Friday, 24 October 2008

Four myths about the financial crisis

At the Federal Reserve Bank of Minneapolis three economists - V.V. Chari, Lawrence Christiano, and Patrick J. Kehoe - set out to look at Four Myths about the Financial Crisis of 2008.

The myths
  1. Bank lending to nonfinancial corporations and individuals has declined sharply.
  2. Interbank lending is essentially nonexistent.
  3. Commercial paper issuance by nonfinancial corporations has declined sharply and rates have risen to unprecedented levels.
  4. Banks play a large role in channeling funds from savers to borrowers.
What do they find? Basically that each of these myths is refuted by financial data, that is available to those who want it, from the Federal Reserve. Its a short paper, so it doesn't take long to read the whole thing. The abstract reads
The United States is indisputably undergoing a financial crisis. Here we examine four claims about the way the financial crisis is affecting the economy as a whole and argue that all four claims are myths. Conventional analyses of the financial crisis focus on interest rate spreads. We argue that such analyses may lead to mistaken inferences about the real costs of borrowing and argue that, during financial crises, variations in the levels of nominal interest rates might lead to better inferences about variations in the real costs of borrowing.
The Free Exchange blog attacks this piece here and Mark Thomas attacks it here. Alex Tabarrok attacks the attackers here.

1 comment:

Matt Nolan said...

I find that the paper:

1) Exaggerates the extent to which the "myths" they discuss are actually popular opinion (they appear to be a characicture of popular opinion)

2) By framing the myths in this way they can prove that their points are trivially true.

Fundamentally, they haven't shown how the distribution of funding to the real economy has changed - and we won't know until the real economy data comes out.

What they have done is probably even more misleading than looking at interest rate premiums - as an interest rate premium gives us some feeling for any change in "risk preference" that has occured in the marketplace.

Now I agree that any change in perceived risk is a factor that doesn't require government intervention - as a result, the fact that interest rate spreads have exploded aren't either.

However, what they have done hasn't disproved the actual motivation for government intervention - which is that there IS credit rationing in some sectors of the economy which will impact on the distribution of resources and real growth. There is always some credit rationing - but in crisises like this the market failure stemming from asymmetric information can become intense - supposadly.

Personally, I think this paper has value only insofar as it might force people to actually look for any market failure that has occured - instead of screaming about interest rate spreads. However, if this was the point of the paper it should have mentioned alternatives - rather than acting like there was no problem. Why? Because even given everything they've said there are strong annecdoal reports of credit rationing - at least in NZ.