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History May Not Repeat, But It Does Rhyme* Looking at the 2000s through a 1930s Lens *Mark Twain

History May Not Repeat, But It Does Rhyme* Looking at the 2000s through a 1930s Lens *Mark Twain. Mark D. Vaughan American University / Economics 639 August 27, 2012 . Disclaimer. The views expressed are mine alone and do not represent official positions of the:

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History May Not Repeat, But It Does Rhyme* Looking at the 2000s through a 1930s Lens *Mark Twain

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  1. History May Not Repeat, But It Does Rhyme* Looking at the 2000s through a 1930s Lens *Mark Twain Mark D. Vaughan American University / Economics 639 August 27, 2012

  2. Disclaimer The views expressed are mine alone and do not represent official positions of the: • National Credit Union Administration Don’t look for a hidden political agenda either! Ghost of Career Past

  3. Everything Old is New Again!

  4. Partisan DistortionEverything Old is New Again Chicago Tribune April 21, 1934

  5. Great Depression vs. Great RecessionInteresting Similarities • Both preceded by good economic times. 1921-29: Annual real GNP growth = 4.4% (2 mild recessions) 1982-2007: Annual real GNP growth = 3.2% (2 mild recessions) • Both preceded by era in which Fed was highly regarded. • Both preceded by movement of banks into new business lines. 1920s: Banks ramped up real-estate lending/investment banking. 1990s-2000s: Banks ramped up real-estate lending/securitization. • Both preceded by innovations in consumer finance. 1920s: Installment credit 2000s: Mortgage/credit-card lending driven by credit-scoring/securitization

  6. Great Depression vs. Great RecessionInteresting Similarities • Both preceded by asset bubbles. 1920s: Florida real estate (mid 1920s); stock market (late 1920s) 1990s-2000s: Tech stocks (late 1990s); housing (mid 2000s) • Both started in U.S., then spread around the world. 1930s: Via gold standard 2008-2009: Via exposure to U.S. housing (toxic MBSs) • Both featured high-profile failure perceived as “trigger.” December 1930: Bank of United States September 2008: Lehman Brothers • Both featured banker/financier bashing. 1930s: Andrew Mellon, Pecora Commission 2008-2010: Backlash over bonuses

  7. Great Recession* • Length:18 months* • Industrial production: ↓14.9%* • Rise in unemployment: ↑5.7 percentage points From May 2007 to October 2009 (peak) • Consumer prices: ↑1.5%* • Bank failures: 443 Since Bear Stearns crisis (3/16/08), 5.2% of U.S. banks in March 2008 • Stock prices (DJIA): ↓53.8% From market peak (10/9/07) to market trough (3/9/09) * Indicator measured from cyclical peak in December 2007 to cyclical trough in June 2009. Worst since World War II!

  8. Great Contraction* • Length:43 months* • Industrial production: ↓51.7%* • Rise in unemployment: ↑19.3 percentage points 1929 average to 1932 average • Consumer prices: ↓27.2%* • Bank failures: ≈ 9,000 37% of U.S. banks in December 1929 • Stock prices (DJIA): ↓89.2% From market peak (9/3/29) to trough (7/8/32) * Indicator measured from cyclical peak in August 1929 to cyclical trough in March 1933. “Great Recession” not close!

  9. Intensity of Great ContractionIt's gonna be cold, it's gonna be grey, and it's gonna last you for the rest of your life. Industrial production (and Real GDP) did not return to pre-1929 trend until 1942.

  10. Great Depression vs. Great RecessionComparing Default Spreads to Gauge Intensity Default-spread peaked in Great Recession at 0.6 times the Great Depression peak.

  11. Great Depression vs. Great RecessionComparing Unemployment Rates to Gauge Intensity Unemployment rate exceeded Great Recession peak (10.1%) for better part of 9 years.

  12. What Caused the Great Depression?Phase I – The Great Contraction (1929-33) Early 1928 Fed tightened money to stop stock speculation; resulting hike in real interest rates discouraged spending. • Construction sector weakened first. Fall 1929 Stock-market crash reduced household wealth/liquidity and increased uncertainty, thereby provoking larger decline in spending. Fall 1930 - Spring 1933 Four banking panics turned a bad recession into a depression. • Currency / reserve hording caused money-supply collapse [M2 ↓ = 35.2% from August 1929 to March 1933] • Real interest rates soared, further depressing spending. • Waves of failures intensified gloom/uncertainty, even further depressing spending. • Failures destroyed lending relationships, depressing spending still further.

  13. What Caused the Great Depression?Phase I – The Great Contraction (1929-33) Fed tightens money – explicitly and implicitly!

  14. What Caused the Great Depression?Phase I – The Great Contraction (1929-33) Declines in Interest-Sensitive Spending/Real OutputGreat Contraction vs. Great Contraction (Benchmark)

  15. What Caused the Great Depression?Phase I – The Great Contraction (1929-33) Policy Mistakes Mortal Sins • Fed did not inject liquidity necessary to stop bank panics (1930-33). • Priority was given to maintaining dollar’s value in gold. • No panics occurred in New York City. • Failures were mostly small, non-member banks; viewed as helpful in disciplining risk-taking. • Impact of currency / reserve hording on money supply was not understood • Low nominal interest rates seen as evidence money was easy. • Death of Benjamin Strong (Governor, New York Fed) created power/intellectual vacuum. • Hoover jawboned businesses to maintain wages (late 1929). • Policies premised on flawed “underconsumption” thesis (artificially high wages explain up to 50% of real-output loss through 1931). Venial Sins • Smoot-Hawley Tariff (1930) • Revenue Act of 1932 Not helpful, but not as bad as once thought!

  16. What Caused the Great Depression?Phase II – The Great Lingering (1933-41) What delayed recovery? → New Deal Policy mistakes Most New Deal policies harmed the macro-economy. • National Industrial Recovery Act (NIRA), Agricultural Adjustment Act (AAA), National Labor Relations (Wagner Act) →lowered output, raised prices/wages. • Attacks on “economic royalism” →created regime uncertainty. • Tax increases (excise, income, corporate, Social Security) → discouraged work, savings, and investment. But some New Deal policies helped the macro-economy. • Devaluing dollar (raising price of gold) / leaving gold standard (1933-34) • Licensing banks to re-open (1933) / Creating FDIC (1934) IRONY: “Key” New Deal policies hurt; “by the way” policies helped!

  17. What Caused the Great Depression?Phase II – The Great Lingering (1933-41) What delayed recovery? Another Policy Mistake: Doubling of reserve requirements (1936-37) • Fed misunderstood record high level of excess reserves. • Money supply collapsed (again), as did the real economy (again). ↓M2 = 2.4%* Mean %Δ in post-1959 recessions = ↑7.3%* ↓ Industrial production = 31.8%* Mean %Δ in post-WWII recessions = ↓8.4%* * From May 1937 cyclical peak to June 1938 cyclical trough. Need to Re-Start Banking / Financial System • Re-establishing credit relationships, acquiring sound collateral took time. • Bankers reacted to 1930-33 by hording liquidity / avoiding credit risk.

  18. Bankers Have Long Memories (I)Took Years to Stop Hoarding Liquidity Cash-to-assets ratio did not fall below 1934 level until 1944. Investment-to-loans ratio did not fall below 1934 level until 1952.

  19. Bankers Have Long Memories (II) Took Years to Get Comfortable with Credit Risk

  20. What Ended the Great Depression? “Accidentally” Expansionary Monetary Policy Apart from 1937-38 recession, growth was impressive. • Average annual real GDP growth, 1933-1937 = 9.0% • Average annual real GDP growth, 1938-1941 = 10.6% Leaving gold standard / devaluing dollar plus Hitler’s rise to power combined to produce rapid monetary growth. • Devaluation raised nominal value of U.S. gold reserves / attracted gold to U.S. • Political anxiety in Europe produced a “flight to quality” / more gold flowed to U.S. • Gold boosted monetary base / banks turned additional base into additional money Average annual growth, monetary base (1933-41) = 13.1% [1982-2007 average = 6.6%] Average annual growth, M2 (1933-41) = 9.2% [1982-2007 average = 5.5%] • Why?

  21. Great Depression vs. Great RecessionKey Differences Dodging the Bullet! • Presidential transition was smooth, cooperative. GD: Election in November; inauguration in March; banking system collapses as FDR rebuffed Hoover. GR: Election in November; inauguration in January; Obama and Bush administrations worked together. • Wealth of data / economic expertise was available. GD: Few real-time numbers to guide policy, no grasp of modern macroeconomics / money multiplier. GR: Fed headed by foremost economic student of Great Depression (Ben Bernanke). • Federal government responded with stimulus (?) GD: Federal deficit as a percentage of GDP, 1929-1941 average = 1.3% GR: Federal deficit as a percentage of GDP, 2009 = 8.9% • Focus remained on banking. GD: Plight of small, non-member banks ignored (some large banks, too) ignored until 1933. GR: Policies targeted at recapitalizing banks / certifying strength. • Federal Reserve provided ample liquidity →KEY GD: Somewhat “passive” Fed allowed M2 to fell 35.2% between August 1929 – March 1933. GR: Wide-open discount window / multiple liquidity facilities stabilized financial system; between December 2007 and June 2009, M2 rose 12.5%.

  22. Fed Provided Ample Liquidity Average excess reserves since advent of financial crisis exceed 500 times pre-crisis average.

  23. Intermediate-Term OutlookThe Economy Sluggish Growth! • Monetary policy has done all it can do. • On the bright side, 1930s deflation did not happened. • Bank lending apt to recover slowly. • Dodd-Frank and continuing regulatory uncertainty discourage risk-taking. • Recapitalizing takes time. • Interest on reserves provides attractive alternative to lending. • “Other shoe” could drop, thereby making liquidity insurance valuable (Greece and parallel to 1931 Creditanstalt failure).

  24. Intermediate-Term OutlookThe Economy Sluggish Growth! • Anti-supply policies will impair recovery. • “Obamacare” taxes job creation. • Increase in minimum wage taxes job creation. • Extension of unemployment compensation discourages job search. • Economic/policy uncertainty will impair recovery. All the following will encourage businesses to defer putting capital at risk… • Uncertainty about legal challenges over Obamacare. • Uncertainty about fiscal policy due to unprecedented structural deficits. • Uncertainty about expiration of Bush tax cuts. • Uncertainty about Euro-zone debt crisis (PIIGS).

  25. Index of Economic/Policy UncertaintyCurrently at Post-1985 High! • Source: “Measuring Economic Policy Uncertainty” by Scott Baker, Nicholas Bloom and Steven J. Davis, September 2011

  26. Any Good News? This is a great time to be aneconomist! 2012

  27. Questionsover History May Not Repeat, But It Does Rhyme: Lessons from the 1930s for the 2000s? Mark D. Vaughan American University / Economics 639 August 27, 2012

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