bimetallism

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Banking/financial crises

• Long history 1819, 1838, 1857, 1893, 1907
• Bank runs
• fractional reserve
• Suspension of payments
• No federal level deposit insurance

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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

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What does the central bank do?

• Modern days
• Lender of last resort
• Monetary policy
• Regulation of banks

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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?

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Money creation

• Money is not just cash in your pocket (currency)
• Includes demand deposits, travelers checks
• Saving deposits, small time deposits, money
  market mutual funds, etc
• Currency to deposit creates extra money in the
  banking system
• Through money multiplier

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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

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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

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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

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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

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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

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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 1920s

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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

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What caused the crash?

• Increased supply of new stocks?
• Smoot-Hawley tariff?
• Shouldve hurt export industries
• Small proportion
• International stock markets?
• Recessions?
• Industrial production went down

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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

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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

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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
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Economic Indicators 1929-1940
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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

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• 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

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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

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Deflation

• But the Fed did not extend more credit
• That means deflation persisted
• Price 24 lower between 1929 and 1933
• consequences debt deflation
• Failed businesses, bankruptcy
• Real interest rate nominal interest
  rate-inflation
• Deflation negative inflation

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Economic Indicators
Year Money Supply NNP Commercial paper rate Real interest
(billions, ) (billions, ) () ()
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
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Banking crises

• Confidence in banking
• Withdrawal of deposits
• Higher reserve ratio
• 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!

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Summary Monetary Contraction

• At first, expectation
• Federal Reserve inaction
• Reinforced by lack of confidence in banking
  system
• Household behavior hoarding cash
• Banks response raise reserve ratio

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So far

• The stock market crash was only the beginning
• Recessions and the Feds 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

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International Aspects

• The Great Depression was a world wide phenomena
• (hindsight) the earlier a country left GS, the
  sooner the recovery

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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

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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

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Why?

• Commitment to GS requires
• Tight control of monetary policy
• Remember lower interest rateexpansionary
  monetary policy
• If US lowers interest rates
• Expand money supply
• Price level rise
• US worth less

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(contd)

• US worth less
• Under GS
• Say, US converts to 0.1 ounce of gold
• But its 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

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• 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

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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

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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

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First New Deal 1933-35

• Banking reform
• Glass-Steagall act
• Firewall
• FDIC
• SEC (security exchange commission)
• Information disclosure
• AAA (Agriculture Adjustment Adm.)
• Price support (floor)
• reduction in output

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First New Deal (contd)

• National Industrial Recovery Act (NIRA)
• Industry codes of good behavior
• Industries set standards and enforced by govt
• Price cooperation
• Price floor, abstain from price cutting
• High wages
• Shorten the work week
• Sanctioned trade union
• PWA Public Works Adm
• What was the diagnosis?
• Effectiveness?

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Second New Deal

• NIRA and AAA ruled unconstitutional
• NIRA too much power in the executive branch
• AAA regulated agricultural production at the
  Federal level
• Social Security
• At first an insurance
• Then Pay-as-you-go
• Unemployment insurance

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• Wagner Act
• Labor union encouragement
• Work relief program
• WPA Works Progress Adm.
• Hire, educate workers
• Public projects
• Limit 30 hrs/week

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• Soil conservation and domestic allotment act
  (continuation of AAA)
• Lower quantity to control price
• Fair labor standards act
• Minimum wage

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Effectiveness?

• Has to evaluate each individual policies
• Examples
• Public Works stimulated local economy
• AAA soil conservation not as effective

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Issues with the New Deal

• Effectiveness? Economic sense?
• Heavy handed regulation?
• Role of the government in economic life
• High wage rate ideology
• Distributive effects
• Interest groups northern businesses
• Work relief programs
• Political side
• swing states?
• Gaining political support

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House Election Results
1932
1930
1934
1936
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Dust Bowl

• Dust bowl of 1930s through 40s
• 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

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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