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Wednesday, July 29, 2015

'Spare Tire? Stock Markets, Banking Crises, and Economic Recoveries'

From Ross Levine, Chen Lin, and Wensi Xie at Vox EU:

Spare tire? Stock markets, banking crises, and economic recoveries: Do stock markets act as a ‘spare tire’ during banking crises, providing an alternative corporate financing channel and mitigating the economic severity of crises when the banking system goes flat?

In 1999, Alan Greenspan, then Chairman of the Federal Reserve System, argued that stock markets could mitigate the negative effects of banking crises, including more fragile businesses and greater unemployment. Using the analogy of a spare tire, he conjectured that banking crises in Japan and East Asia would have been less severe if those countries had built the necessary legal infrastructure so that their stock markets could have provided financing to corporations when their banking systems could not. If firms can substitute equity issuances for bank loans during banking crises, then banking crises will have less harmful effects on the public.

But researchers have not evaluated the spare tire view. Although official entities and others discuss the spare tire argument (e.g. US Financial Crisis Inquiry Commission 2011, Wessel 2009), we are unaware of systematic assessments of the testable implications emerging from Greenspan’s view of how financial markets can ease the effects of systemic banking failures.

In a recent paper, we provide the first assessment of the spare tire view... The findings are consistent with the three predictions of the spare tire view. ... The estimated economic effects are large...

    Posted by on Wednesday, July 29, 2015 at 10:52 AM in Economics, Financial System | Permalink  Comments (6)


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