bordo credit market turmoil

7/29/2019 Bordo Credit Market Turmoil

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Credit Market Turmoil, Monetary Policy and Business Cycles: an historical

view.

Michael D. BordoRutgers University and NBER

Joseph G. Haubrich1

Federal Reserve Bank of Cleveland

1 The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank

of Cleveland or the Board of Governors of the Federal Reserve System. We thank Kent Cherny and Sagar

Shah for excellent research assistance, and David Wheelock for sharing data.

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I. Introduction

Creditmarketdistressarisesinitsmorevirulentformonlyincertainmonetary

environments,andhasitsmostextremeeffectswhenitexacerbatesabusiness

cycledownturn. Policyquestionsaboutacentralbanksroleaslenderoflast

resortorregulatormustbeseeninthecontextofmonetarypolicy.

Therelativelyinfrequentnatureofmajorcreditdistresseventsmakesan

historicalapproachtotheseissuesparticularlyuseful.Usingacombinationof

historicalnarrativeandeconometrictechniques,weidentifymajorperiodsof

creditdistress1875to2007,examinetheextenttowhichcreditdistressarisesas

partofthetransmissionofmonetarypolicy,anddocumentthesubsequenteffect

onoutput.

Theseissues

involve

relationships

between

policy

rates

(monetary

aggregates)creditspreads,andGDPgrowth. Usingturningpointsdefinedby

theHardingPaganalgorithm,wecomparethetiming,duration,amplitudeand

comovementofcyclesinmoney,creditandoutput. Fortheperiodsincethe

1920s,thisismosteasilydonewithariskspreadbetweencorporateand

Treasurybonds,thediscountrate,andrealGDP. Thisallowsustopickoutand

compareperiodsoftightcreditthatresultfromtightmonetarypolicyandthose

thathaveamoreexogenouscause. Fortheperiodfrom1875to1920creditspreads

are

measured

by

differences

between

yields

on

different

rail

road

bonds,

andtheconditionsinthemoneymarketaremeasuredbycommercialpaper

yields. Wealsoexaminethepatternsforrealstockpricessincestockmarketcrashesalsocanactasanexacerbatingfactorincreditturmoil.

Literaturereview

Theeffectofcreditonthebroadereconomyhasbeenofconcerntoeconomists

sincetheearlydaysoftheprofession.Nineteenthcenturyauthorsoftenspokeof

discredit,atermKindleberger(2000)adoptsforthelaterphaseofafinancial

crises. Mitchell(1913)wasanearlyexpositorofthecreditchannelaswas

Hansen(1921),andJ. LaurenceLaughlin(1913)testifiedthattheorganization

creditismoreimportantthanthequestionofbanknotes.Disentanglingthe

impactofcreditsupplyfromchangesindemandaswellasfromthemyriad

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althoughthereweresomefamousregionalbusts,eg.Californiainthe1890s.In

threeoftherecessionsassociatedwithpanics,BankofEnglandtighteningleadingto

suddenstopofcapitalinflowswaslikelythesourceoftheshock.Inaddition

monetarytighteningcontingentonthefearthatlegislationassociatedwiththeFree

Silvermovement(BlandAllisonAct of1878andtheShermanSilverPurchaseActof

1893)likelyledtothepanicof1893andthecurrency(andminorbanking)crisisof

1896(FriedmanandSchwartz1963,Gorton1987).AccordingtoCalomirisand

Hubbard(1989)citingSpragueandothers,creditcrunchesoccurredinthemajor

recessions.

ImportantEpisodes

1873.AseriousinternationalcrisiswithoriginsinarealestatebustinViennaand

BerlinwasintheU.S.associatedwithcorporatemalfeasanceinthedominantrailroadsector(BenmelechandBordo2008),astockmarketcrashandabanking

panicwithwidespreadbankingfailures.Thepanicendedwiththesuspensionofof

convertibilityofbankliabilitiesintocurrency.Theevidenceoffraudinrailroads

precipitatedasuddenstopincapitalinflowsfromEngland.Theresultantrecession

lasteduntil1879.Mishkin(1990)providesevidencethataqualityspreadbetween

MoodysBaacorporatebondrateandthelongtermTreasurybondratespikedafter

thebankingpanicandstockmarketcrash.Thisiscitedasevidenceforthepresence

ofdeclining

net

worth

and

asymmetric

information,

which

in

turn

increased

agency

costsandreducedbanklending.

1893.Aseriousbankingandstockmarketcrashinthesummerof1893wastriggered

bythepassageoftheShermanSilverPurchaseActwhichledtofearstheU.S.would

beforcedoffthegoldstandardandtocapitalflight.Inthecrisishundredsofbanks

failed.AttemptsbytheNewYorkClearingHousetoissueclearinghouseloan

certificatesdidnotstopthepanic.Itendedwiththesuspensionofconvertibility.As

inthecrisisof1873,CalomirisandHubbardciteevidenceofequilibriumcredit

rationing,eg.Stevens(1894)wholesaletransactions[are]usuallydoneoncredit.

[New]generalbusinesswasbeingdonealmostonacashbasispage141,and

Mishkin(1990)showsthequalityspreadpeakswiththecrisis.Thecontractionof

lendingbythebankingsystemasaresultofitstroublereduceditsroleinsolving

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adverseselectionandagencyproblemsandclearlymadetheseproblemsworsein

thefinancialmarkets(page19).

1907.Thisseriousrecessionwasalsoaccompaniedbyabankingpanicandstock

marketcrash.ItmayhavebeentriggeredbyBankofEnglandtighteningin1906in

reactiontoagoldoutflowtotheU.S.tocoverinsuranceclaimsfromtheSan

Franciscoearthquake(OdellandWeidenmeir2004).IntheU.S.thecollapseofa

cornerofthecoppermarketinOctoberledtothefailureof8banks,followedbythe

failureoftheKnickerbockerTrustCompany.Thisledtoarunontheothertrust

companiesandthenageneralpanic.Theissueofclearinghouseloancertificates,the

transferoffundsfromtheTreasurytokeyNewYorkbanksandarescuebya

syndicateorganizedbyJ.P.Morganalleviatedthepressure,butthepaniconly

endedwiththesuspensionofconvertibility.Thepanicwasassociatedwithhundredsofbankfailures,asignificantdropinmoneysupplyandadeeprecession.

Asinotherpanicepisodes,CalomirisandHubbardcitecontemporaryevidencefora

creditcrunch.Persons(1920)discussesahaltinfurthercreditexpansionpage147;

Sprague(1910)Itwouldseem,then,pastbusinessdistressfromlackofcredit

facilitieswasdueatleasttothreeinfluences:therestrictionofcashpaymentsbythe

banksincreasedtherequirementsofborrowers;thesupplyofloanswasreducedby

amoderateamountofcontraction;andtheshiftingofloansinvolvedconsiderable

uncertaintyand

inconveniences

page

303.

Mishkin(1990),

as

in

the

previous

crisis

showsaspikeinthequalityspread.Accordingtohimthedeclineinthevaluation

offirms[inthestockmarketcrash]raisesadverseselectionandagencyproblemsfor

borrowingfirmsbecauseithasineffectloweredtheirnetworth.Theresulting

increasesinasymmetricinformationproblemsevenbeforetheOctoberbanking

panic,shouldraisethespreadbetweeninterestratesforhighandlowquality

borrowers.Theprocessofsevereasymmetricproblemsevenbeforethebanking

panicsuggeststhattheywerepotentiallyimportantfactorsincreatingasevere

businesscyclecontraction.pp2127.

1914.TheoutbreakofWorldWarIledtoamassivecapitaloutflowfromU.S.

financialmarketstothebelligerents.ThismassivesuddenstopthreatenedtheNew

Yorkstockmarket,thebankingsystemandU.S.goldreserves.TreasurySecretary

McAdooinvokedtheAldrichVreelandActtoissueemergencycurrencytoallaythe

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bankingpanic,closedtheNYSEandpooledU.S.goldreserves.Thecrisiswas

largelyaverted.Thereisnonarrativeevidenceofacreditcrunch.

2.19181945

TheFederalReservewasestablishedin1914inparttosolvetheabsenceofalender

oflastresortinthecrisesofthepre1914NationalBankingera.Initsfirst25years

therewerethreeveryseverebusinesscycledownturns:192021,192933and1937

38.Allthreewereassociatedwithverytightmoney.The192933recessionhadfour

bankingpanicsproducingtheGreatContraction.Thestockmarketcrashedin1920,

1929,193032 and1937.AccordingtoWhite(2008)therewasarealestateboombust

inthe1920sandanotherin192933.Thereisconsiderableevidenceforcollapseof

banklending(acreditcrunch)in193033and193738.AccordingtoBernanke(1983)

boththenumerousbankfailuresthatoccurredandthecollapseinnetworthbroughtaboutbybankruptcies,fallingassetpricesanddeflation,increasedthecostofcredit

intermediationandreducedrealoutputoverandabovetheeffortsofadeclinein

moneysupplypositedbyFriedmanandSchwartz(1963).

192021.

TheFedtighteneddramaticallyraisingitsdiscountrateinlate1919torollback the

inflationthathadbuiltupduringWorldWarIandtorestoreeffectiveadherenceto

thegold

standard.

This

followed

asevere

but

brief

recession

(industrial

production

fell23%,wholesalepricesfell37%andunemploymentincreasedfrom4%to12%)

possiblybecauseFedactionswerenotanticipated(Bordo,ErcegandLevin2007).No

bankingcrisesoccurredbuttherewasastockmarketcrashaccordingtoMishkin

andWhite(2002).Alsothereisnonarrativeevidenceforacreditcrunch,the

transmission oftightmoneyoccurredthroughariseinrealinterestrates(Meltzer

2005p.118).

192933

TheFedtightenedbeginninginearly1928tostemthestockmarketboomwhich

beganin1926.ThistighteningledtoarecessioninAugust1929andastockmarket

crashinOctober.TheNewYorkFedinitiallyfollowedexpansionarypolicyto

preventamoneymarketpanicinOctober.Itthenstoppedeasingbytheendofthe

year.DespitedemandsfromNewYork,theFederalReserveBoardinWashington,

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followingtherealbillsdoctrine,wasconcernedaboutrekindlingstockmarket

speculation.AseriesofbankingpanicsbeginninginOctober1930ensued.TheFed

didlittletooffsetthemhenceallowingtherecessiontobecomeadepression.

AccordingtoFriedmanandSchwartz(1963),thebankingpanicsreducedthemoney

stockbyathirdandledtosimilardeclinesinrealoutputandprices.Theprocess

wasaggravatedbydebtandassetpricedeflation.AccordingtoBernanke(1983)the

bankfailuresandthecollapseofnetworth(Mishkin1978)raisedthecostofcredit

intermediationseeninanincreaseinqualityspreads.Inaddition,Calomirisand

Mason(2003) andCalomirisandWilson(2004)identifytheshockstobanklending

(creditcrunch)usingrespectivelyapanelofbankdatabystatesandbyNewYork

Citynationalbanks.

193738RecoveryfromtheGreatContractionbeganwithRooseveltsBankingHolidayin

earlyMarch1933andTreasurygoldpurchases(Romer1992).Itwasslowed

somewhatbythesupplyshocksoftheNIRA(ColeandOhanian2004).Asecond

severerecessionin193738wasproducedbyamajorFedpolicyerror.Itdoubled

reserverequirementsin1936tosopupbanksexcessreserves.Thisledtoanother

collapseinmoneysupplyandareturntosevererecession.BothBernanke(1983)and

CalomirisandWilson(2004)seeevidenceforadeclineinthesupplyofbankloans

(acrunch)

in

response

to

deflation

and

declining

net

worth.

3.19451980

TheFedemergedfromWorldWarIIstillpeggingTreasurybondprices.Thispolicy

ledtohighinflationwhichendedwithtighteninginOctober1947(Romerand

Romer1989)thatledtoarecessionin1948.ThefamousFederalReserveTreasury

accordof1951restoredFedindependence.Thenext15yearswascharacterizedby

relativelystablemonetarypolicy(Meltzer2004).TheFedunderWilliamMcChesney

Martininthe1950sviewedpricestabilityasitsprimaryobjective.Onseveral

occasions,whenfacingincipientinflation,theFedtightened, precipitatinga

recession.

Inthepostwarperiodtherewerenobankingpanicsandnoseriousstock

marketcrashes.However,accordingtoWojinlower(1980,1982,1992),Credit

crunchesoccurredwhentheFedtightenedraisingshortterminterestrates.Asrates

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requirements:apparentlyithadshiftedtoapolicybasedonthepricemechanism

ratherthancreditavailability.4(OwensandSchreft1993page26).YetonMay22,

ChairmanBurnswrotealettertobankersaskingthemtoallocatecreditthrough

nonpricerationinginsteadofraisingratesfurther(ibid).TheFedcontinuedto

tightenthrough1974byrepeatedhikesinthediscountratebutceasedpressuring

thebankswithnonpriceallocationtechniques(ibidpage28).

4.19802007

Inflationcontinuedunabatedthroughthe1970s.Debateswirlsoverthecausesof

theGreatInflation19651982.Someobserversattributeittotheaccommodationof

expansionaryfiscalpolicy,otherstothePhillipsCurvetradeoffandanunwilling

nessdrivenbypoliticalpressuretoraiseunemploymentattheexpenseof inflation

andotherstomeasurementerrorsinestimatingpotentialoutput(BordoandOrphanides2009).Finallyinthefaceofanexchangeratecrisisandgrowingpopular

discontent,PresidentCarterinOctober1979appointedPaulVolckerasChairmanof

theFederalReserve.MonetarypolicytightenedsignificantlyasVolckereffectively

targeted monetaryaggregatesinsteadofinterestrates,andproducedaseriesof

sizeablehikesinthefederalfundsrate.Howeverthetightmonetarystancewas

temporarilyabandonedinmid1980aseconomicactivitydeceleratedsharply.

InMarch1980attherequestoftheCarterAdministration,asasignaltothe

publicin

an

election

year

of

its

willingness

to

fight

inflation,

the

Fed

imposed

selectiveconsumercreditcontrols.Thecontrolsinvolveddirectrestrictionsonbank

loangrowth.TheFedprovidedbroadguidelinesforcreditallocationsuggestingfor

examplethatbanksavoidmakingunsecuredconsumerloans(OwensandSchreft

1993page30).Theprogramledtoamarkeddeclineinconsumercreditaslending

rateshitbindingusurylawceilings.Thisreducedpersonalconsumption,

contributing toaverysharpdeclineineconomicactivity.Thecontrolswereliftedin

July1980.

TheFederalReserveembarkedonanewroundofmonetarytighteninginlate

1980.Thefederalfundsrateroseto20percentinlateDecember,implyinganexpost

realrateofabout10percent(Bordo,ErcegandLevin2007).NewlyelectedPresident

ReaganssupportofVolckerspolicywassignificantingivingtheFederalReserve

4According to Owens and Schreft (1993) the 1973-74 episode was not a true credit crunch which they

define as non price credit rationing because bank lending rates were permitted to rise.

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themandateitneededtokeepinterestrateselevatedforaprolongedperiod,and

providedsomeshieldfromgrowingoppositioninCongress(Feldstein1993).This

secondandmoredurableroundoftighteningsucceededinreducingtheinflation

ratefromabout10percentinearly1981toabout4percentin1983,butatthecostof

averysharpandveryprolongedrecession.Inthisepisodethereisnonarrative

evidenceofacreditcrunch.

Therecessionof199091wasprecededbyFedtighteningbeginningin

December1988(RomerandRomer1994).ItcoincidedwiththefirstGulfWar.There

wasnobankingcrisisbuttherewasastockmarketcrashinAugust1990.Therealso

wasnotarealestatebustalthoughrealhousepricesdeclined13%19891993.

AccordingtoBernankeandLown(1991)therewasacreditcrunchwhichtheydefine

asasignificantleftwardshiftinthesupplyofbankloansholdingconstantthesafe

realinterestrateandthequalityofpotentialborrowers.AccordingtothemacollapseinNewEnglandrealestatereducedtheirequitycapitalandforcedbanksto

scalebacktheirlending.Thisreducedaggregatedemandviathelendingchannel

(BernankeandBlinder1988)andcontributedtotherecession.

OwensandSchreft(1993),whodefineacreditcrunchasnonpricecredit

rationing,alsopositthattherewasacreditcrunchinthecommercialrealestate

market,asectorspecificcreditcrunchthatpreventedcommercialrealestate

developersandbusinessborrowersusingrealestateascollateralfromgettingcredit

atany

price

(page

50).

Therecessionof2001wasprecededbyamildtighteningofmonetarypolicy

(thefundsratewasraisedfrom41/2%inNovember1998to6%inMay),andthe

collapseofthetechboominthestockmarketinthespringof2001.Thereisno

narrativeevidenceofarealestatebustoracreditcrunch.

FinallytherecessionwhichbeganinDecember2007wasprecededbyFed

tighteningbeginninginJune2004following3yearsofexcessivelylowrates.The

lowpolicyratesaswellasaglobalsavingsgluthelpedfundahousingboomwhich

begandeflatingattheendof2006.Theensuinghousingbustinitiallycentered on

theU.S.subprimemortgagemarket inthespringof2007.Factorsbehindtheboom

inadditiontolowinterestrates includeU.S.governmentinitiativestoextendhome

ownership,changesinfinancialregulation,laxoversightandtherelaxingofprudent

standards(Bordo2008).

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Thedefaultonsubprimemortgagesproducedspillovereffectsaroundtheworld

viathesecuritizedmortgagederivativesintowhichthesemortgageswerebundled,

tothebalancesheetsofinvestmentbanks,hedgefundsandconduitswhich

intermediatebetweenmortgageandotherassetbackedcommercialpaper andlong

termsecurities.Theuncertaintyaboutthevalueofthesecuritiescollateralizedby

thesemortgagesledtothefreezingoftheinterbanklendingmarketinAugust2007

andsubsequentlytoamassivecreditcrunch.Thecollapseincreditreflectedasevere

dropinassetpriceswhicherodednetworthandcollateralgreatlyincreasingagency

costs andqualityspreads.Inadditiontheweakeningofmajorbanksbalancesheets

hasimpairedtheirlending.Thishasbeengreatlyaggravatedbyamorethan50%

dropinstockprices.Despiteextensivecentralbankliquidityinjectionsandthe

creationofanumberoffacilitiesattheFedtorejuvenatethecreditmarkets,the

crunchstillprevails.ThecreditcrunchhasproducedaseriousrecessionintheU.S.whichhasspreadtotherestoftheworld.

III. EmpiricalMethodologyWithanaimofexaminingcyclesinmoney,creditandoutputsince1875,data

availabilityandconsistencybecomekeyissues. Forbusinesscycles,weusethe

NBERchronology(ataquarterlyfrequency). ForRealGrossNationalProduct(note

itisGNP,notGDP)weusethenumbersfromBalkeandGordon(1986),extended

viathe

NIPA

accounts.

Likewise

for

the

money

supply,

we

use

the

M2

numbers

fromBalkeandGordon,splicedandupdatewiththeM2numbersfromtheBoardof

Governors. Formanyotherseries,1919becomesanaturalbreakpoint.Forthe

interestrate(risk)spreadin1919andafter,weuseMoodysSeasonedBaaCorporate

BondYield(%p.a.)lessLongTermTreasuryComposite,Over10Years(%p.a.). For

theearlierperiod,weconstructadifferencebetweenaveragesofthehighyielding

andlowyieldingrailroadbondyieldstakenfromMaCaulay(1938)5. MaCaulayis

alsothesourceforearlyvaluesofcommercialpaper. Thediscountratesince1945is

theratefromtheBoardofGovernorsandpriortothatistherateattheFederal

ReserveBankofNewYork,fromBankingandMonetaryStatistics(1943). Thestock

priceindexfor18751917istheCowlesCommissionindex,itsleveladjustedto

5 For 1914 quarter 3, the markets were closed, and we entered a judgmental value of 1% for the spread. As

this was a time of turmoil in the markets, it is not an innocuous assumption.

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Thesecondsetofregressionslooksathowmonetary,credit,andasset

cyclesaffectthebusinesscycle. Forexample,dorecessionsthatstartduringa

creditcrunchlookdifferentthanthosethatdont? EachNBERcontractionis

associatedwiththemoney,credit,orassetcyclephasethatitstartsin. The

amplitudeofthecontractionisthenregressedagainsttheamplitudeoftheother

cyclephases. Forexample,arecessionthatstartsinaperiodoftighteningcredit

andtighteningmonetarypolicyisassociatedwiththeamplitudesofthosetwo

contractionphases.

IV. EmpiricalResultsCyclecharacteristics

Inoursample,from1875:Ito2007:III,wehave27(NBER)recessions,counted

ascompletepeaktotroughepisodes.Tables2and3reportthemeanamplitudeanddurationofcyclesforthe1875:I1918:IVperiod,andtables4and5reportthe

amplitude and durations for 1919:I2007:IV, calculated for the peaktotrough

andtroughtopeak. Ifthebeginningquartersbelongtoacontractionthatstarted

before our sample, those are not counted. Likewise for an expansion that

continuesbeyondoursample.

Theaveragedurationofarecession(peaktoTrough)is15.4months,thatof

anexpansion39months. Becauseofdatalimitations,weseparatelylookattwo

subsamples,

from

1875:I

to

1918:IV

and

from

1919:I

to

2007:IV,

the

period

for

which we have Federal Reserve discount rate data. For the later period,

recessionshaveshortenedandexpansionslengthened. Fortheearlyperiod,the

averagedurationofa recession is6quarters (8.3 forexpansions).For the later

period,thedurationsare4.5forcontractions,17.7quartersforexpansions.

Creditshowsalongercycle. Fortheearliersample,ourmeasureofcredit

is the spreadbetweendifferent rail roadbonds. These show ameanpeakto

trough duration of 8.25 quarters, and a troughtopeak duration of nearly 10

quarters,aswellasshowingnoticeably longermaximumcycles. Alsonotethe

greater symmetry between expansions and contractions in the credit spread

series.Forconsistency,thePTofratesandspreadsshouldbecomparedtotheT

PofRGNP.For the latersample,using the spreadbetweenMoodys seasoned

Baacorporatebondyieldlessthe longtermtreasurycomposite,contractions,

orperiodsofgenerally falling spreads, lastanaverageof11.1quarters, longer

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associate the amplitude of the NBER recession with the amplitude of that

monetary contraction (which will rarely have the same turning points or

duration). Tables10and11reporttheresultsforthe19thand20thcenturies. The

resultsarebroadlysimilar to those in theNBER focusedregressionofTables9

and10,buttherearesomedifferences. Thecoefficientontheriskspreadshows

up as positive in the 20th century. The stock index remains positive and

significant,exceptwheninteraction2isadded.

Both the historical narrative and the empirical results suggest that a

confluence of financial shocksin risk spreads, assets prices and money

supplywill exacerbate a contraction, or at least be associated with deeper

contractions. Acloser look that thedeeperrecessions inoursamplebears this

out, even though the correspondencebetween financial shocks and depth of

recession is not onetoone. Figures 2 and 3 provide scatterplots of recessionamplitude against the risk spread, shortterm rates,money supply, and stock

movements.

SincetheFirstWorldWar,fourrecessionareparticularlydeep(measured

aspercentchange inrealGNP frompeak to trough): thoseof1929,1945,1920,

and 1937. Thesewere at least triple the sizeof anyother contraction (with a

possible exception of the combined 19801981 drop). 1945 stands out as an

anomaly, but the other three stand out as having the three largest drops

percentagedrops

in

the

money

supply

and

stock

prices,

and

two

of

the

three

largest increases in the risk spread. Contemporary accounts of the 1920

contraction do not mention a credit crunch in line with the only moderate

increaseintheriskspreadinthatcontraction.

PriortotheFirstWorldWar,threecontractionsstandout,allovertwiceas

deepastheothers:1907,1893,and1913. Theconnectionswithfinancialshocks

areperhapsnot as striking as for the laterperiod,but still strong. The three

contractionshavetwoofthetopthreedeclines instockprices,andthetoptwo

changes inmoney andbond spread. Contemporary accounts noted a credit

crunchin1893despiteonlyasmallmovementintheriskspread.

An alternative approach is to sort on the size of movements in risk

spreads,money and stockprices, looking to see if largermovements in these

variables leads to larger recessions. SinceWorldWar I, four contractionshad

particularlylargeincreaseintheBaaspread,fourhadparticularlylargedropsin

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the differencebetween the yield on Baabonds and longterm Treasuries has

movedup393basispoints,a larger increase that seen in the1929contraction,

and approaching the combine increase of 436 bp over both the Depression

contractions. ThepercentagedropininS&Pindexof44.5%issecondonlytothe

78% of theGreatContraction. Money supply,however, is adifferentmatter,

withanincreaseof15.2%inthecurrentperiod,thelargestincreaseofM2seenin

any contraction. This should not be particularly surprising, however. As

Friedman and Schwartz point out, prior to deposit insurancebanking panics

wouldcauseacollapse in themoneymultiplier,drivingM2down. Zarnowitz

(1992)showsthatbusinesscyclesdownturnswithpanicsaremuchmoresevere

thanothers. Todaybecauseofdeposit insuranceetc financialturmoildoesnot

lead topanicsandcollapses in themoneymultiplier,andcredit turmoil is less

likely to feed into the money supply. The credit disturbance thusbecomesrelatively more important, given that disturbances on the asset side of the

balancesheetnolongerhaveasstronganinfluenceonthemoneysupply.

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JournalofMonetaryEconomics,vol.49,(2002)pp.365381.

24


25/45

Haubrich,JosephG.andPaulWachtel,(1993)CapitalRequirementsandShifts

inCommercialBankPortfoliosEconomicReview,(FederalReserveBankof

Cleveland)vol.29,pp.215.

AlvinH.Hansen,(1927)BusinessCycleTheory,Boston,Ginn.

OwenLamont,(1997),CashFlowandInvestment:EvidencefromInternal

CapitalMarketsTheJournalofFinance,Vol.52,pp.83109

CaraLownandDonaldP.Morgan(2005)TheCreditCycleandtheBusiness

Cycle:newfindingsusingthesurveyofseniorloanofficers,JournalofMoney,

CreditandBankingvol.

FrederickR.Macaulay,(1938)SomeTheoreticalProblemsSuggestedbyThe

Movementsof

Inerest

Rates,

bond

Yields

and

Stock

Prices

in

the

United

States

since

1856,NBER.

AllanH.Meltzer(2003)AhistoryoftheFederalReserveVolume1,19131951.

Chicago:UniversityofChicagoPress.

FredericS.Mishkin(1978)TheHouseholdBalanceSheetandtheGreat

DepressionJournalofEconomicHistory38(December):91837.

FredericS.

Mishkin(

1990)

Asymmetric

Information

and

Financial

Crises:

A

HistoricalPerspectiveNBERWorkingPaperNo.3400.July

FredericS.MishkinandEugeneN.white(2002)U.S.StockMarketCrashesand

TheirAftermath;ImplicationsforMonetaryPolicy.NBERWorkingpaper

no.8992June.

WesleyClairMitchell,(1913),BusinessCycles,Univ.ofCaliforniaPress,Berkeley.

KerryOdellandMarcWeidenmeir(2004)RealShock,MonetaryAftershock:

the1906SanFranciscoEarthquakeandthePanicof1907Journalof

Economic

History52(December):757784.

RaymondE.OwensandStaceyL.Schreft,(1993)IdentifyingCreditCrunches.

FederalReserveBankofRichmondWorkingPaper932.

25


26/45


27/45

AlbertM.Wojnilower(1985) PrivateCreditDemand,SupplyandCrunches,

HowDifferentarethe1980s.AmericanEconomicReview.Vol75No.2May,pp

351356.

AlbertM.Wojnilower(1992) CreditCrunchesintheNewPalgraveDictionary

ofMoneyandFinance.London:MacMillan.

27


28/45

TABLE 1:Descriptive Data 1873-2008

NBERBusiness

Cycle Peak

BankingCrises

StockMarketCrash

RealEstateBust

TightMonetary

Policy

CreditCrunch

Comments

1 October

1873

September

1873

September

1873

no Bank of

Englandtightens

? International Financial

Crisis; real estate bustin Germany, Austria;

Railroad scandal stockmarket crisis andserious recession

focused on railroads.Panic ends withsuspension ofconvertibility.

2 March 1882 June 1884 February1884

no no yes1

Minor panicconsequent upon

failure of Grant andWard, attenuated byNY clearing house.

3 March 1887 no no no no no Minor recession

4 July 1890 November1890

November1890

no Bank ofEnglandtightens

no Baring crisis inLondon caused byArgentine defaults.Bank of England

tightening leads tosudden stop, minor

banking panicattenuated by NYclearing house.

5 January1893

May 1893 May 1893 no Silver risk yes1

Major U.S. bankingpanic related to fearsU.S. would be found

off gold standard afterpassage of ShermanSilver Purchase Act.

Panic ends with

suspension ofconvertibility.

6 December1895

October1896

2

no no Silver risk no Gorton(1987)identifies a banking

panic but Sprague andFriedman and

Schwartz (1963) donot. Silver risk inducedrun on U.S. Treasury

gold reservesstemmed by Belmont

MorganSyndicate(Friedman

and Schwartz)

7 June 1899 no no no no no Minor recession

8 September1902

no October1903

no no no Minor recession. Richman's panic

(Friedman andSchwartz p.151)

28


29/45

NBERBusiness

Cycle Peak

BankingCrises

StockMarketCrash

RealEstateBust

TightMonetary

Policy

CreditCrunch

Comments

9 May 1907 October1907

October1907

no Bank ofEnglandtightens

yes1

Major recession andbanking panic, rescue

by JPMorgan,

suspension ofconvertibility.

Contemporariesdiscuss credit

squeeze.

10 January1910

no no no no no Minor recession

11 January1913

August1914

(incipient)

August1914

(incipient)

no no no Outbreak of WorldWar I

12 August 1918 no Fall 1917 no no no Mild recession,Mishkin and

White(2002) attributestock market crisis torising interest rates

and controls on newissues.

13 January1920

no Fall 1920 no yes no Major recessioninduced by Fed tightmoney to roll backwartime inflation.

14 May 1923 no no no yes no Minor recession. Fedfollowed policy of

moderaterestraint(Friedman

and Schwartz 1963.p.287) to offset

incipient inflation.

15 October1926

no no no3

yes no Minor recession. Fedtakes "moderate

restrainingmeasures"(Friedmanand Schwartz 1963.

p.288)

16 August 1929 October1930 April

1931Sept/Oct

1931Jan/Feb

1933

October1929

yes4

yes yes5

Great contraction.Tight Fed policy 1928-

29 to stem stockmarket speculation for

Banking crises.Contraction in net

worth, debt deflation,bank capital crunch.

17 May 1937 no February1937 May

1940

no yes yes6

Major recession. Feddoubles reserve

requirements in 1936,Contraction in networth, bank capital

crunch.

18 February1945

no September1946

no no no End of World War II.Sharp decreases in

governmentexpenditures.

Adjustment from warto peace.

29


30/45

NBERBusiness

Cycle Peak

BankingCrises

StockMarketCrash

RealEstateBust

TightMonetary

Policy

CreditCrunch

Comments

19 November

1948

no no no yes no Fed tightens to offset

post war inflation.

20 July 1953 no no no yes yes8

Mild recession.

Moderate tightening

reflecting Fed concern

of inflation. Bond crisis

raises rates.

21 August 1957 no no no yes9

yes10

Significant recession

induced by Fed

tightening. Evidence

of credit rationing.

22 April 1960 no Spring

190211

no yes yes12

Mild recession

induced by Fed

tightening.Disintermediation as

market rates pierced

Regulation Q. ceilings

leads to reduced bank

lending.

August

- Sept

196613

"Credit crunch" of

1966 background of

Fed tightening

monetary policy end of

1965. Fed bank

regulators urged

restraint on bank

lending.Disintermediation

Regulation Q. ceilings

bound.

23 December

1969

no14

May 1970 no yes15

yes16

Mild recession. Fed

tightening and

jawboning by Fed and

government to restrain

lending.

Disintermediation as

market rates exceed

Regulation Q. ceilings.

24 November

1973

no17 November

197318

no yes yes19 Fed tightening. OPEC

shock. Significant

recession. Arthur

Burns May 1974 urges

banks to allocate

credit through non

price rationing.

30


31/45

NBERBusiness

Cycle Peak

BankingCrises

StockMarketCrash

RealEstateBust

TightMonetary

Policy

CreditCrunch

Comments

25 January

1980

no no no yes yes Significant Fed

tightening begins

October 1979 (Volcker

shock). March 1980Fed at Carter's

administration request

imposes selective

consumer credit

controls. Controls

lifted July 1980.

26 July 1981 no no no yes no Tight Fed policy

induces serious

recession.

27 July 1990 no August

1990

no25

yes26

yes27

Fed tightening. Gulf

war. Mild recession.Evidence of non price

credit rationing and a

capital crunch.

28 March 2001 no Spring

2001

no yes no Fed restraint leads to

mild recession, tech

bust

29 December

2007

September October28

yes29

yes30

yes Fed tightening

beginning in June

2004 may have

helped trigger a real

estate bust, Lehman

Brothers failure, creditcrunch, stock market

slide, and severe

recession.

Endnotes

1Calomiris and Hubbard(1989) Citing Sprague and others.

2Gorton(1987).

3Florida land bust, White(2008).

4White(2008).

5

Bernanke(1983), Calomiris and Mason(2003), Calomiris and Wilson(2004).6Bernanke(1983), Calomiris and Wilson(2004).

7Romer and Romer(1989) pick October 1947 as the start of Fed tightening.

8Wojnilower(1992) states that bank lending was impaired by the collapse in Treasury bond

prices.9Romer and Romer(1989) date tightening as beginning September 1955.

10Wojnilower(1980, 1982, 1992), Eckstein and Sinai(1985) discuss credit rationing as leading to

the 1957-58 recession.

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11Real stock prices decline by 29% January 1966 to October 1966(Bordo, Dueker and Wheelock

2008).12

According to Wojnilower(1980, 1992), Fed tightening pushed T-bill rates above the Regulation

Q ceiling leading to disintermediation.13

Wojnilower(1980), Owens and Schreft(1993).14

Penn Central collapse in July 1970. The Fed averted a crisis by backstopping the money center

banks' support of the commercial paper market.15

Romer and Romer(1989) date Fed tightening as beginning in December 1968.16

Owens and Schreft(1993).17

Failures of Franklin National Bank October 1974 and Germany's Herstatt Bank June 1974.18

Romer and Romer(1989) date monetary tightening as beginning in April 1974.19

Owens and Schreft(1993).20

Real stock prices decline by 20%, November 1980 to July 1982(Bordo, Dueker and Wheelock

2008).21

Shiller(2005) figure 2.1 shows a 13% decline in real house prices 1979-1993.22

Owens and Schreft(1993).

23Failures of Continental Illinois and Penn Square banks in 1984. Also Savings and Loan crisis in

1984.24Owens and Schreft(1993).

25Shiller(2005) figure 2.1 shows a 13% decline in real house prices 1989-1993.

26Romer and Romer(1989) give December 1988 as the beginning of tight policy.

27Bernanke and Lown(1991) provide evidence of a capital crunch in New England. Bonds

reduced lending to replenish their capital to meet regulatory standard. Owens and

Schreft(1993) document non price credit rationing in the real estate sector.

28The Standard and Poor stock price index declined 55%. July 2007 to March 2009.

29The Case and Shiller real home price index declined 33% from December 2006 to October

2008.

30The Federal Funds rate increased from a trough in May 2004 at 1.00% to a peak of 5.26% in

July 2007.

Sources

Banking Crises: Bordo(1986), Friedman and Schwartz(1963), Gorton(1987).

Stock Market Crashes: Bordo(1985), Bordo, Dueker and Wheelock(2008), Friedman and

Schwartz(1963), Mishkin and White(2002), Sprague(1910)

Real Estate Busts: Shiller(2005), White(2008).

Tight Monetary Policy: Friedman and Schwartz(1963), Meltzer(2004), Romer and Romer(1989).

Credit Crunch: Bernanke(1985), Bernanke and Lown(1991), Calomiris and Hubbard(1987),

Calomiris and Mason(2003), Calomiris and Wilson(2004), Eckstein and Sinai(1985), Owens and

Schreft(1993), Wojnilower(1980, 1985, 1992).

32


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Amplitude Peak-

Trough

P-T % Trough-peak T-P %

RGNP (NBER

cycles)

-11.13 -7.8% 36.37 34.1%

Rail Road Spread -0.28 0.27CP -2.63 2.51

M2 growth 10.4% 12.1%

Table 2: Cycle Amplitudes, 1875:1-1918:4, quarterly

Duration (Quarters) 19th Peak-Trough Trough-peak

RGNP (NBER cycles) mean 6

max 13min 3

8.3

125

Rail Road Spread mean 8.25max 18

min 2

9.89

36

2

CP mean 5.54max 11

min 3

6.75

14

3

M2 growth mean 7.45max 18

min 4

6.91

12

3

Table 3 Cycle durations, 1875:1-1918:4, quarterly

33


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Amplitude Peak-Trough P-T % Trough-peak T-P %

RGNP (NBER

cycles)

-28.69 -5.9% 238.52 29.0%

Baa Spread -1.18 1.14

Discount Rate -2.18 2.18M2 growth -2.9% 3.1%

Table 4: Cycle Amplitudes, 1920:1 to 2007:4

Duration

20thPeak-Trough Trough-peak

RGNP

(NBER

cycles)

mean 4.5

max 14

min 2

17.7404

Baa Spread mean 11.1max 30

min 4

8.421

2

Discount

Rate

mean 8.8125

max 18

min 2

20.8

66

9

M2 growth mean 11max 65

min 3

6152

Table 5: Cycle Durations, 1920:1 to 2007:4

34


35/45

Baa Discount M2 (log dif) NBER

Baa SpreadconcordanceExpected concordance

Prob. Of independence

1 54.0%

48.8%

26%

40.3

50.5

0.5%

34.4%

45.5%

0.005%Discount Rate 1 38.1

49.50.4%

61.6

54.60.9%

M2 (log difference) 1 50.3

48.0

35.4%

NBER cycle 1

Table 6: Concordances, expected concordances, and probability of independence(regression method) for 20th century series: 1920:1 to 2007:4, quarterly, M2 is annual log

difference, using data from 1919:1 calculated from Balke-Gordon, spliced with Board of

Governors M2 data.Moody's Seasoned Baa Corporate Bond Yield (% p.a.) less Long-Term TreasuryComposite, Over 10 Years (% p.a.)

Discount Rate: Pre 1945, FRB NY rate, then BOG rate.

NBER Rail spread CP rate M2 (log dif)

NBER CycleconcordanceExpected concordance

Prob. Of independence

1 59.7%

50.1%

8.1%

63.6

51.0

1.3%

50.6%

49.8%

80.9%Railroad Spread 1 54.0

50.137.9%

50.0

50.084.3 %

Commercial Paper

rate

1 39.2

49.76.4%

M2 (log difference) 1

Real GNP 67.054.1%

0.000%

Table 7: same as above, for 19th

century data, 1875:1 to 1918:4 (quarterly).

35


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Table 8 NBER 19 Recession Amplitude, 19th Century.Recession amplitude (Peak-trough Real GNP as a fraction of Peak RGNP) for NBERcontractions, regressed against the Peak-Trough change in other variables. Money supply andStock index are also measured as fractional changes.Dependent Variable: RNGP

Data is for the NBER recessions starting in 1882,1887,1890, 1893,1895,1899,1902,1907,1910,

and 1913.With Heteroscedasticity-Consistent (Eicker-White) Standard Errors

(t-statistics in parentheses)

IndependentVariables

1 2 3 4

Constant0.404**(2.39)

0.002(0.08)

-0.032(-1.54)

0.041**(2.53)

RR Spread-0.282**(2.43)

-0.485*(-1.91)

-0.032(-0.33)

-0.291*(-1.78)

Commercial Paper 0.679***(5.31)

0.684***(5.33)

Stock Index0.237**(2.19)

0.319**(2.38)

0.636***(5.63)

0.233**(2.10)

M2 growth0.008(0.37)

0.025**(2.54)

Interaction 1-0.548***(-6.94)

Interaction 2-0.174(-0.10)

Observations 10 10 10 10

R2

0.814 0.407 0.732 0.814

R-bar2

0.720 0.111 0.518 0.665

* 10% significance level

** 5% significance level

*** 1% significance level

36


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TABLE 9 NBER 20 Recession Amplitude, 20th

century.Recession amplitude (Peak-trough Real GNP as a fraction of Peak RGNP) for NBERcontractions, regressed against the Peak-Trough change in other variables. Money supply andStock index are also measured as fractional changes.Dependent Variable: RNGP

Data is for the NBER recessions starting in 1920, 1923,1926,1929, 1937, 1945, 1948, 1953,

1957, 1960, 1969, 1973, 1980, 1981, 1990, 2001.Dependent Variable: RNGP

With Heteroscedasticity-Consistent (Eicker-White) Standard Errors



1 2 3 4

Constant0.048**(2.48)

0.061***(4.49)

0.039***(2.82)

0.072***(2.67)

Baa Spread-0.010(-0.48)

-0.025***(-3.12)

-0.014(-1.08)

0.031(0.94)

Discount Rate-0.004(-0.35)

-0.039***(-2.93)


-0.045(-0.85)

0.014(0.22)

0.168**(2.45)

M2 growth0.765***(7.45)

-0.024(-0.05)

Interaction 1-0.341*(-1.76)

Interaction 2-0.041***(-3.54)


R2

0.506 0.743 0.834 0.763

R-bar2

0.383 0.679 0.774 0.677




37


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TABLE 10: PAGAN 19 Recession Amplitude associated with cycles in other variables.

This shows the results of regression of RGNP percent amplitude in an NBER contraction (P-T)

against the change other variables over their individual Harding-Pagan cycle.

Dependent Variable: RNGP

For the recessions of the 19th

century.




1 2 3 4

Constant-0.128***(-4.65)

-0.095***(-3.54)

-0.114***(-3.54)

-0.232***(-4.74)

RR Spread-0.003(-0.08)

-0.058(-1.43)

-0.109**(-2.37)

-0.471***(-3.61)

Commercial Paper0.029***(3.81)

0.058***(6.71)

Stock Index0.384***(2.75)

0.509***(4.91)

0.616***(4.44)

0.552***(4.42)

M2 growth-0.206***(-3.65)

-0.038(-0.22)


Interaction 20.196***(4.07)


R2

0.609 0.578 0.632 0.806R-bar

20.414 0.367 0.339 0.651




38


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Table 11: PAGAN 20 Recession Amplitude associated with cycles in other variables.

This shows the results of regression of RGNP percent amplitude in an NBER contraction (P-T)

against the change other variables over their individual Harding-Pagan cycle.

Dependent Variable: RNGP




1 2 3 4

Constant0.075**(2.37)

0.064***(2.86)

0.038**(2.27)

0.033(0.82)

Baa Spread0.019(0.83)

0.012(0.68)

0.024***(3.63)

0.039(1.38)

Discount Rate-0.012**(-2.01)

0.020(1.19)


0.006**(2.18)

0.003*(1.64)

-0.002(-0.23)

M2 growth0.083(0.41)

0.071(0.97)

Interaction 10.138***(13.34)



R2

0.293 0.167 0.858 0.400R-bar

20.100 -0.060 0.801 0.160




39


40/45

Table 12 Recession Amplitudes with and without large financial events.

P-T RGNP

Amplitude, 20th

credit M2 Stock

With crunch 10.4% 14.8% 15.2%

Without crunch 3.8% 2.9% 2.8%

t-statistic 0.98 1.57 1.34

P-T RGNPAmplitude, 19th

credit M2 Stock

With crunch 7.1% 6.9% 5.4%

Without crunch 0.1% -0.7% 0.8%

t-statistic 1.83** 3.12** 0.94

t-tests for equal mean with unequal variances.*significant at 10% level

**significant at 5% level

***significant at 1% level

40


41/45

41


42/45

-15

-10

-505

10

15

20

25

18

75

18

80

188

5

18

90

18

95

19

00

19

05

19

10

19

15

Log

change

Rea

lGNP

Comm

erc

ialban

ks

loans

M2

Source:Balke

&G

ordon,

NBER,

FederalReserve

Board,

FDIC,

Fried

m

an

&S

chw

artz,

Authors

calculations

012345678910 7

5

0

5

0

5

0

5

0

5

0

0.0

0

0.2

5

0.5

0

0.7

5

1.0

0

1.2

5

1.5

0

Percen

t

Ra

ilroa

d

bon

d

sprea

d(

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le)

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erc

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ra

te

(leftsca

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Percen

t

-35

-25

-15

-55

15

25

35

45

19

20

19

25

19

30

19

35

19

40

19

45

19

50

19

55

19

60

19

65

19

70

19

75

19

80

19

85

19

90

19

9520

00

20

05

Log

change

Rea

lGNP

Com

m

erc

ialbank

sloans

M2

Source:Balke

&G

ordon,

NBER,

FederalReserve

Board,

FDIC,

Friedm

an

&S

chwartz,

Authors

calculations

0246810

12

14

0

5

0

5

0

5

0

5

0

5

7 0

7 5

0

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5

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Percen

t

Baa

bon

d

sprea

d

Discoun

tra

te

Figure1

42


43/45

43

012345678910

11

12

18

75

18

80

188

5

18

90

18

95

19

00

19

05

19

10

19

15

19

20

Source:

Stan

dar

d

an

d

Po

or

s

S&P

500

index

In

dex,

Logar

ithm

icsca

le

110

100

1000

10000

19

20

19

25

19

30

19

35

19

40 1

94

519

50

19

55

19

60

19

65

19

70

19

75

19

80

19

85 1

990

19

95

20

00

20

05

Source:Standard

&P

oors

S&P5

00

index

Index,

Logarit

hm

icscale

Figure1

continued

020

40

60

80

100

120

140

160

180

200

220

1

1

1

2 1

3 1

4 1

5 1

6 1

7 1

1

1

1

Rea

lHPI

In

dex


44/45

44 -0.10

-0.05

0.00

0.05

0.10

0.15 -

0.10

-0.05

0.00

0.05

0.10

0.15

0.20

BLS

Data

RGNPvs.RR

Spread(1800s)

RGNPcontraction

RR

sp

readcontraction

93

07

13

-0.05

0.00

0.05

0.10

0.15

RGNPvs.

M2(1800s)

RGNPcontraction

93

07

13

-0.10

-0.05

0.00

0.05

0.10

0.15 -

0.20

-0.12

-

0.04

0.04

0.12

0.20

0.28

BLSData

RGNPvs.CP(1800s)

CPcontraction

RGNPcontraction -0.05

0.00

0.05

0.10

0.15

RGNPvs.Stocks(1800s)

RGNPcontraction

93

07

13

93

07

13

Figure2


45/45

50

-2.00

-1.50-

1.00

-0.50

0.00

0.50

1.00

1.50

2.00

NPvs.BaaSpread(1900s)

Baaspreadcontraction

45

20

37

-0.05

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

0.40 -

1.00

0.00

1.00

2.00

3.00

4.00

5.00

BLSData

RGNP

vs.Discount(19

00s)

Discountratecontraction

RGNPcontraction

45

29

20

37

RGNPv

s.M2(1900s)

45

29

20

3

7

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

0.40

RGN

Pvs.Stocks(190

0s)

RGNPcontraction

45

29

20

37

Figure3

bordo credit market turmoil

Documents