From the Federal Reserve Board, May 30, 2012:
Abstract
Does credit availability exacerbate asset price inflation? What channels could it work through? What are the long run consequences? In this paper we address these questions by examining the farm land price boom (and bust) in the United States that preceded the Great Depression. We find that credit availability likely had a direct effect on inflating land prices. Credit availability may have also amplified the relationship between the perceived improvement in fundamentals and land prices. When the perceived fundamentals soured, however, areas with higher ex ante credit availability suffered a greater fall in land prices, and experienced higher bank failure rates. Land prices stayed low for a number of decades after the bust in areas that had higher credit availability, suggesting that the effects of booms and busts induced by credit availability might be persistent. We draw lessons for regulatory policy.Asset price booms and busts often center around changes in credit availability (see, for example, the descriptions in Kindleberger and Aliber (2005) and Minsky (1986), theories such as Geanakoplos (2009), and the evidence in Mian and Sufi (2008)). Some economists, however, claim that the availability of credit plays little role in asset price movements (see, for example, Glaeser, Gottleb and Gyourko (2010)). In this paper, we examine the boom (and bust) of farm land prices in the United States in the early twentieth century, using both the variation in credit availability across counties in the United States as well as the exogenous boom and bust in agricultural commodity prices at that time to tease out the short- and long-run effects of the availability of credit on asset prices.
The usual difficulty in drawing general lessons from episodes of booms and busts in different countries is that each crisis is sui generis, driven by differences in a broad range of hard-to-control-for factors. The advantage of focusing on farm lending in the United States in the early twentieth century is that lending was local. So in effect, we have a large number of distinctive sub-economies, specifically, counties within each state, with some common (and thus constant) broad influences such as monetary policy and federal fiscal policy. At the same time, differences in state regulations allow us to isolate exogenous differences in credit availability.
In addition, we have an exogenous boom and bust in agricultural commodity prices in the years 1917-1920, to which counties were differentially exposed. The reasons for the commodity price rise are well documented. The emergence of the United States as an economic power helped foster a worldwide boom in commodities in the early 20th century. The boom, especially in the prices of wheat and other grains, accelerated as World War I disrupted European agriculture, even while demand in the United States was strong. The Russian Revolution in 1917 further exacerbated the uncertainty about supply, and intensified the commodity price boom. However, European agricultural production resumed faster than expected after the war’s sudden end, and desperate for hard currency, the new Russian government soon recommenced wheat and other commodity exports as a result, agricultural commodity prices plummeted starting in 1920 and declined through much of the 1920s (Blattman, Hwang and Williamson (2007), Yergin (1992))....MUCH MORE (50 page PDF)
HT: Echoes
