ECON 323-2 FINAL
Explain how 1931-33 banking panics lowered the money supply?
...1) When banking panics occurred, people ran on banks and attempted to retrieve their deposits. If a bank could stay solvent, their reserves were then incredibly low. So they would sit on these reserves, and any incoming liquidity from interest or loan payments would go directly into reserves, effectively lowering the money supply.
Clemens and Williamson discuss two explanations for the high level of British overseas investment in rich countries. Explain the "capital market failure" explanation of British investment in rich countries and the "Rational Investors" explanation of British investment in rich countries.
1) During first globalization boom prior to WWI, British capital did not go to poor, labor abundant economies (wealth bias). Results suggest the observed wealth bias was not explained by global capital market failure. 2) Global Capital Market Failure a) Global Capital Market Failure view predicts that wealth bias can be explained by market segmentation (international borrowing constraints) or departures from purchasing power parity (exchange rate movements), and borrowing does not increase in wartime. b) Studies positing that wealth bias can be explained by failure in a competitive international capital market invite the following organization. c) Demand for foreign savings can be choked off by domestic tariffs, distance from source, and other distortions that yield wide user cost differentials between countries even where financial costs are equalized. d) Supply of foreign savings can be deflected by other global capital market failures (adverse selection-banks, herding, absence of a stable monetary standard, and colonial intervention through force). e) Capitial Market Failure: demand for foreign savings can be choked out by tariffs, distance from source, and other distortions that lead to cost differentials between countries. Supply of foreign savings can be deflected by any other global market failures such as adverse selection, herding, the absence of a single monetary standard like the gold standard, and colonial intervention through force. Adverse Selection is when wealthy investors wont accept high returns b/c its not worth the risk and so move towards diversified low risk investments. Herding and foreign bias=city of London had an irrational foreign bias and systematically discriminated against domestic borrowers. Gold standard dissolves exchange risk, promotes international capital mobility. Colonial intervention-created a friendly market for lending 3) Unproductive Domestic Capital: a) The Unproductive Domestic Capital view predicts that wealth bias can be explained by endowments of immobile third factors, and borrowing increases in wartime. b) Unproductive Domestic Capital View ('Rational View'): The alternative view of the wealth bias is to explain it by appealing to absent third factors. This unproductive domestic capital view actually assumes perfect financial capital markets, although it stresses that there may be failures in other markets that might impact on this one. The supply of foreign capital may be cut back by positive correlations of business cycles between developed and developing countries, since wealthy-country investors seek both high average returns and insurance against financial disaster that a diversified portfolio offers. The demand for international investment can be choked off by limitations on internationally immobile third factors such as schooling, skills, natural resources, demographic factors, un-enforceable property rights and, what has come to be called, social capital. To test he compared the effect of adding foreign assets to the risk and return of a British investor's portfolio (Lucus Paradox) c) British investors sought to diversify to diminish risk, invested in things with low covariance, low or inverse corr with domestic investment to hedge. Demand for international capital was choked by lack of internationally immobile third factors: schooling, natural resources, demographics, unenforceable property rights, and social capital. British investors wanted to invest in things that weren't correlated with domestic investment to diversify their portfolios. Brits cared about GDP, development status, colonial status, pop growth, immigration, exports, schooling, and urbanization. Conclusion: 1) Global capital market failure did not determine how large a slice of British capital-export pie was received by a given capital-importing country at the height of the boom. 2) Furthermore, the major fundamentals that determined where capital went were, in order of importance, schooling, natural resource endowment, and demographic attributes. 3) Whether the fundamentals driving capital exports in the late 19th century were the same as those driving capital exports in the late 20th century is a question that could certainly be answered, but it must await future research.
Is the post-WWII business cycle less volatile? How do Davis and Romer answer this question? (NO) + 6 Agreements, + Davis argument summary (4) + Davis Methods (3) + Romer argument summary (6) + Davis Methods (4) + Results (6) + Counterarguments (2)
NO - both agree prewar period was not less volatile compared to post-war period as others seem to believe. Agree: 1) Both Davis and Romer agree to be cautions before jumping to conclusions about prewar data. 2) Obviously, technological innovations, changing markets, fiscal policy all have effects, and there simply was not a lot of information available early on. 3) Historical output series are unreliable. 4) Post WWII recessions have become less frequent. 5) Average magnitude of output loss per recession declined in post-WWII data but this entirely due to the 1921 recession and great depression. 6) Little countercyclical fiscal or monetary policy before WWII. Davis: 1) This is why Davis uses a new index, simple annual industrial index. 2) The NBER's pre-WWI chronology of annual peaks and troughs states that the US has spent 45.8% of the time in a recession from 1796-1914. 3) The new index alters more than 40% of the peaks and troughs, and removes cycles long considered the most questionable. 4) Economy goes down from being 45.8% in recession to 22% in recession. Methods: 1) Davis constructing peaks and troughs using the annual index of US industrial production. 2) He did this to evaluate the reliability of Thorp's annual business cycles. 3) The paper's comparison between periods is limited by its reliance on the index of annual industrial production (as opposed to GDP, which would be more comprehensive). Romer: 1) One of the generalizations about the US economy is that the prewar economy was substantially more volatile than the postwar economy. 2) Romer states that this generalization is actually a figment of the data caused by exaggerated business cycles. 3) To affirm this, she looks at the Frickey index. 4) When consistent industrial production data are compared, there is very little dampening of business cycle fluctuations between the pre 1914 and post 1947 periods. 5) The methods used to construct the historical series exaggerate cyclical fluctuations in industrial production. a. When this exaggeration is taken into account, there is very little stabilization between the pre-1914 and the post-1947 eras. 6) Together with other studies on historical unemployment and GNP, all three cases reveal fundamental inconsistencies between the historical and modern series that account for much of the damping of cyclical fluctuations between the pre-war and postwar eras. Methods: 1) Romer separates true economic changes from the improvements in data collection procedures and uses the same metrics for analysis used before mass data was available, and extrapolates to modern times. 2) She also updates this analysis, with the FRB materials index. a. Essentially, take modern data and make it as bad and sparse as the older stuff. 3) The cyclical exaggeration stems from using a series that is too volatile to proxy for the aggregate series being created. 4) Romer uses conventional industrial production series for pre-WWI and post-WWII and shows that the apparent stabilization of this series actually a figment of the data. Results: 1) The Great Depression throws off a lot of data in terms of volatility as well. Once it is accounted for, volatility seems fairly similar. 2) Monetary policy does seem to help, but it often hurts as well. 3) Davis is questioning the validity of the business cycles; In this article, Davis proposes an alternative set of annual peaks and troughs between 1796-1914 by mapping to the absolute peaks and troughs in a new dataset: his annual index of U.S. industrial production. 4) Davis -> By removing spurious recessions that interrupted genuinely long booms (Eg., the 1820s, 1840s, and 1880s), the average phase duration of prewar expansions doubles and the length of full cycles rises one-half. 5) Romer's study suggests that the severity of economic fluctuations on both sides of the Great Depression were roughly equal. Paper emphasizes how the GD is an anomaly in the history of American business cycles. 6) Romer -> Prewar macroeconomic data are excessively volatile → Quality of 1866-1928 output data is poor. Counter: 1) Davis doesn't explain why their continued to be more frequent cycles during 1890-1930 than the postwar era even after the new dates are used. While period from 1800s looks similar to the post-1945 period, the 1890-1940 = more volatile. 2) Romer doesn't challenge the economic declined of the 1930s.
Did adherence to the gold standard lower sovereign borrowing costs? How do Bordo & Rockoff differ from Alquist & Chabot?
...Alquist and Chabot say no, that the gold standard did not reduce the cost of capital. They look at a much larger sample of data in realized holding pattern returns (40x bordo and rockoff) new method adjusts for previous bond valuation problems. they find that the collective action mechanisms are not strong enough to punish "bad" countries. the At Most 40 basis points received from being on the gold standard is not worth the downsides, like the great depression. the higher return of off-gold countries vanishes conditional to exposure to other risk factors, like deficit/gdp, inflation, exports/gdp....If you buy off gold and sell on gold standard you should theoretically get a higher alpha, but we see a negative alpha where alpha as the ability to beat the market in the return equation. Bordo and Rockoff say yes: served as a good housekeeping seal of approval. interest rates differ substantially by nation but correlate with adherence to gold standard. test with long term interest rate on govt bonds.
Was the Deflation of the Great Depression anticipated? How do we know?
...In the models Cecchetti presents using modern econometric techniques, people should have known deflation would continue once it began. At most ¾ of the deflation could have been anticipated. Hamilton uses commodity prices and the crops futures market. Commodity prices fell tremendously during the GD. In the first year of the GD, people anticipated little change in the overall price level, yet prices declined 5%. In the second and third years of the GD, people anticipated drops in consumer prices about half of what they actually were. Real interest rate shoots up with deflation and people don't buy anything. Once the deflation goes down people will start spending
Explain the theory that the gold standard served as a "Good-Housekeeping" seal of approval?
...• Argue that during period from 1870-1914, adherence to the gold standard was a signal of financial rectitude, a "good housekeeping seal of approval," that facilitated access by peripheral countries to capital from the core countries of Western Europe. Members of the GS were expected to adhere to convertibility except in the event of a well-understood emergency as a war, financial crisis, or a shock to the terms of trade. Possible reason of faithful adherence to the rule is that it provided improved access to capital vital to development. This explains why countries adhered even though the GS had significant costs. GS adherence showed that country followed prudent fiscal and monetary policy and would only temporarily run large fiscal deficits in well-understood emergencies. • It showed essentially that nations were doing the right thing, if you had a poor history of adherence, costs of capital went up. It signalled that countries had good monetary and fiscal policy and would only run deficits in times of emergencies, like wars. Convertibility was possible to suspend in these situations. Long term bond strength correlate strongly with gold standardization. requires collective action by bondholder to forgo arbitrage opportunity. Also, gold standard prevents the gov from pursuing inconsistent policy. Links countries to fixed exchange rates. Transparency.
What evidence is there that the Fed could have mitigated the severity of the banking panics by acting as a lender of last resort before 1933?
...• During the banking panic that began in December 1930, banks failed at lower rates in the 6th Federal Reserve District, where the Atlanta Fed injected liquidity into the banking system, than in the 8th Federal Reserve District, where the St. Louis Fed followed the doctrine of real bills. The St. Louis Fed could have followed the same policy as the Atlanta Fed, and if it had, bank failure rates would have been lower, commercial lending would have remained higher, and the contraction would not have been as severe. • If those scholars are correct, the evidence presented in this essay indicates that Federal Reserve System missed opportunity to take inexpensive actions that would have stemmed the initial wave of banking panics and altered the course of contraction. Broader implications of this finding remain to be determined. Would mitigating the initial wave of panics have prevented panics that came later? Would mitigating panics have prevented debilitating deflation and collapse of intermediation that dragged U.S. economy ever deeper into depression? What were relative strengths of the money and credit channels for transmission of monetary policy? These questions remain unanswered. Evidence presented here is only suggestive. However, we believe the approach that we pioneer—applying quasi-experimental methods to panels of data on banks and businesses exposed to different monetary regimes along Federal Reserve district borders—can be extended to answer these and other questions concerning monetary policy, financial intermediation, and the causes, consequences, and possibilities of preventing Great Depressions.
The deflation of the great depression lowered the value of firms and household's collateral. Explain how this had real effects on lending and investment.
...• The threat of loss of collateral provides the right incentives for borrowers to use loans only for profitable projects. The combination of collateral and simple loan contracts helps to create a low CCI. • A useful way to think of the 1930-1933 debt crisis is as the progressive erosion of borrowers' collateral relative to debt burden. As the representative borrower became more and more insolvent, banks (and other lenders) faced a dilemma. Simple, noncontingent loans faced increasingly higher risks of default; yet a return to a more complex contract involved other costs. This increased the cost of credit intermediation (CCI). • A higher CCI for a bank means that the banks had to raise the rate that they charged borrowers. A simple solution banks did, was to not loan to some people they may have loaned to during more financially stable times. Basically, the extraordinary rate of defaults led banks and insurance companies to "practically stop making mortgage loans, except for renewals." This situation disallowed many buyers, even with good projects, from securing funds, while lenders rushed to compete for high-grade assets. Banking panics led to deflation, destruction of collateral and financial intermediaries, which then slowed recovery. Deflation=decline in assets=increase in precautionary savings and decrease in goods consumption. M1 decline= increase in probability of default=increase in probability of a bank run=increase in reserves, decrease in loans=further M1 decline in a bank facing the diamond dybvig model. Good businesses who deserve loans cant get them, cant expand, people stop borrowing lending and allocating capital Even if the value of your farm goes down, you still have to pay your loan back in nominal terms. Deflator lowers value of assets distressed debtors sell=further price decline and financial difficulty. Banks are threatened as well as nominal claims get replaced by real (collateral) claims, squeezed by deflation.
According to Romer, have monetary policy shock dampened economic volatility in the post-WWII era? (11) + New "Steady Hand" Economy Explained (5)
1) Analyzes the extent of the growing stability of the U.S. economy post WWII => According to Romer, monetary policy (which did not really exist prewar) can have a positive or negative effect on the economy as a whole. 2) However, since WWII, we have done as much damage as good with monetary policy. 3) Using counterfactual data and regression analysis, Romer finds the effects of monetary policy and what would have happened with monetary shocks without monetary policy, and finds that we have indeed dampened economic volatility in the postwar period. 4) Recessions and periods of downturn have been lessened by discretionary policy. 5) However, there have been times where policy has created rather than ameliorated recession. This could help explain the clustering of less-wild recessions. 6) Increasing government control of aggregate demand in the postwar era has served to dampen many recessions and counteract some shocks entirely. 7) Thus, the advent of effective aggregate demand management after World War II explains why cycles have become less frequent and less likely to mushroom. 7) At the same time, however, there have been a series of episodes in the postwar era when monetary policy has sought to create a moderately sized recession to reduce inflation. 8) It is this rise of the policy-induced recession that explains why the economy has remained volatile in the postwar era. Furthermore, the replacement of the large and small shocks from a wide variety of sources that caused prewar recessions with moderate shocks from the Federal Reserve also explains why recessions have become more uniform over time. 9) The rise of policy-induced recessions explains why output and related macroeconomic indicators have not stabilized dramatically over time. 10) In short, it is the fact that we have replaced uncontrolled random shocks from a wide variety of sources with controlled policy shocks that explains the changes we do and do not see in fluctuations over time. Modest stabilization. 11) Macroeconomic indicators (such as real GNP, industrial production, and unemployment) have been stable and recessions few since 1985 because inflation has been firmly under control => Policy has not generated bouts of severe inflation and so has not had to generate bouts of recession to control it. New Economy Explained: 1) The "new economy" is not the inevitable result of structural changes, globalization, or the information revolution; instead, it has emerged because we have had a steadier hand on the macroeconomic tiller in recent years than in the years before. 2) Whether the management of aggregate demand has been steadier because of new economic theories, the skill of particular policymakers, or a new consensus about the goals of policy is hard to say. 3) What is clear is that, replace that steady hand with an unsteady one, and the old economy could re-emerge in a flash. 4) As long as policy continues to make few mistakes toward over-expansion, policy-induced recessions to control inflation should continue to be rare. 5) Inflation has been a persistent problem in the postwar era because policy, especially monetary policy, has tended to be overly expansionary.
Why is the mortality of settlers during colonial times correlated with differences in GDP today? (10 + 1)
1) Differences in settler mortality may have influenced the type of institutions Europeans adopted in the New World 2) Given 16th-18th century technology mortality was largely a function of climate and therefore exogenous 3) Europeans adopted very different colonization policies in different colonies, with different associated institutions. 4) In places where these colonizers faced high mortality rates, they could not settle permanently, and they were thus more likely to establish extractive institutions which persisted after independence with the intention of transferring resources rapidly back to the parent country (Ex: Congo); in places where they could settle permanently, they established more development-minded institutions, enforced the rule of law and encouraged investment. 5) Low settler mortality rates as seen in the US, Canada, Australia and New Zealand triggered the early build-up of European-like institutions in the colonial outposts that developed into their forms today. 6) Today, these institutions are correlated with higher GDP. Conversely, countries with high settler mortality rates did not end up with good present-day institutions, and thus with low income per capita. 7) Differences in current institutions may explain cross-country differences in current wealth. 8) Want a colony and need to maintain the colony, while fending off fellow European powers; Starts with (potential) settler mortality → settlements → early institutions → current institutions → current performance. 9) If all these influences hold and influence each other (they all must be true) than something that was exogenous long ago may affect current performance today through institutions 10) Potential settler mortality rates were a major determinant of settlements and settlements were determinant of institutions. 1) Set. Mort. Is correlated with GDP b/c of the inherent risk involved and the necessary extractive institutions to promote settlement.
According to Clemens and Williamson which factors explain why some nations attracted British capital and some nations did not?
1) During first globalization boom prior to WWI, British capital did not go to poor, labor abundant economies (wealth bias). 2) Results suggest the observed wealth bias was not explained by global capital market failure. 3) Found Global Capital Market Failure view predicts that wealth bias can be explained by market segmentation (international borrowing constraints) or departures from purchasing power parity (exchange rate movements), and borrowing does not increase in wartime. 4) The Unproductive Domestic Capital view predicts that wealth bias can be explained by endowments of immobile third factors, and borrowing increases in wartime. THREE MAIN FACTORS: schooling, natural resource endowment, and demographic attributes. Other factors: Also distance to London, exports, pop growth, urbanization, colony status, immigration. Reasons being strong economy, colonial friendly market, etc.. Conclusion: 1) Global capital market failure did not determine how large a slice of British capital-export pie was received by a given capital-importing country at the height of the boom. 2) Furthermore, the major fundamentals that determined where capital went were, in order of importance, schooling, natural resource endowment, and demographic attributes. 3) Whether the fundamentals driving capital exports in the late 19th century were the same as those driving capital exports in the late 20th century is a question that could certainly be answered, but it must await future research.
Bernanke suggests three possible causes for the great moderation; structural change, improved macroeconomic policies, and good luck. Be able to discuss the arguments in favor of each. Good Luck: (2)
1) Good Luck that Shocks hitting economy became smaller and less frequent, where there is not an intrinsically stable economy or better policies. 2) Market conditions have stabilized on their own, and thus there has been a decrease in the size and frequency of economic shocks.
What is the "great moderation" in post-WWII macroeconomic data? (9)
1) Great Moderation = diminishing macroeconomic volatility; diminishing volatility of business cycles starting in mid-80s. 2) Reduction in variability in GDP growth rate (output) and inflation rate. 3) Often attributed to rise of activist monetary policy => Great Moderation made macroeconomic policy much easier. 4) Bernanke states the variability of quarterly growth in real output (as measured by standard deviation) has declined by 50% since the mid-1980s. 5) Volatility of quarterly inflation declined by 2/3rd. 6) Post WWII recessions have become less frequent and less deep on average. 7) GM = Apparent in other countries as well (particularly developed ones). 8) Output has become less volatile and more predictable in most economies. 9) Expected inflation = less volatile & more predictable.
What's the difference between English common law and Civil Code legal traditions? How does legal tradition influence development?
1) Legal origins: two types: "common law" countries that were in the British Empire and "civil law" countries where French, German, or Scandinavian legal systems prevailed. 2) Either origin is an important determinant of type and effectiveness of institutions installed. 3) English legal origin led to bad contracting institutions. 4) Legal system = an exogenous variable that has an important effect on legal formalism 5) In the sample of former Euro colonies, the legal system imposed by colonial powers has a strong effect on all three measures of contacting institutions, and little effect on our measurement of property rights institutions today 6) Countries with English legal origin colonies have higher average income per capita than French legal origin colonies. 7) Investment ratios are higher in former colonies with lower settler mortality rates and higher in former colonies with English legal origin. 8) Legal system = most important component of contracting institutions. 9) Firms' assessments of the quality of the courts, functioning of the judiciary, violation of their copyrights, patents, and trademarks by other firms - are predicted by legal origin and NOT Related to PPIS or mortality rates and density. IF: 1) Low settler mortality rates and English legal origin → higher levels of credit to the private sector. 2) Low settler mortality rates and English legal origin → higher stock market capitalizations. 1) Settler mortality and population density have a large effect on the constraint on executive and no impact on legal formalism. 2) No relationship between constraint on executive and English legal origin, though strong relationship between English legal origin and estimated effect on legal formalism. → the way in which countries were colonized, but NOT who colonized them, is a robust determinant of PPIs → who colonized, but not the details of the strategy, shapes contracting institutions.
Bernanke suggests three possible causes for the great moderation; structural change, improved macroeconomic policies, and good luck. Be able to discuss the arguments in favor of each. Improved Monetary Policy Argument: (8)
1) Policymakers had a better understanding of the structure of the economy and the impact of their policy actions to shift the economy closer to the efficient frontier described by the Taylor Curve. a. Output optimism and inflationary pessimism. 2) Look at Taylor Curve in macro data from recent years => every time the Taylor Rule is violated, volatility in GDP growth and inflation increase, and the results of poor monetary policy and excessive "inflation pessimism and output pessimism." 3) Improvements in the execution of monetary policy can plausibly account for a significant part of the Great Moderation. 4) Economists generally agree that the 1970s = the period of highest volatility in both output and inflation, where the Taylor Rule was deviated from and monetary policy performed quite poorly, relative to both earlier and later periods. => Output stimulus objective of monetary policy in 1970s, whereas stabilization became the priority post-1984. (Stabilization Policy = Taylor Rule) 5) Some of the benefits of improved monetary policy may easily be confused w/ changes in the underlying environment (improvements in monetary policy may be incorrectly identified as shifts in the Taylor Curve.) 6) Monetary policy may have brought the stabilizing change that upholds the good luck hypothesis. 7) Bernanke's main factor resulting in the Great Moderation - improvement in monetary policy accounts for the decrease in volatility of inflation and output as well. 8) Improved Monetary Policy also may have pervasive effects which may have been misidentified as exogenous changes in economic structure or in the distribution of economic shocks.
How was national banking during the National Banking Era (1863-1913) similar to free banking during the "free banking era" (1837-1861). How was it different?
1) Prior to 1838, a bank charter could be obtained by a specific legislative act, but in that year, NY adopted the free banking act which permitted anyone to engage in banking upon compliance w/ certain charter conditions. These banks could issue bank notes against specie (gold and silver coins) and the states regulated the reserve requirements, interest rates for loans and deposits, the necessary capital ratio, etc. Numerous banks that were started during this period ultimately proved to be unstable- many Western states, banking industry degenerated into "wildcat" banking. 2) To correct such conditions, Congress passed in 1863 the National Bank Act, which provided for a system of banks to be chartered by the federal government. National Banking: no lender of last resort, real shocks lead to real banking panics, can only use US bonds as collateral, every national bank must take other national banknotes at par, lots of entry and exit, no branch lending, banks could issue notes backed by treasury, created greenbacks and taxed local/state currency-putting them out of circulation Free Banking: no longer need state legislature to charter (wildcat banking emerges), Free entry, capital and reserve requirements are regulated at the state level, allowed to issue your own notes that do not trade at par with one another all for gold specie collateral, no lender of last resort, no unified currency. SIMILAR: 1) No lender of last resort 2) Large amounts of entry and exit 3) Both backed by gold standard DIFFERENT: 1) Non unified currency in free banking 2) Free entry and exit 3) State regulation vs fed regulation 4) Lending to other banks in free banking.
Why does Romer think the observed moderation of the business cycle is a "figment" of the data? (7)
1) Says beliefs that prewar economy was substantially more volatile than the postwar one is a figment of the data. 2) Examines the conventional industrial production series for pre-WWI and post-WWII periods and shows that the apparent stabilization of this series is actually a figment of the data. 3) Essentially: data on the prewar times is bad; once the great depression is removed and separate metrics are used, the prewar data seems no less volatile than postwar, implying there is no moderation at all, merely continuity. 4) Prewar macroeconomic data are excessively volatile → Quality of 1866-1928 output data is poor. 5) The methods used to construct the historical series exaggerate cyclical fluctuations in industrial production. a. => When this exaggeration is taken into account, there is very little stabilization between the pre-1914 and the post-1947 eras. 6) Together with other studies on historical unemployment and GNP, all three cases reveal fundamental inconsistencies between the historical and modern series that account for much of the damping of cyclical fluctuations between the pre-war and postwar eras. a) => Errors in the three series rather than genuine economic changes account for the apparent stabilization of these key macroeconomic series. b) => All three studies suggest that the prewar macro data are excessively volatile to proxy for the aggregate series being created. 7) Since economic fluctuations on either side of the Great Depression are roughly equal, the finding contradicts the empirical studies that find a dramatic stabilization between the prewar and postwar economies.
What ended the Great Depression?
1) The rapid rates of growth of real output in the mid and late 1930s were largely due to conventional aggregate demand stimulus, primarily in the form of monetary expansion. 2) In absence of aggregate demand stimuli, economy would have remained depressed far longer and far more deeply than it actually did. 3) Monetary developments were a crucial source of the recovery of the US economy from the GD. The very rapid growth of the money supply beginning in 1933 appears to have lowered real interest rates and stimulated investment spending. 3) derives policy multipliers for fiscal and monetary policy. 4) Money supply grew mostly because of huge inflows of gold to the US. 5) The economy returned to its trend path in 1942, meaning that the recovery was nearly complete before WWII had a noticeable fiscal impact. • a) => US $ supply started to rise by 1938 b/c of capital flight from Europe b/c of instability. Thus, WWII may have helped to end the GD in the US, but its expansionary benefits worked initially through monetary developments rather than through fiscal policy. 6) Also supports studies that emphasize devaluation of 1933-1934 as engine of recovery • b) => Aggregate demand stimulus was main source of the recovery from the GD 7) Simulations suggest that without the tremendous increase in the money supply, economy would still have been roughly 50% below its pre-Depression trend level in 1942.
Where the banking panics of the national banking era (1863-1913) the result of or cause of economic recessions? How do we know? examines 7 panics during this era; reduced form equation; newly constructed data.
1) The results suggest that banking panics can be explained by economic theory explaining consumer behavior during non-panic times. 2) Banking panics during U.S. National Banking Era were systematic responses by depositors to changing perceptions of risk, based on the arrival Panics are systematic events linked to the business cycle. Panics turn out not be mysterious events after all. 3) The evidence favors the conclusion that panics were a manifestation of consumption smoothing behavior on the part of cash-in-advance constrained agents. 4) Panics seem to have resulted from changes in perceived risk predictable on the basis of prior information. 5) Consumers saw certain variables indicative of a recession reach a threshold, and then responded to the perception of risk by running on banks, ergo panic. 6) Panics are systematic events linked to biz cycles, people perceive a recession, then the panics occur. Only after these variables hit the threshold do national bank era runs occur. 7) Used economic indicator "liabilities of failed non-financial businesses," capital loss, pig iron production as a proxy for consumption, and interest rate on commercial short term securities to find this info. 8) The recession hypothesis best explains what prior information is used by agents in forming conditional expectations. Banks hold claims on firms and when firms begin to fail, a leading indicator of recession (when banks will fail), depositors re-assesses the riskiness of deposits. 9) BUT we can say that influence of such unknown factors must happen the same way at panic and non-panic dates, which isn't consistent with sunspot theories of panics. Sunspot theories argue there is something special going on at panic 10) Important shock seems to be the liabilities of failed businesses => this result was the basis of the counterfactual about the 1920s and 1930s 11) After 1914, private insurance arrangements of commercial bank clearinghouses were replaced by the Federal Reserve System. Evidence suggests that the private insurance arrangements of clearinghouses compare favorably to the Federal Reserve System in responding to banking panics.
Were British investors irrational when they chose to invest much of their savings outside of the UK? What can explain the large fraction of foreign assets in Victorian British portfolios?
1) They were NOT irrational: would have been worse off investing domestically. 2) Wanted to diversify portfolios to hedge risk, invest in things with little/no/inverse covariance with domestic investments. 3) Diversification and risk is very important here, not just returns. 4) Less risk since foreign assets correlate less w/ domestic ones. Once all low-risk investment exhausted domestically, moved to foreign rather than invest in high risk domestic assets that may have generated higher returns.. Colonies were friendly markets, gold standard dissolved capital market exchange risk. 5) International investment significantly expanded their mean variance frontiers. 6) The benefit of international investing was the diversification benefit of holding foreign assets that had a low correlation with their domestic counterparts. By sending capital overseas, Victorian investors were able to increase their returns while simultaneously decreasing the risk of their portfolios.
Explain how the gold standard served as a "good housekeeping seal of approval". Did capital markets reward countries on gold with lower capital costs?
Bordo & Rockoff use CAPM models to analyze data consisting of annual interest rate observations and related variables, including exchange rates, real income, fiscal deficits, and the money supply for nine countries during the GS Era. They find reduction in borrowing costs associated with adhering to gold is ~30-40 basis points per year. Alquist & Chabot use updated expansive dataset from a large cross-section of sovereign bonds. The dataset consists of a sample of sovereign and colonial bonds that were traded on the LSE during the GS era, they include bonds issued by countries on and off of gold. They use holding-period returns rather than coupon yields. Use robustness checks as well. Reject the good housekeeping hypothesis. The effect of gold-standard adherence on borrowing vanishes with the inclusion of other explanatory variables that capture default risk. Evidence on the pattern of long-term government bond yields suggests that longterm commitment to the gold standard mattered even when bonds were denominated in gold: countries that remained on gold throughout the classical era were charged lower rates than countries that had a mixed record of adherence. The gold standard was, in the Bordo-Kydland terminology, a "contingent rule." Markets understood that countries could leave the gold standard during emergencies, war being the most important, and countries would not be punished with higher interest rates, if they convincingly committed to return after the emergency had passed.
How big was the government spending multiplier during the Great Depression? Does the type of government spending matter (AAA vs. relief spending)?
Fishback and Kachanovskaya find that the government spending multiplier during the Great Depression varied depending on the type of government spending. For example, the multiplier for retail sales and for wages and salaries was substantially less than one. use panal data to measure the multiplier during the depression. multiplier ranges on average from .4-.96, which is lower than expected. but they find what type of government spending matters. 1. The 1930s fiscal stimulus programs were combos of new spending and taxes that had little impact on stimulus (Deficit/GDP did not change much) 2. Fed gov't sought to combat the GDP through sharp increases in federal spending. 3. Despite relatively small multipliers during the Great Depression, the New Deal transformed the way the government responds to downturns. 4. Growth in the size of the federal gov't during the ND & WWII made fiscal stimulus possible during the post-war era. 1. The type of gov't spending does matter b/c of the different effects it can have on crowding out private spending. AAA (farm grants): 1. Under AAA, gov't spending "crowds out" private spending, leading to a low multiplier, b/c it employs resources that are already in use. (increase prices) 2. low and often negative multiplier Relief Spending: 1. Under relief spending, there is only a little crowding out of private spending b/c it putts to work unemployed resources), leads to higher multiplier. 2. More productive than the private spending it replaces 3. Encourages migration into the treated state. 4. Produces social overhead capital (Roads, Public health, Hoover Dam). When you take out AAA spending, multiplier is higher than it appears otherwise. This makes sense since interest rate was so low.
Explain why Cole and Ohanian think the NIRA prevented recovery from the Great Depression.
GD Recover = weak & real wages in several sectors rose significantly above trend → opposite of what Neoclassical data predicts of a strong recovery w/ low real wages. 1. Linked collusion with high paying wages. 2. Kept wages high despite output being low → Committed to keeping prices and wages high at the expense of output and employment. 3. ND cartelization policies were designed to limit competition, impose barriers to entry, & increase labor bargaining power. a. fiscal stimulus deters growth w/ enhanced labor bargaining power. Policies play role in slow recovery, because enhanced labor bargaining power depresses aggregate output & employment. b. Repeal anti-trust restrictions for industries that agreed to raise wages and collectively bargain. c. Industry incumbents agreed on "code of conduct" which kept wages & profits high & discouraged entry from new firms. 4. Model indicates ND policies reduced competition & investment roughly 14% relative to their competitive balanced growth path levels → so the model accounts for roughly half of the continuation of the GD between 1934-1939. 5. ND labor and industrial policies didn't lift the U.S. out of the Great Depression, but instead the joint policies increased labor bargaining power, linked collusion w/ paying high wages, impeded the recovery by creating an inefficient insider-outsider friction that raised wages significantly and reduced employment → Recovery would have been stronger if wages in key sectors had been lower.
What is "protection against expropriation" (EXPROP)? How is EXPROP correlated with modern GDP? What methods do AJR use to argue that causation flows from protection against expropriation to GDP?
Protection against EXPROP = 1) Protecting investors and investments from acts of expropriation, nationalization, and dispossession by host governments. 2) While a state has a right to expropriate, the exercise of that right, to be legal under the applicable treaty, must be done according to specified conditions. 3) Property rights institutions: the rules and regulations protecting citizens against the power of the government and elites. These are related to the political and state-society interactions, CIs are NOT. Example: institution protecting investors against government expropriation. 1) EXPROP is positively correlated with modern GDP. 2) Run a 2 SLS regression of EXPROP as a proxy for institutions on current level of GDP, but instrument EXPROP w/ log settler mortality in order to isolate an exogenous source of variation of institutions. 3) Significant at 5% level, the coefficient on EXPROP on GDP. Not random. AJR: Hypothesis: 1) Europeans had different colonization policies for different colonies. They set up different institution based on if they could settle there or not. They set up crappy institutions where there Europeans faced high mortality rates. The early institutions continued to present times. 2) Differences in current institutions may explain cross-country differences in current wealth. Settler mortality=settlements=institutions=current institutions=wealth or not. Methods: 1) Showing differences in mortality rates for soldiers, bishops and sailors in the colonies in 17th-19th century as instrument for current institution. 2) OLS regressions of GDP per capita on our index of institutions. 3) Equation Below log yi = µ + αRi + Xiγ + εi (y is income per capita, R is protection against expropriation, X is vector of covariates, E is error term, the alpha coefficient is the effect of institutions on income per capita) 4) Empirical Implication => Countries with poor property right protection should have lower levels of investment and capital per worker
Was the Fed Fettered by the Gold Standard? How do we know?
Q1) Was the Federal Reserve fettered by the Gold Standard? How do we know? No, the Fed was not fettered by the Gold Standard. Problems w/ the Gold Standard: 1. The Gold Standard does hinder monetary policy, such as preventing credible deposit insurance & overall prevents large expansionary monetary measures that can be performed by a central bank. 2. The GS links national price levels w/ a dangerous asymmetry and leaves nations susceptible to contagious deflation. 1. HOWEVER, Romer and Hseich conclude from a 1932 OMO example (using a $1 billion expansionary OMO case study and looking at forward exchange rate differentials) there would've been little devaluation risk and that even on the GS, the FED had room to maneuver without threatening the system. 2. OMO could have been effective w/ limited mobility in the interwar period, where the U.S. was large enough to affect world interest rates. 3. FX premiums for the dollar relative to other countries wedded to the GS barely moved & not in response to FED actions. 4. The Fed had room to mitigate the Depression w/ monetary policy but failed to do so, which had brutal implications and worsened the recession. 5. So lack of expansion in OMO was a policy mistake and not the inevitable result of adherence to the Gold Standard.
How does Christina Romer explain the huge drop in consumption between 1929-1931? What evidence does she use to support her theory?
Romer says the huge drop in consumption was because of two main reasons: 1) Consumption depends on wealth, and there was a lot of wealth destroyed with the stock market crash in October 1929. 2) Secondly, there was a lot uncertainty and when there's uncertainty, people don't want to spend money on goods. People spent more on food than they had previously. 3) The evidence she uses is department store sales and new car registrations. Both of these figures greatly decreased. 4) The behavior of the various retail sales series following the crash is consistent with the uncertainty hypothesis. I.e. new car registrations plummeted in November 1929, and by Jan 1930 they were 24% lower than they had been in Sept 1929 5) In general durable goods consumption decreased as well. 6) This paper argues that the collapse of stock prices in October 1929 generated temporary uncertainty about future income which led consumers to delay purchases of durable goods, as they waited for further information about the likely course of economic activity. 7) Decline in spending drove down aggregate income through a standard Keynesian mechanism. 8) Basically 2 premises: Uncertainty in future income reduces spending on durable goods and SM crash creates uncertainty in future income as well. Evidence: 1) Uncertainty and the Behavior of Spending: Looks at the FRB index of department store sales (converted to real and adjusted for seasonal variation) to show decrease in durable good spending (method) 2) Consumer spending and SM Variability: Uses Shaw commodity output series. Regresses annual percentage change in real output of a type of consumer good on its own lagged value, and on the lagged percentage change in total commodity output (which provides a model for the output of that class of good). To this, she adds a measure of the variability of real stock prices and the change in the real value of stock prices over the year. (Method)
Bernanke suggests three possible causes for the great moderation; structural change, improved macroeconomic policies, and good luck. Be able to discuss the arguments in favor of each. Structural Argument: (3)
Structural: Structural change bases its argument on the fact that the changes in institutions over time have contributed to this reduction in volatility. 1) Changes in economic institutions, technology + information services (helps business understand business needs and inventory), business practices, or other structural features of the economy have improved the ability of the economy to absorb shocks. 2) Other Examples of Structural Changes => The increased depth and sophistication of financial markets, deregulation in many industries, the shift away from manufacturing toward services, and increased openness to trade and international capital flows are other examples of structural changes that may have increased macroeconomic flexibility and stability. 3) Some economists have argued, for example, that improved management of business inventories, made possible by advances in computation and communication, has reduced the amplitude of fluctuations in inventory stocks, which in earlier decades played an important role in cyclical fluctuations.