Mon 2009-12-21 18:24 EST

Credit Booms Gone Bust: Monetary Policy, Leverage Cycles and Financial Crises, 1870-2008

Moritz Schularick, Alan M. Taylor

The crisis of 2008-09 has focused attention on money and credit fluctuations, financial crises, and policy responses. In this paper we study the behavior of money, credit, and macroeconomic indicators over the long run based on a newly constructed historical dataset for 12 developed countries over the years 1870-2008, utilizing the data to study rare events associated with financial crisis episodes. We present new evidence that leverage in the financial sector has increased strongly in the second half of the twentieth century as shown by a decoupling of money and credit aggregates, and we also find a decline in safe assets on banks' balance sheets. We also show for the first time how monetary policy responses to financial crises have been more aggressive post-1945, but how despite these policies the output costs of crises have remained large. Importantly, we can also show that credit growth is a powerful predictor of financial crises...

1870-2008; Credit Booms Gone Bust; financial crises; leverage cycle; monetary policy.

The Big Picture Wed 2009-10-14 11:36 EDT

Andy Xie: Here We Go Again

Former Morgan Stanley Analyst Andy Xie explains why China is a potential bubble: [Consider] the US Savings and Loans crisis of the late 1980s and early 1990s. The US Federal Reserve kept monetary policy loose to help the banking system. The dollar went into a prolonged bear market. During the descent, Asian economies that pegged their currencies to the dollar could increase money supply and lending without worrying about devaluation, but the money couldn't leave home due to the dollar's poor outlook, so it went into asset markets. When the dollar began to rebound in 1996, Asian economies came under tightening pressure that burst their asset bubbles. The collapsing asset prices triggered capital outflows that reinforced asset deflation. Asset deflation destroyed their banking systems. In short, the US banking crisis created the environment for a credit boom in Asia. When US banks recovered, Asian banks collapsed. Is China heading down the same path? There are many anecdotes to support the comparison. Property prices in Southeast Asia became higher than those in the US, but ``experts'' and government officials had stories to explain it, even though their per capita income was one-tenth that of the US. Their banks also commanded huge market capitalizations, as financial markets extended their growth ad infinitum. The same thing is happening in China today. When something seems too good to be true, it is. World trade -- the engine of global growth -- has collapsed. Employment is still contracting throughout the world. There are no realistic scenarios for the global economy to regain high and sustainable growth. China is an export-driven economy. Bank lending can support the economy for a short time, however, stocks are as expensive as during the heydays of the last bubble. Like all previous bubbles, this one, too, will burst.

Andy Xie; Big Picture; Go.