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

Tobin’s q q = =

Tobin’s investment hypothesis  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

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 only BUT  Market undervalued if include intangible capital  Financial market in sync with planned real investment