?
Smoot-Hawley tariff?




Should’ve hurt export industries
Small proportion
International stock markets?
Recessions?

Industrial production went down
NY Fed responded



To avoid the overall financial crisis
NY Fed open up discount window
Outside creditors demanded payment


Could cause widespread bankruptcy
Which in turn hurts the banking system
Repercussions



The Stock market crash does not equal to the
Great Depression
Less than 5% held stock
Continued to trade after the crash


Large volumes through 1933
Historical evidence: stock market crash did
not always lead to recession
10/1929
Stock market crash
10/1930
Bank failures in Midwest and South
12/11/1930
Bank of the US in NY failed
5/1931
Failure of Kreditanstalt (largest in Austria)
7/1931
Closing of German banks
9/1931
Britain left Gold Standard
4/1932
Large Scale Open Market Operations
3/1933
Banking panic of 1933
4/1933
US off Gold Standard
Economic Indicators: 1929-1940
140
120
100
GDP
80
Real GDP
Investment
60
Consumption
40
20
1940
1939
1938
1937
1936
1935
1934
1933
1932
1931
1930
1929
0
Features of the Great Depression

Monetary contraction


Deflation
Caused by




Distrust of banking system
Contraction in monetary money stock
Expectation
Breakdown of banking system


Bank runs/failures
Channels to create money disrupted

High unemployment



25% at one point
Definition varies after new deal
International aspect

Smoot Hawley Tariff


Other countries followed
Gold Standard fell apart

Commitment to GS became burdensome
Monetary Contraction

Because the contraction of money supply

At first, bursting the bubble



Tighten credit to curb speculation
Mechanism?
Did not increase money supply when they should


Inexperience?
Forming expectations of deflation
Deflation


But the Fed did not extend more credit
That means deflation persisted


consequences: debt deflation


Price 24% lower between 1929 and 1933
Failed businesses, bankruptcy
Real interest rate= nominal interest rateinflation

Deflation= negative inflation
Economic Indicators
Year
Money NNP
Supply
Commercial
paper rate
(billions, $)
Real
interest
(%)
1929
46.6
90.3
5.78
5.88
1930
45.7
76.9
3.55
8.15
1931
42.7
61.4
2.63
15.46
1932
36.1
44.8
2.72
14.99
1933
32.2
42.7
1.67
3.03
Banking crises

Confidence in banking


Higher reserve ratio


Withdrawal of deposits
Reinforces the decrease in money supply
More credit to save the banks?



Solvent banks faced crises too
Not about insolvency, more about confidence
Lender of last resort!
Summary: Monetary Contraction



At first, expectation
Federal Reserve inaction
Reinforced by lack of confidence in banking
system


Household behavior– hoarding cash
Bank’s response– raise reserve ratio
So far…



The stock market crash was only the
beginning
Recessions and the Fed’s missteps
Expectation of falling price level




High real interest rate– investment falling
Deflation– low consumption
Collapse of financial system
But there was no “macroeconomics” yet
International Aspects


The Great Depression was a world wide
phenomena
(hindsight) the earlier a country left GS, the
sooner the recovery
Remember

The circular adjustment





Trade surplus
Money supply increase (gold flow in)
Price increase
Export decrease
Or trade deficit, gold outflow, price decrease,
export decrease
France and Britain




This mechanism broke down
French gold inflow, Britain outflow
But French did not inflate
Thus more gold outflow for Britain, then
finally go off gold standard
Why?

Commitment to GS requires



Tight control of monetary policy
Remember lower interest rate=expansionary
monetary policy
If US lowers interest rates



Expand money supply
Price level rise
US $ worth less
(cont’d)


US $ worth less
Under GS






Say, US $ converts to 0.1 ounce of gold
But it’s only worth 0.05 ounce in the open market
What would you do?
“Speculative attacks”
The Fed could maintain GS so long as it meets the
demand of speculators
But if it runs out of gold…



That means, US will have to keep the money
supply low (interest rate high)
Economy suffers
Key: it was the commitment of GS that really
fettered the monetary policy of the Fed
Recovery


1933 FDR inaugurated
Hoover



“enlightened” conservative
Small government, high wages, etc
FDR




… the only thing we have to fear is fear itself
Debt financed new deal
Influenced by Keynes
Reshaped the role of government
Two new deals

First new deal


Banking (FDIC), securities market (SEC),
Abandon GS, centralized power for Fed, NIRA,
price support
Second new deal


Some of the first new deal acts ruled
unconstitutional
Social security, unemployment insurance, Wagner
act, work relief program
First New Deal 1933-35

Banking reform

Glass-Steagall act



SEC (security exchange commission)


Firewall
FDIC
Information disclosure
AAA (Agriculture Adjustment Adm.)


Price support (floor)
reduction in output
First New Deal (cont’d)

National Industrial Recovery Act (NIRA)

Industry codes of “good behavior”


Price cooperation







Industries set standards and enforced by gov’t
Price floor, abstain from price cutting
High wages
Shorten the work week
Sanctioned trade union
PWA Public Works Adm
What was the diagnosis?
Effectiveness?
Second New Deal

NIRA and AAA ruled unconstitutional



Social Security



NIRA too much power in the executive branch
AAA regulated agricultural production at the
Federal level
At first an insurance
Then Pay-as-you-go
Unemployment insurance

Wagner Act


Labor union encouragement
Work relief program




WPA Works Progress Adm.
Hire, educate workers
Public projects
Limit 30 hrs/week

Soil conservation and domestic allotment act
(continuation of AAA)


Lower quantity to control price
Fair labor standards act

Minimum wage
Effectiveness?


Has to evaluate each individual policies
Examples:


Public Works: stimulated local economy
AAA & soil conservation: not as effective
Issues with the New Deal

Effectiveness? Economic sense?



Role of the government in economic life
High wage rate: ideology




Heavy handed regulation?
Distributive effects
Interest groups– northern businesses
Work relief programs
Political side


“swing states”?
Gaining political support
House Election Results
1930
1934
1932
1936
Dust Bowl


Dust bowl of 1930’s through 40’s
Drought

Sterile the arable land



Carried ton of fertile soil away
Loss in productivity (crop) $400 million annually
Destruction and Damaging crop, livestock,
building, human health
A Coordination Problem


As much man-made disaster as a natural one
Erosion techniques available but not used



Small farms: externality
Large farms: internalization
But Homestead Act created large number of
small farms