Economics 210C/236A Christina Romer Spring 2016 David Romer L ECTURE 8 The Effects of Financial Crises October 12, 2016
I. O VERVIEW
Central Issue • What are the macroeconomic effects of financial crises? • Papers for today look at aggregate, time-series evidence. • Next week look at more micro, cross-section evidence.
What Is a “Financial Crisis?” • Many candidates: Could involve sovereign debt, the exchange rate, intermediation, asset prices, …. • Today’s papers all focus on developments involving financial intermediation—something causes a rise in the cost of credit intermediation. • And if the goal is to focus on “crises,” need some way of distinguishing crises from more run-of-the-mill disruptions to intermediation.
Papers • Reinhart-Rogoff: Aftermaths of crises in a large sample of countries. • Jalil: Detailed study of the United States, 1825– 1929. • Krishnamurthy-Muir: A more statistical approach to identifying crises and their effects.
II. R EINHART AND R OGOFF , “T HE A FTERMATH OF F INANCIAL C RISES ,” C HAPTER 14 OF T HIS T IME IS D IFFERENT : E IGHT C ENTURIES OF F INANCIAL F OLLY
Two Key Steps • Identifying crises. • Estimating their effects.
Reinhart and Rogoff’s Definition “We mark a banking crisis by two types of events: (1) [systemic, severe] bank runs that lead to the closure, merging, or takeover by the public sector of one or more financial institutions and (2) [financial distress, milder] if there are no runs, the closure, merging, takeover, or large-scale government assistance of an important financial institution (or group of institutions) that marks the start of a string of similar outcomes for other financial institutions.” From: Reinhart and Rogoff, This Time Is Different , p. 11.
Reinhart and Rogoff’s Application of Their Definition • Secondary sources. • Limited discussion of why they classified things as they did.
Japan From: Reinhart and Rogoff, This Time Is Different , p. 371.
Issues with Their Identification of Crises • Accuracy? • Could the procedures for identifying crises introduce bias? • Is a binary classification appropriate?
Key Components of Good Narrative Analysis • Evaluate reliability of narrative sources. • Know what you are looking for in the sources. • Read as carefully and objectively as possible. • Document classification extensively.
Digression on Romer and Romer’s New Measure of Financial Distress • Use a single, real-time narrative source. • Define financial distress as a rise in the cost of credit intermediation. • Try to come up with a scaled series on financial distress. • Series is quite different from Reinhart and Rogoff and the IMF.
New Distress Measure New Distress Measure Comparison of Chronologies for Key Pre-2008 Episodes 10 12 14 10 12 14 0 2 4 6 8 0 2 4 6 8 1986:1 1988:2 1989:2 1987:1 1988:1 1990:2 1991:2 1989:1 a. Finland c. Norway 1992:2 1990:1 1993:2 1991:1 1994:2 1992:1 1995:2 1993:1 1996:2 1994:1 1997:2 1995:1 1998:2 1996:1 New Distress Measure New Distress Measure 10 12 14 10 12 14 0 2 4 6 8 0 2 4 6 8 1990:1 1983:1 1991:1 1984:1 1992:1 1993:1 1985:1 1994:1 1986:1 d. United States 1995:1 1996:1 1987:1 b. Japan 1997:1 1988:1 1998:1 1999:1 1989:1 2000:1 1990:1 2001:1 2002:1 1991:1 2003:1 1992:1 2004:1 2005:1 1993:1 2006:1
Reinhart and Rogoff’s Empirical Technique • Average peak-to-trough change in GDP “around” crises. • Very simple; no standard errors or tests of statistical significance.
Sample of Crises Considered • 21 major banking crises. • 6 recent; 13 other postwar (5 in advanced countries, 8 in developing); 2 others (Norway 1899, U.S. 1929).
Reinhart and Rogoff’s Evidence on The Aftermath of Financial Crises Percent Decrease in Real GDP Per Capita Duration in Years From: Reinhart and Rogoff, This Time Is Different .
Issues with Their Estimation of the Impact of Financial Crises • Might reverse causation be important? • Simple statistics may lead them astray (example: Finland). • What is the logic behind the sample of countries included?
Real GDP in Finland, 1985–1996 11.7 11.7 11.6 Logarithms 11.6 11.5 11.5 11.4 11.4 1985-I 1987-I 1989-I 1991-I 1993-I 1995-I
From: Reinhart and Rogoff, This Time Is Different .
Romer and Romer’s Regression Technique • Jordà regressions of outcome variable at various horizons on financial distress at time t . • Timing assumption: Financial distress in t can affect GDP in t , but not vice versa. • Panel data: 24 countries, 1967–2015. • Use weighted least squares to deal with heteroskedasticity.
Figure 6 Impulse Response Function, Outcome to Distress a. Real GDP, Full Sample, WLS 4 Response of Real GDP (Percent) 2 0 0 1 2 3 4 5 6 7 8 9 10 -2 -4 -6 -8 -10 Half-Years After the Impulse From: Romer and Romer, “New Evidence on the Aftermath of Financial Crises in Advanced Countries”
III. J ALIL , “A N EW H ISTORY OF B ANKING P ANICS IN THE U NITED S TATES , 1825-1929: C ONSTRUCTION AND I MPLICATIONS ”
Overview • Like Reinhart and Rogoff, interested in the macroeconomic effects of financial crises. • But focuses on one country over a defined period: United States, 1825–1929. • Again, two key steps: • Identifying crises. • Estimating their effects.
Previous Panic Series for the U.S. • Bordo-Wheelock • Thorp • Reinhart-Rogoff (2 versions) • Friedman-Schwartz • Gorton • Sprague • Wicker • Kemmerer • DeLong-Summers
From: Jalil, “A New History of Banking Panics in the United States, 1825–1929”
Jalil’s Definition of a Panic • A financial panic occurs when fear prompts a widespread run by private agents … to convert deposits into currency (a banking panic).” (p. 300) • “A banking panic occurs when there is an increase in the demand for currency relative to deposits that sparks bank runs and bank suspensions.” (p. 300) • “A banking panic occurs when there is a loss of depositor confidence that sparks runs on financial institutions and bank suspensions.” (p. 302)
Implementing the Definition • Use articles in Niles Weekly Register, the Merchants’ Magazine and Commercial Review, and The Commercial and Financial Chronicle . • A banking panic requires accounts of a cluster of bank suspensions and runs. • A cluster means 3 or more, and excludes ones mentioned in articles that do not reference other suspensions or runs or general panic. • A panic ends if there are no references to panics or suspensions for a full calendar month. • A panic is major if it is mentioned on the front page of the newspaper and if its geographic scope is greater than a single state and its immediately bordering states.
Documentation from the Online Appendix From: Jalil, “A New History of Banking Panics in the United States, 1825–1929,” Appendix
From: Jalil, “A New History of Banking Panics in the United States, 1825-1929”
Seasonality of Panics From: Jalil, “A New History of Banking Panics in the United States, 1825–1929”
Issues in Jalil’s Identification of Crises • Very different from other series—is this a problem? • Should NYC panics be counted as local? • 3 of his 7 major panics are in the 1830s—does that raise questions about his procedures? • Is there corroborating evidence? • Is his narrative work of high quality?
Interest Rates during Major Panics From: Jalil, “A New History of Banking Panics in the United States, 1825-1929,” Online Appendix
Peak-to-Trough Change in IP around Crises From: Jalil, “A New History of Banking Panics in the United States, 1825–1929”
Percentage Change in Industrial Production 0.20 0.15 0.10 0.05 0.00 -0.05 -0.10 -0.15 -0.20 1820 1825 1830 1835 1840 1845 1850 1855 1860 1865 1870 1875 1880 1885 1890 1895 1900 1905 1910 1915 Standard Deviation 1820-1889 0.060 1890-1915 0.089
Jalil’s VAR Specification 3 3 𝐺 𝑢 = 𝑏 + � 𝛽 𝑗 𝐺 + � 𝛾 𝑗 ∆𝑍 𝑢−𝑗 + 𝑣 𝑢 𝑢−𝑗 𝑗=1 𝑗=1 3 3 ∆𝑍 𝑢 = 𝑑 + � 𝛿 𝑗 𝐺 + � 𝜀 𝑗 ∆𝑍 𝑢−𝑗 + 𝑤 𝑢 𝑢−𝑗 𝑗=1 𝑗=1 • Where F is the crisis dummy and ∆ Y is the change in log output, and u and v are uncorrelated with one another and over time. • Notice timing assumption: Neither variable is allowed to affect the other contemporaneously.
From: Jalil, “A New History of Banking Panics in the United States, 1825–1929”
From: Jalil, “A New History of Banking Panics in the United States, 1825–1929”
How Does Jalil Attempt to Deal with Endogeneity? • Narrative evidence on the cause of the crises. • Restrict sample to major crises that were not caused by a decline in output.
Does he need Dimension 2, given he uses a VAR? From: Jalil, “A New History of Banking Panics in the United States, 1825–1929”
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