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Business cycles and financial crises: the roles of credit supply and demand shocks

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  • James M Nason
  • Ellis Tallman

Abstract

This paper explores the hypothesis that the sources of economic and financial crises differ from noncrisis business cycle fluctuations. We employ Markov-switching Bayesian vector autoregressions (MS-BVARs) to gather evidence about the hypothesis on a long annual U.S. sample running from 1890 to 2010. The sample covers several episodes useful for understanding U.S. economic and financial history, which generate variation in the data that aids in identifying credit supply and demand shocks. We identify these shocks within MS-BVARs by tying credit supply and demand movements to inside money and its intertemporal price. The model space is limited to stochastic volatility (SV) in the errors of the MS-BVARs. Of the 15 MS-BVARs estimated, the data favor a MS-BVAR in which economic and financial crises and noncrisis business cycle regimes recur throughout the long annual sample. The best-fitting MS-BVAR also isolates SV regimes in which shocks to inside money dominate aggregate fluctuations.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Cleveland in its series Working Paper with number 1221.

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Date of creation: 2012
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Handle: RePEc:fip:fedcwp:1221

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Keywords: Business cycles ; Forecasting ; Financial markets ; Economic history;

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Citations

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Cited by:
  1. Gorton, Gary & Huang, Lixin, 2006. "Bank panics and the endogeneity of central banking," Journal of Monetary Economics, Elsevier, Elsevier, vol. 53(7), pages 1613-1629, October.
  2. Laurent Le Maux & Laurence Scialom, 2013. "Central banks and financial stability: rediscovering the lender-of-last-resort practice in a finance economy," Cambridge Journal of Economics, Oxford University Press, Oxford University Press, vol. 37(1), pages 1-16.
  3. Asaf Bernstein & Eric Hughson & Marc D. Weidenmier, 2008. "Can a Lender of Last Resort Stabilize Financial Markets? Lessons from the Founding of the Fed," NBER Working Papers 14422, National Bureau of Economic Research, Inc.
  4. Gorton, Gary & Winton, Andrew, 2003. "Financial intermediation," Handbook of the Economics of Finance, Elsevier, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 8, pages 431-552 Elsevier.
  5. Reinhart, Carmen & Felton, Andrew, 2009. "The first global financial crisis of the 21st century: Part II, June-December, 2008," MPRA Paper 13604, University Library of Munich, Germany.
  6. Bernstein, Asaf & Hughson, Eric & Weidenmier, Marc D., 2010. "Identifying the effects of a lender of last resort on financial markets: Lessons from the founding of the fed," Journal of Financial Economics, Elsevier, Elsevier, vol. 98(1), pages 40-53, October.
  7. Margaret Jacobson & Ellis W. Tallman, 2013. "Liquidity provision during the crisis of 1914: private and public sources," Working Paper 1304, Federal Reserve Bank of Cleveland.
  8. Tallman, Ellis W & Wicker, Elmus R., 2009. "Banking and Financial Crises in United States History: What Guidance can History Offer Policymakers?," MPRA Paper 21839, University Library of Munich, Germany.
  9. Daniel Sanches, 2013. "On the welfare properties of fractional reserve banking," Working Papers 13-32, Federal Reserve Bank of Philadelphia, revised 04 Feb 2013.
  10. Hoag, Christopher, 2005. "Deposit drains on "interest-paying" banks before financial crises," Explorations in Economic History, Elsevier, Elsevier, vol. 42(4), pages 567-585, October.
  11. Hugh Rockoff, 2013. "O.M.W. Sprague (the Man who “Wrote the Book” on Financial Crises) and the Founding of the Federal Reserve," NBER Working Papers 19758, National Bureau of Economic Research, Inc.
  12. Jörg Breitung & Sandra Eickmeier, 2014. "Analyzing business and financial cycles using multi-level factor models," CAMA Working Papers 2014-43, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  13. Simon Gilchrist & Egon Zakrajsek & Cristina Fuentes Albero & Dario Caldara, 2013. "On the Identification of Financial and Uncertainty Shocks," 2013 Meeting Papers, Society for Economic Dynamics 965, Society for Economic Dynamics.
  14. Daniel R. Sanches, 2013. "Banking crises and the role of bank coalitions," Working Papers 13-28, Federal Reserve Bank of Philadelphia, revised 04 Feb 2014.
  15. Ellis W. Tallman, 2012. "The Panic of 1907," Working Paper 1228, Federal Reserve Bank of Cleveland.
  16. Amir-Ahmadi, Pooyan & Matthes, Christian & Wang, Mu-Chun, 2014. "Drifts, Volatilities, and Impulse Responses Over the Last Century," Working Paper, Federal Reserve Bank of Richmond 14-10, Federal Reserve Bank of Richmond.
  17. Eickmeier, Sandra & Marcellino, Massimiliano & Prieto, Esteban, 2013. "Time Variation in Macro-Financial Linkages," CEPR Discussion Papers, C.E.P.R. Discussion Papers 9436, C.E.P.R. Discussion Papers.
  18. Michael D. Bordo & Angela Redish & Hugh Rockoff, 2011. "Why didn’t Canada have a banking crisis in 2008 (or in 1930, or 1907, or ...)?," NBER Working Papers 17312, National Bureau of Economic Research, Inc.

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