MIT14_02F09_lec23_24

MIT14_02F09_lec23_24 - Great Great Depression and Current...

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Great Depression and Current Recession
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Great Depression 2
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1929-1933: Bank Runs From “A Monetary History of the United States 1857-1960” by Milton Friedman and Anna J. Schwartz 3 Year ending Real GDP Price level Bank deposits Reserves -3.1 4.3 -5.9 2.2 7.8 35.8 16 -11.6 -11.3 -20.6 -4.7 -1.4 2 -4 -8.8 -9 -2.6 7.7 5.9 -9.3 -8.0 -14.1 -2.1 7.4 1929 1930 1931 1932 1933 1934 Year-to-year Percent Changes Figure by MIT OpenCourseWare.
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“Flight to Currency” • Cumulative decrease of bank deposits over 1929-1933 was 48.2% hy??? It was not because reserves fell given that they rose by 8 4% Why??? It was not because reserves fell, given that they rose by 8.4% A fractional reserve banking system is fragile Two possible equilibria: 1. people believe banks have enough reserves to cover withdrawals and hence they do 2. people believe banks do not have enough reserves and hence they don’t In 1929-33: three episodes of bank runs in 1930 and 1933 4 Hence aggregate decrease in deposits due to bank failures + preemptive withdrawals from sound banks
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How can increased demand for currency precipitate a depression? o b ild p cash reser es people sell off other assets (M ifts!) To build up cash reserves, people sell off other assets (M d shifts!) • But the economy as a whole cannot get more liquidity if M is fixed. The only effect of this effort is that i increases Only possibility to hold more cash is to reduce cash outflows, and hence spending reduced by 58% • Spending decline results in both deflation and decline in production. 5
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MIT14_02F09_lec23_24 - Great Great Depression and Current...

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