John Maynard Keynes Narrates the Great Depression: His Reports to the Philips Electronics Firm

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Until the disruption in the banking market, in 2023, monetary policy was considered a less important indirect factor that can lead to banking crises. In 2023, a disruption occurred, which proved exactly the opposite, namely that monetary policy can directly cause imbalances in the banking market. According to many authors, this crisis is much stronger than the one in 2008. It was caused by an aggressive increase in interest rates by the American FED (Federal Reserve System). The measure led to huge losses on government bond portfolios held by US banks. The losses influenced the emergence of fear among depositors who withdrew their money from banks and thus led to the collapse of four American banks. The imbalance in the banking market did not remain only in the United States of America but spread through a domino effect to the rest of the world, and above all to the European market. The reason for the emergence of this disorder was not only interest rates. The atmosphere in the financial sector has been tense for a long time. Covid-19, the war in Ukraine, but also the unethical behavior of certain banks are just some of the factors that contributed to the appearance of instability in the banking market. The aim of this paper is to point out the causes and consequences of the banking crisis that just started in the United States of America [USA] and spilled over to the rest of the world, but also to point out the importance of the responsible behavior of banks and the deposit insurance system in prevention and preventing banking crises.

Because the U.S. Federal Reserve's monetary policy is at the center of the world dollar standard, it has a first-order impact on global financial stability. However, except during international crises, the Fed focuses on domestic American economic indicators and generally ignores collateral damage from its monetary policies on the rest of the world. Currently, ultra-low interest rates on short-term dollar assets ignite waves of hot money into Emerging Markets (EM) with convertible currencies. When each EM central bank intervenes to prevent its individual currency from appreciating, collectively they lose monetary control, inflate, and cause an upsurge in primary commodity prices internationally. These bubbles burst when some accident at the center, such as a banking crisis, causes a return of the hot money to the United States (and to other industrial countries) as commercial banks stop lending to foreign exchange speculators. World prices of primary products then collapse. African countries with exchange controls and less convertible currencies are not so attractive to currency speculators. Thus, they are less vulnerable than EM to the ebb and flow of hot money. However, African countries are more vulnerable to cycles in primary commodity prices because food is a greater proportion of their consumption, andiabeing less industrializediathey are more vulnerable to fluctuations in prices of their commodity exports. Supply-side shocks, such as a crop failure anywhere in the world, can affect the price of an individual commodity. But joint fluctuations in the prices of all primary productsiaminerals, energy, cereals, and so oniareflect monetary conditions in the world economy as determined by the ebb and flow of hot money from the United States, and increasingly from other industrial countries with near-zero interest rates.

Currency crises are found to be strongly associated with banking crises. This paper constructs a twin banking and currency crisis model by introducing the banking sector into the currency crisis model and examining the case in which the exchange rate risk is located in the banking system. The model shows that an unanticipated shock caused by the shift of investors’ expectations and/or a negative productivity shock can trigger a twin banking and currency crisis. To achieve both financial stability and economic stability, the central bank uses multiple monetary policy instruments. In contrast to the conventional policy recommendation in response to a currency crisis, i.e., interest rate hike, we find that when the exchange rate risk is located in the banking sector, the monetary policy option to prevent a twin crisis is to lower the policy interest rate and the reserve requirement ratio and raise the interest rate on reserves. Our results show that the location of the exchange rate risk matters for the choice of an appropriate monetary policy response during a crisis.

A bank is the prototypical financial institution; there are notable outward differences between the wealth invested by owners of financial institutions and that of other industries. The capital of a financial institution consists largely of financial assets and only to a small degree of the physical plant and equipment usually associated with capital in other industries. Moreover, these physical differences are associated with important functional differences. A financial institution, like any other firm, faces the problem of combining the inputs which it purchases to produce the outputs which it sells. In banking, the most important inputs are labor and deposits, and they produce liquidity services, brokerage services, accounting and information services, and the like. In this production process, bank capital has two roles: (1) It cooperates directly with the other inputs in the production of bank services, and (2) it is used to attract the deposit input by providing insurance to depositors against a decline in the value of a bank's assets; the more capital a bank has, the more the value of its assets can fall before depositors incur losses. The difference between banking (and financial institutions in general) and most other industries is in the relative importance of these two roles. The equity capital of any firm serves, in part, to guarantee the value of the firm's fixed obligations, but that function is usually subordinate to the provision of assets to the firm. However, in banking, equity capital (and equity is the form that almost all nondeposit ownership interest in bank assets has taken) typically accounts for only about a tenth of total bank resources, and most of the returns to equity capital derive from its insurance function. Bank owners invest capital primarily to attract deposits, which are then used to buy assets, and only secondarily to buy assets directly. Apart from these novel economic aspects, a study of investment in banking provides the opportunity to study the effects of government

PurposeThe purpose of this paper is to explore the Irish banking crisis and explain how various factors contribute to a collapse in asset prices, an economic recession and the near failure of the banking system. The paper seeks to document the dangers of pro‐cyclical monetary and government policies, particularly in an environment of benign financial regulation and pent‐up demand for credit.Design/methodology/approachThe paper maps the Irish banking crisis against its general background. It describes the roots of the crisis, with particular attention given to government and monetary policies, the practices of the financial regulator and banks during the property bubble, together with the difficulties associated with the international sub‐prime crisis.FindingsWhile the global financial crisis exacerbated matters, the banking crisis in Ireland was largely a home‐grown phenomenon. The crisis stemmed from the collapse of the domestic property sector and subsequent contraction in national output. Its root cause can be found in the inadequate risk management practices of the Irish banks and the failure of the financial regulator to supervise these practices effectively.Originality/valueThe paper documents the “Celtic Tiger” phenomenon of the last decade: the Irish economic and property miracle, its sharp decline, and the sub‐prime crisis. It delineates one of the most severe banking and economic crisis in a developed country since the great depression with a number of key policy lessons for rapidly expanding economies.

This study examines how macro-prudential regulation is related to the predicted probability of systemic banking crises. Given a wide range of regulatory frameworks across different economies and their complex relationships, we investigate how monetary policy stance affects the link between measures of macro-prudential regulation and banking crises. Using a panel logit regression of 532 banks in 29 African countries over the period, 2006–2018, we confirm that macro-prudential regulation and monetary policy play significant roles in reducing the probability of systemic banking crises. We also find evidence to support that tightening monetary policy alters the negative effect of macro-prudential policy action on systemic banking crises, and that a tight monetary policy stance magnifies the negative effects of both countercyclical capital requirement and reserve requirement on systemic banking crises. Interestingly, the interaction effect between measures of macro-prudential regulation and monetary policy in reducing systemic banking crises seems to favour countries with strong institutions compared to those with weak institutions.KeywordsMacro-Prudential RegulationMonetary PolicySystemic Banking Crises

The collapse of Silicon Valley Bank (SVB) and Signature Bank on 8-10 March 2023 has triggered deep financial turmoil in the US and prompted financial and monetary authorities to intervene to swiftly avert a contagion. SVB specialized in providing finance and banking services to venture-backed start-ups, most of which are technology firms. It was the largest US bank to fail since the global financial crisis (GFC) of 2008. SVB’s failure is generally attributed to liquidity exacerbated by large and quick withdrawals, net interest margins associated with the broader tech sector downturn, and rising interest rates that resulted in the deterioration of their balance sheets because of large unrealized losses. The collapse of SVB occurred amid tightening global financial conditions and increasing uncertainty about global recovery prospects. As such, it is imperative to understand and examine the extent to which broader central bank policies interacted with SVB’s failure. In 2022, in response to the global inflation acceleration, central banks, especially the Federal Reserve System (the Fed) of the US, raised interest rates, from 0.125% in February 2022 (pre-East European crisis) to 4.625% in February 2023. Because of the shift from monetary easing to tightening, bond yields have started to reflect changing market sentiments in the US, the impact of which can be observed in bank balance sheets. As a result, the value of long-term assets, such as government bonds and mortgages, have deteriorated, exposing solvency concerns and liquidity stress, especially for mid-sized and regional banks. Despite massive bailouts for the US banking sector, investor sentiment has remained fragile and global contagion risks remain. This topical paper aims to provide further insights into the US banking crisis as it unfolds. The analysis focuses on the following aspects: (i) understanding the circumstances that led to the crisis (ii) highlighting the policy reactions so far, (iii) assessing the risks of contagion globally, and (iv) drawing potential lessons and recommendations.

We review the recent literature on macroprudential policy and its interaction with other policies, extracting several points. First, there are externalities in the financial sector, often in the form of excessive credit growth. Second, monetary policy needs to take financial stability into account. Third, macroprudential instruments can moderate the financial cycle. Finally, there are complementarities between monetary and macroprudential policies, but also potential conflict. We then relate these points to recent events in the euro area where, following the sovereign debt crisis, a retrenchment of finance within national borders is taking place, amplifying the divergences across economies. We argue that in principle national authorities would like to adjust macroprudential instruments to compensate for the highly heterogeneous financial conditions, but at present they have little leeway to do so, since in the run-up to the crisis insufficient capital buffers had been accumulated. Various factors may explain low bank capitalization levels worldwide. We discuss the role of risk-weighted assets, which may have inadequately captured actual risks in many jurisdictions; we also document that European and US banks’ capital ratios decline monotonically with bank size. This confirms that key features of the microprudential apparatus are crucial for preventing financial instability.

Monetary Policy Report - July 2022

This paper uses the 2007-2009 financial crisis as a negative liquidity shock on banks to analyze their lending behavior and study the differences between US and euro-area banks. When faced with a negative liquidity shock, US banks transmitted liquidity shocks to the real economy by reducing the amount of their loans whereas euro-area banks did not show any decline in their lending. The main difference between US and euro-area banks is the ability of finding alternative financing. Euro-area banks were able to issue short-term debt whereas US banks seemed unable to do so. Financing frictions prevented US banks from finding alternative financing which led to a decline in their loan supply. This difference in their access to alternative financing sources could be explained by the different monetary policy responses. Overall, this paper concludes that differences in the monetary policy responses of the Federal Reserve in the US and the ECB in the euro area has led to differences in the transmission of liquidity shocks to the real economy.

This paper explores the transmission of US monetary policy through US banks to emerging market economies (EMEs) and the role that stress tests play in this transmission. Data on US banks’ monthly commercial and industrial loan originations shows that: (a) US bank lending to EMEs was sensitive to domestic monetary policy changes during the zero‐lower bound period. (b) Effects of monetary easing were heterogeneous across banks and depended on banks’ stress test results, a proxy for their capital strength. Only banks that comfortably passed the stress tests issued more loans to EME borrowers. (c) Effects of monetary tightening were more similar across banks. (d) Banks shifted their lending to safer borrowers within EMEs in response to monetary easing, leaving the risk of their overall loan books unchanged. These results support the hypothesis that bank capital affects the transmission of easier monetary policy, including across borders. We conjecture that bank lending to EMEs during the zero‐lower bound period would have been even higher had the United States not introduced stress tests for their banks.

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PurposeThis paper sets out to explore three areas in which the experience of the great depression might be relevant today: monetary policy, fiscal policy, and the systemic stability of banks.Design/methodology/approachA critical review of the US data for the 1920s and 1930s is presented and stylised facts for monetary, fiscal and banking policies during the noughties are shown and compared with those of the great depression.FindingsThe authors confirm the consensus on monetary policy: deflation and massive bank failures must be avoided. With regard to fiscal policy it is impossible to confirm a widespread opinion according to which fiscal policy did not work because it was not tried. The paper finds that fiscal policy went to the limit of what was possible under the conditions as they existed then. Policy reaction after 1932 was no less bold than that of today if one accounts for sustainability issues. Lastly, the investigation of the US banking system shows a surprising resilience of commercial banks that remained profitable, at least on average, even during the worst years.Originality/valueFirst, the paper presents a systematic comparison between the great depression and the great recession, highlighting similarities and differences. Second, it suggests a relevant policy implication. Findings on commercial bank sector resilience suggest that at present national authorities have little choice but to make up for the losses on “legacy” assets and wait for banks to earn back their capital. However, to prevent future crises, at least a partial separation of commercial and investment banking seems justified.

In this paper we discuss the lessons learned from the US banking panics in the 1930s for the response by the Federal Reserve to the crisis of 2008. We revisit the debate over illiquidity versus insolvency in the banking crises of the 1930s and provide empirical evidence that the banking crises largely reflected illiquidity shocks. In the recent crisis the Fed under Bernanke had well learned the lesson from the banking panics of the 1930s of conducting expansionary monetary policy to meet demands for liquidity. However, unlike in the 1930s, the deeper problem of the recent crisis was not illiquidity but insolvency and especially the fear of insolvency of counterparties. A number of virtually insolvent US banks deemed too big and too interconnected to fail were rescued by fiscal bail-outs.