The credit crunch illusion? Guest post from Rabee Tourky

Here’s a post on the credit crisis from my colleague, Rabee Tourky

In a Minneapolis Fed. research paper Chari, Christiano, and Kehoe
three claims about the way the financial crisis is affecting the economy as a whole and argue using a number of graphs that all three claims are in fact myths.

The claims that they dismiss are that bank lending to non-financial corporations and individuals has declined sharply; that interbank lending is essentially nonexistent; and that commercial paper issuance by non-financial corporations has declined sharply, and rates have risen to unprecedented levels.

They conclude their note with the following sharp message:

Our main point is that policymakers have not done the hard work of convincing the public or even academic economists of the precise nature of the market failure they see, of presenting hard evidence, not speculation, that differentiates their view of the data from other views, and the logic by which the particular intervention they are advocating will fix this market failure. We feel that a trillion dollar intervention warrants a bit more serious analysis than we have seen. Our analysis is based on publicly available data. Policymakers have access to other sources of data as well. Policymakers could well believe that bold action is necessary based on data that are different from that considered here. If so, responsible policymaking requires that they share both the data and the analysis that underlies the need for bold policy…

Of course, they cleverly anticipated Brad Delong’s response to their note by arguing that analysis of the financial crisis focusing on interest rate spread lead to mistaken inferences.

I came across the Chari, Christiano, and Kehoe paper via another
to it, which kind-off skirts some of the shaper ends of the Chari, Christiano, and Kehoe mythology.

I wonder how the credit crunch myth sits with the following graph of the M1 multiplier (the ratio of M1 to Base Money)? I generated the graph on the
Federal Reserve Bank of St. Louis site

Has the money multiplier really collapsed to almost one? What are banks doing with their deposits? Are they hording new deposits in underground volts?

Will somebody please either tell the Fed. to correct their October-November entries for the M1 multiplier or tell
Chari, Christiano, and Kehoe that there is too a credit crunch?

35 thoughts on “The credit crunch illusion? Guest post from Rabee Tourky

  1. This is not market failure. This is market correction. Where are the costs extended on to those who were not a buyer or seller. Buyers who couldnt pay back loans because they werent aware the loans would re set? lenders sitting on loans they suspected might be toxic but didnt have time to flick to someone else?

    Come on – this isnt market failure at all. Its a speculative bubble that burst. The only failure was a regulatory failure because Greenspan didnt put the brakes on sooner and try and reign it in and failed to correctly regulate the financial markets to ensure transparency and even Greenspan admits it.

    Market failure here? Nonsense.


  2. Will (#24), if I understand your example correctly, you are saying that as a consequence of xyz events in the financial system, the market for syndicated loans of good quality (ie economically profitable projects, managed by reasonable people) does not exist at present at least in some places. If so, then you have given a nice example of practical relevance to illustrate the meaning of the theoretical result in general equilibrium theory: equilibria of competitive private ownership economies with incomplete markets are generically Pareto inefficient (ie resource misallocation is the norm except perhaps on a sunny, say Wednesday afternoon between now and the end of the world). [The text Quinzii and MaGill, Theory of Incomplete Markets, contains references to the original works. Hope this reference will do for current purposes]

    G.E. theory has its limitations. However, to the best of my knowledge it is the body of literature where a ‘market system’ and hence system failure can be discussed in a coherent fashion.

  3. Ernestine,

    Generically in the incomplete market setting equilibrium allocations are not even second best efficient. That is they can be dominated by an allocation of resources that can be achieved without adding new markets. Quinzii and MaGill’s book doesn’t capture this because they don’t cover assets with real returns.

    The principal reference is “An introduction to general equilibrium with incomplete asset markets” Journal of Mathematical Economics, 1990 vol 19.

  4. Rebee,

    True, there is a distinction between spanning a space of security returns (nominal) and spanning a space of real assets. Hence my qualification ‘for current purposes’.

    The situation described by Will is, as you indicated in #20, comparable to a ‘dramatic collapse in the span of existing assets’, ie in financial markets. By contrast, global warming is an example of market failure in ‘real assets’.

  5. Hi Ernestine,

    Your of course right in what you wrote. I was making the point that with real assets the situation is even worse that Pareto inefficiency.

    Real assets are financial assets whose payoff depend on the prices of more than one future spot market.

    I guess I’m being pedantic because I labored away at this literature for a decade.

    Well here we have it, a collapse in the span of assets resulting in the biggest changes in asset prices in a very long time.

  6. Rabee, I enjoyed this thread very much. I also laboured away at this literatue for decades – and never regretted a minute of it.

  7. Ernestine,

    I only said the same thing that McFarlane said today in the newspaper. I dont beleive the financial crisis is a market failure. Its a regulatory failure. We didnt spend decades putting in place regulation to constrain the excesses of the market for nothing. The market needs planning and infrsatructure for it to function satisfactorily. We dont just need regulation to correct market failure – we need (and have always needed) regulation to prevent the markets operating suboptimally.
    The deregualation ethos was taken too far for too long. An ideology had all faith put in it, at the expense of reality.

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