EH447, 08/09, Week 4-1 Great Depressions in Economic

History

A Bubble in the 1929 Stock Market?

Albrecht Ritschl

Bubble hypothesis

Frenetic stock market activity(Galbraith, 1958, many others)

Index increased faster than dividends (Rapoport/White, 1991)

No-bubble hypothesis

Fisher (1929) McGrattan and Prescott (2004):

– Price/earnings ratios not out of ordinary– Capital taxes far lower than today– Market capitalisation 1.66 x GNP– Tangible capital 1.26 x GNP 30% less?– Intangible capital 0.87 x GNP 12% more

An intermediate position

Examine comovement between

stock market and

Leading indicator of investment

Speculative bubble? The U.S. stock market 1920-35

Orders of US Machine Tools and Tobin's q in the Dow Jones Stock Market Index, 1921-35

0

20

40

60

80

100

120

140

160

180

Jan

-21

Jan

-22

Jan

-23

Jan

-24

Jan

-25

Jan

-26

Jan

-27

Jan

-28

Jan

-29

Jan

-30

Jan

-31

Jan

-32

Jan

-33

Jan

-34

Jan

-35

Ind

ex 1

928=

100

MACH_ORD DJONES(PM)

Tobin’s q

q =

=

Capital New of PriceCapital Existing of Price

Index PriceMachinery IndexMarket Stock

Tobin’s investment hypothesis

0'),q(I ff

Machinery orders an indicator of I Deflated version of Dow Jones an

indicator of q

Observations on Stock Market

Strong comovement in stock prices and orders of machinery

Orders of machinery a leading indicator of investment

Stock prices reflect (anticipated) investment / Tobin’s q holds

Peaks in early 1929 and Sept 1929

Recession in Germany in 1927

Orders to German Machinery Industry and Tobin's Q in the Berlin Stock Market

0

20

40

60

80

100

120

140

160

1925

:01

1926

:01

1927

:01

1928

:01

1929

:01

1930

:01

1931

:01

1932

:01

1933

:01

1934

:01

1935

:01

Inde

x 19

28=1

00

Domestic Orders Foreign Orders Berlin Stock Market Index

Observations on German stock market in 1920s

Comovement between machine orders and stock market, just like in U.S.BUT

Comovement is only between stock market and DOMESTIC orders

INTERNATIONAL orders peak in late 1929, in line with U.S. market

NO STOCK MKT CRASH IN 1929

Speculative bubble?

Maybe... Market 30% overvalued if account

for tangible capital onlyBUT

Market undervalued if include intangible capital

Financial market in sync with planned real investment