Bruce Champ

Currency Elasticity and Banking Panics: Theory and Evidence

Existing models of banking panics contain no role for monetary factors and fail to explain why some banking systems experienced panics while others did not. A monetary model is constructed, where seasonal variations in the demand for liquidity and credit play a critical role in generating banking panics. These panics occur when there are restrictions on the issue of currency in private banks, but they do not occur if banks are unrestricted. Empirical evidence from Canada and the United States for the period 1880-1910 is largely consistent with the predictions of the model.

Inflation and financial market performance: what have we learned in the last ten years

The last decade has witnessed a great deal of theoretical and empirical research on the relationships between inflation, financial market performance, and economic growth. This paper provides a survey of that literature and presents new cross-country empirical results on this topic. We find that inflation is negatively associated with banking industry size, real returns on financial assets, and bank profitability. We also discover a positive relationship between asset return volatility and inflation.

Redemption Costs and Interest Rates under the U.S. National Banking System

Interest rates under the U.S. National Banking System (1863-1914) appear to imply that banks failed to exploit an arbitrage opportunity for two reasons: yields on government bonds exceeded the tax rate on note issue by approximately 150 basis points, and short-term interest rates varied seasonally. This paper examines whether note redemption costs can explain observed interest rates. We present a model in which redemption costs create a spread between the tax rate on note issue and bond yields and in which temporary seasonal fluctuations in currency demand generate seasonal movements in short-term interest rates. Calibration of the model to actual data lends support to the models implications. Further, interest rates are shown not to vary seasonally when banks do not incur the costs of note redemption.

The National Banking System: The National Bank Note Puzzle

The era of the National Banking System (1863–1913) has been a puzzling one for monetary theorists and economic historians for well over a century. The puzzles associated with this period take various forms. Despite calculations of high profit rates on note issue for certain periods of the era, national banks never fully utilized their note-issuing powers. Relatedly, the behavior of interest rates during the period is also puzzling given the regime of bank note issuance put in place by the National Bank Acts. On the surface, it appears that an arbitrage condition is broken. The observed inelasticity in aggregate national bank note issue also is puzzling, particularly given the behavior of interest rates. This paper examines many of the puzzles of the national banking era and provides a summary of the current attempts to explain those puzzles.

Resolving the National Banking System Note-Issue Puzzle

Under the National Banking System, 1863-1914, national banks that deposited sufficient collateral could issue notes provided they paid a tax on notes in circulation: 1 percent per year before 1900 and 1/2 percent thereafter. Because note issue was far below the allowed maximum, an arbitrage argument predicts that short-term nominal interest rates should have been bounded above by the tax rate. They were not. That is the note-issue puzzle. Our resolution takes the form of a model in which notes play a role, but in which the profitability of note issue is not tied to anything that resembles a market rate of interest.

Modeling Monetary Economies: Money Stock Fluctuations

WE OBSERVE IN real-world data a great deal of fluctuation in our measures of the money stock. Why is this so? Are central banks playing with the money stock, capriciously increasing or decreasing it? To this point in our studies, the government has determined the nominal stock of money through its complete control over the monetary base and reserve requirements. We observe, however, that central banks often miss the announced targets for the money stock. Are the people in charge hopelessly incompetent, or have our models overlooked some important source of fluctuation in the money stock? By definition, the total money stock is the product of the monetary base and the money multiplier. Observable changes in the money stock that do not come from changes in the monetary base must result from changes in the money multiplier. If the money multiplier is random, a central bank cannot exactly predict the total money supply even though it knows how much money is has printed (the monetary base). In Chapter 8, the money multiplier was found to be simply the inverse of the reserve requirement. Because reserve requirements rarely change (and would be well known to the central bank), they cannot be the source of the observed fluctuations in the money multiplier. Something else must be responsible. Figure 9.1 plots quarterly money multiplier data for the U.S. economy. Note the patterns in the money multiplier in relation to recession years (shaded regions of the graph).