90: The 800 Year Decline in Interest Rates with Paul Schmelzing

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Hosted by
Will Jarvis

In this episode I’m joined by economist Paul Schmelzing to talk about the 800 year decline in interest rates and the history of banking crises  https://www.pfschmelzing.me/

William Jarvis 0:05
Hey folks, welcome to narratives. narratives is a podcast exploring the ways in which the world is better than in the past, the ways that is worse in the past, or it’s a better, more definite vision of the future. I’m your host, William Jarvis. And I want to thank you for taking the time out of your day to listen to this episode. I hope you enjoy it. You can find show notes, transcripts and videos at narratives podcast.com.

Unknown Speaker 0:42
Well, Paul,

William Jarvis 0:42
how are you doing today?

Paul Schmelzing 0:44
I’m good. Thank you for the invite to the podcast. We’ll

William Jarvis 0:47
Absolutely sir. Thank you so much for taking time out of your day to come on, I really quite appreciate it. Do you mind giving us a brief bio and some of the big ideas you’re interested in?

Paul Schmelzing 0:58
Sure, in terms of bio, I’m originally from Germany, I did high school there in and graduated just when the global financial crisis broke out. I originally wanted to be a lawyer and study law, but in the final and and then do do finance in the political sphere eventually. But in my final two years of high school, the global financial crisis broke out I was interning in the finance committee of the German Bundestag at

when institutions like hyper real estate, fell off a cliff and, and starting started taking other big institutions with it. And people slowly realize that we might be facing a big event here, a generational event. And politicians, policymakers, people from you know, the ECB other institutions. They rushed to find some sort of blueprint, what to do in a major global tail event like the financial crisis. And it turns out, there is nothing like a blueprint. Because we assumed that there would be no more financial crisis in the world, that markets are efficient, and risk can basically be allocated away between market participants. And around the same time, Ken and Carmen Reinhart book on eight centuries of financial folly came out. And to me, it was a revelatory moment, in many ways, because I thought this is the way to study finance and economics and policy making it through the historical lens. And through the realization that there’s more than just model building or, or physical equations to economics, we are dealing with, with chaotic systems with humans. In the end, we’re emotional. And history is the best laboratory to study these these chaotic processes over time. And so I really became strongly convinced that I wanted to do economic history, financial history, with a with a strong applied angle to very much focus on the on the market side on the on the trading, but also on the policymaking side, eventually to to provide better answers for for the practical world, in other words, and I decided to go on a longer academic journey and to financial history and economic history. And I started that at LSE and then continued at Harvard. And now I’m here at Yale, doing writing a book for Yale University Press on my dissertation, and on long run trends and interest rates. And since that’s the, that’s the short version of it, I guess.

William Jarvis 4:19
I love that. And, you know, Paul, I really liked your approach, because it seems like, you know, a lot of, you know, opinion analysts and even scholars, you know, when they talk about, you know, the great stagnation, secular stagnation, they all look at this, like super small sample size, right? It’s like, well, the last like 50 years, what happened since 1971. But what I liked about your approach, what I found fresh was like, Okay, let’s take a much bigger, bigger sample size. What’s what of the last 800 years been like, and what is the trend look like? And let’s try and figure out what’s going on there. I’m curious, can you talk a little bit about what you’ve found looking at interest rates over the last 800 years? Yeah, absolutely.

Paul Schmelzing 4:59
So During my time during my PhD studies, I was seconded to the Bank of England for a couple of years. And was again, it was it was a great experience because it was, again, a very applied slash policy oriented environment. And of course, the big question then, as well as now, was, from a policymaking perspective, what are we doing about that key measure in the global financial system? Namely the interest rate? And why is it behaving in such weird ways? Why is it behaving contrary to everything that we find in textbooks and in in financial literature and models? Because, you know, all the reference literature tells us something very different to what we have seen not not not just since the financial crisis, but for a longer time. So there was a big puzzle here, it puzzled market people as well, people in investment banks and hedge funds, etc. And and people who invest in pension funds will invest for the long term, for instance. So it has a massive, not just policy, but massive market relevance, that question now, I’m not, I’m not so original, as a financial historian per se, for wanting to take a longer look, then then the mainstream econ literature, so my advisor at LSE, Steve broadberry, he constructed GDP series starting in the 13th century for England, for instance, and I got exposed to these approaches in my undergraduate years. The thing is, nothing like this exists for capital for the capital markets side. So we have an increasingly good understanding for some of the macro variables, including including output growth, including living standards, ie per capita, GDP, Angus Madison, these people have done tremendous advances over the years, but not so much in capital markets. In fact, our reference work for interest rates is six decades old. Homer and Scylla has a history of interest rates, which first came out in 1963. And, you know, we have several updates and diksa came in at a later stage and did a tremendous job. However, for a lot of purposes, it doesn’t really cut it. So our our reference literature on the capital market side is, I would say deeply deficient, and and unsatisfactory. So that’s where I saw a niche. And that’s where I saw a great applied relevance and a chance to demonstrate the value of applied history to answer, you know, the secular stagnation questions in a much more satisfying way, I would argue, but also have a big relevance to the practical to not get mad at people and punishment.

William Jarvis 8:21
Got it? Got it. And can you talk a little bit about what you found it? So I want to summarize what I read in the paper. It’s something like over the last 800 years, we’ve had this long run trend downward of interest rates, intersecting with zero right about now, maybe a little bit for maybe a little bit after Is that better correct understanding.

Paul Schmelzing 8:43
So that two streams of literature, I would I would say that that I try to reply to. So one is a more abstract finance literature that has looked at the statistical properties of interest rates and the the general dynamic behavior of interest rates, i e, is the interest rate a stable variable over time? Is it a random walk? Is it you know, subject to certain regime changes where the mean shifts around? Now that sounds very abstract, but it’s, it’s a big relevance for asset pricing in in a very fundamental way. Because if you say, the interest rate is a random walk, but other variables like growth, or consumption are clearly not a random walk. Then a lot of the asset pricing models have a problem when they assume higher growth means higher interest rates. Okay? So he has a big impact for this stylized facts that people operate with on a daily basis in markets and in finance. So that was one of the A stream of the literature that I wanted to address of the long run, nobody had ever done more than a couple of decades of data on that front. And the other one is really is really the the Econ financial history literature, I mentioned Homer and Scylla and apply a new, comprehensive empirical investigation to two secular stagnation to the zero lower bound literature, all these all these questions about, okay, the key tenant here is that if you talk about secular trends, and secular stagnation, namely, then I think it’s it’s deeply problematic to look at four or five decades of data, okay. secular stagnation, secular trends in the economy, by definition, per se. They try to make general statements about the economy, they try to uncover the structural glacial movements in the economy. That’s, that’s, that’s the the secular component here. And so I think it’s, it’s it’s quite pointless to base these kinds of thesis on four or five decades of data, because then you’re capturing maybe one cycle of the secular glacial movements in the economy and financial markets, okay. But that’s not a secular picture that you have, you have one one cycle of the secular way the economy behaves. So that called, in my view for a long run reconstruction of global real interest rates, which, which I then did, on the basis of both published data in existing secondary works in existing printed primary sources, as the historian calls it, ie registries from from early treasuries in France, in Germany, in the urban centers were the big merchant banks, where we’re based like the fingers in Augsburg. And so it turns out with a bit of patience, you can uncover a lot of material even without going into archives, and really looking at dusty old files and trying to decipher 14th or 15th century Latin.

That is the the icing on the cake, I would say which which I also tried to do to the best extent possible, which is completely lacking in the in a worksite, homerun seller, they never went into archives and tried to get primary sources. So you asked about the results. Yet, the big result is that global real interest rates have actually fallen for over five centuries in a consistent cross country cross acid fashion. And the idea that something happened in the 1970s or 1980s, that initiated a trend fall in the global real rate is quite misleading. Because the real interest rate, the global real interest rate has never been stable, prior to the 1970s or 80s. There’s no natural level of the global real rate, say somewhere between three and 5%. And once we figure out what happened in the 70s, and 80s, we can go back to that sort of level. This isn’t an implicit or often explicit assumption that people make in the debates. Know, the global real rate has always fallen in a range of one to two basis points per annum, throughout monetary regimes throughout different political regimes, whether it’s a democracy or a monarchy, like the French monarchy over centuries, the Holy Roman Empire, they all saw this trend fall, starting, at least in the early 16th century, after the famous bullion femoral feminine that gripped the entire world. And and after the Italian wars, one of the biggest conflict and long lasting conflicts in the early modern period started. That has also not just big implications for the whole secular stagnation debate, but also for the first set of literature that I mentioned. It means we can we can statistically look at this new time series and the new evidence over centuries. We can confirm statistically okay, it’s a downward monotonic downward trend over time. But it’s also not a random walk. Okay. The interest rate is not a random walk, which is the consensus view in the finance literature. For some time, in fact, the global real rate is something that that these statisticians would call stationary. In other words, it has a predictable component over time. So if you’re an investor, and if you had access to that time series in the 60s of 17th century, you could have predicted that the global economy and markets would discuss and grapple with the zero lower bound in the early 21st century, you could already have predicted, let’s see, the stationary component, the predictable component is downward trending over time. So these are two or three elephants in the room that are tried to take out or at least question from from a long run financial historians perspective. And that’s, that’s the motivation behind it.

William Jarvis 16:01
I love that. It’s, I mean, it’s a super interesting finding. Right. And it’s also you know, it begs the question, you know, why is like, what is this structural force underneath the economy, this pushing, you know, interest rates down over time in such a consistent manner? You know, why is like the why question is always over determined. But have you thought about it at all? Like, why this is the case?

Paul Schmelzing 16:27
Yeah, absolutely. Of course, this, this immediately comes to mind. And there’s not one conversation where, where people squeezed me on that. I tried to start answering this question in a negative way, in the sense that I tried to go through all the usual suspects that are being invoked at the moment in the context of the secular stagnation debate in the context of the of the current finance literature, which basically tries to, to, to highlight three factors, one is a potential productivity story. In other words, the whole Robert Gordon argument that we run out of ideas, we are no longer as, as productive, we are no longer

William Jarvis 17:20
a low hanging fruit.

Paul Schmelzing 17:23
Exactly. We’re no longer making the kind of gray matter leaps that we did in the first wave of industrial revolution segment. So that one is easy to rule out. Because as I mentioned, actually, the output picture of the long run is pretty good. So you can take my new data on interest rates and compare it or set it against the Angus medicines data on GDP and on productivity, right? Or on against Steve broadberry series for England, for instance, when you take my English series, it turns out that not just our interest rates, and GDP growth, not strongly correlated over time, which love asset pricing models assume, no, in fact, they’re going in opposite directions have a very long run. So the graph series can be thought of if you look at the works out there, it’s basically a hockey stick trajectory over time, right. So for long time, it hovers around 300 $400 per capita in real terms in 19 $90, up until the point where the industrial revolution starts, and we will see a sharp acceleration. However, at the time of the Industrial Revolution, global real rates have already come down substantially by a big amount I mentioned it starts in the early 16th century. So for for about 300 years, global real rates are already consistently falling when the industrial revolution takes off. So that’s, that’s why I first question this whole productivity story that is supposed to lie behind the downward trend since the 1980s. No, I don’t think it’s a productivity story. I think that even if growth sharply accelerates again, if we make another big, ICT, a big, big, general purpose, technology invention, like the internet like something else, that doesn’t necessarily mean that we’re going to trend break in global real rates, and they start going up again, structurally, I don’t think so. History tells you that actually, there’s there are long, sustained periods when they go in completely opposite directions and that might be you know, a And that might call for a lot of revisiting of these asset pricing models and, and market people would always assume that there should be a positive correlation between these two variables, which might still be true for the short term for business cycle. Okay, if we look at quarter a quarter revisions of GDP growth, it’s it’s still very much plausible that the real rate should go up. Okay, but I’m talking about the structural the more glacial trends in the economy. So second, second explanation demographic factors. Maybe some of your listeners have seen the new book by Charles Goodhart and and other people have invoked demographics. The idea being that if people live longer, if life expectancies go up, they have to save more for retirement, increasingly, okay. And let’s invest this money typically in fixed income, because this is a long term asset, okay, with predictable returns, okay, less risk than equities or other asset classes. Makes make sense from the outset. Right? The problem is that we have reasonably good data on life expectancies over time as well. Demographic historians, other people have written books about this. We have good time series, and advanced advanced economy. Life expectancies hovered around 40 years, until the 19th century or so. Okay, so, guys, like us, I guess, have a couple of more years, and then we expected to either go into retirement or or, you know, we, we passed basically, okay. So within a century, in the 19th century, advanced economy, life expectancies go from from 40 to something like 70. Okay, it’s the biggest leap in demographic variables ever seen.

But again, if you remember what I just said, real interest rates start declining in the 16th century, rather than the 19th century pay for it. So which means the beginning inflections in life expectancy, don’t really cut it either. In my view, we should have seen a massive break in global real rates in the 19th century, when there happens when a demographic revolution happens. Not in the data, not we don’t we don’t see that. Okay. So that’s why I’m very skeptical about the childhoods arguments as well, and the whole demographic channel. It’s it’s not really it’s not really there. Which leaves, which leaves a couple of other factors, which I think are more promising. And I should also say from the outset, that it’s not a sovereign risk story in the sense that, of course, a lot of your listeners will immediately say the first thing they will say is that, of course, these kinds of issuers, these governments in the 15th and 16th century, of course, they are so much more risky to lend to as an investor, I would charge it’s natural that I would charge a much higher risk premium, of course, okay, to to hedge myself against the risk of luck, we have all these examples where the creditors of the French king, if they are too insistent on repayment, they end up in the French tower or the sea. They wish they hadn’t really, you know,

William Jarvis 23:43
buckle up so much

Paul Schmelzing 23:45
for the money back. So absolutely, of course, the governments per se, are today are safer. Okay, in terms of the default risk than they were in the 14th to 15th century. But it’s not a default premium story, either of the long run, okay, because risk, sovereign risk is relative, we can isolate the safest economy over time. And we see the same downward trend over time in the safe issuers will never throw their creditors in jail, who never resorted to big debasement operations, which is the classical default event in the early modern period. So you simply, you simply reduce the gold content of your coins by 50% or so. And then you tell your credit as well. Here you have my new currency. Look, it says the same. It’s the same nominal amount, okay. It’s just 50% less gold in this. So that’s how governments did it for Long time, they didn’t even have to default on the principle okay. They, they repaid the nominal amount and the principal just with a very different currency. Okay. So we have knowledge of these events, we can trace them we can we can reasonably relate these to real interest rates and we don’t see that. So even the even the countries have never had debasement shocks, debasement defaults, even these countries sort of show the same properties. And secondly, I touched upon it earlier, we see that trend in other assets as well. So not just sovereign assets, we actually see the downward trend in private rates as well. So, I’m showing one series in the paper on private mortgage rates in real terms over time. And with good reasons, you can argue private households in the 14th 15th 16th century are actually safer to lend to than governments. Okay, you can you can make that argument is fair point. However, we are seeing the same trend in private real mortgage rates, long maturity, mortgage rates, voluntary market rates, over very long periods of time, we get one and a half basis points per annum, okay? And the the acid, the acid is highly comparable to a mortgage that you take out nowadays, okay, a 30 year fixed mortgages, okay, same properties. You have, you have collateral you need to put up collateral you need to, you know, it’s it’s, it’s tradable in the secondary market, it’s typically secured by the underlying real estate, to some extent, okay, and your personal income, and, and it’s heritable, okay, so your descendants still have to pay it, if you’re on the on the debtor side. And if you’re on the creditor side, you you receive your still received payments. If the, if you’re if you’re, if the other party Dyess or just runs away or so you have good legal protection, in other words, so which in my view, leaves two very promising factors here. One is a time preference channel that is at work. And one is a more general capital longevity story, which are both important, which I think there might well be more to it than these two explanations. And I very much think there’s more to it. There is a bigger factor here that we still end that I still don’t fully understand. Okay, that I, I’ve used you can imagine I’ve read for years now I tried to I try to figure it out, talk to too many, many people who spend their lives thinking about long run trends. There’s still a big question mark over. Overall, this okay, maybe something happened in the 16th century. For which all evidence, all the documents, everything has been discovered. And there’s a big mystery that we will never uncover in that sense. Okay. We cannot unfortunately, we can’t go back to the early 16th century and interview contemporaries or so.

It’s a big challenge. In that sense, something happened in the 16th century, which we, in a very fundamental sense, still don’t understand. I think. So. But two things are evident one. You have to remember that, that capital markets over time, are basically a story of of Top 1% Top 5% people investing and taking money out, etc. Dynamics. That’s true nowadays. That’s true in the 15th century as well. So in other words, the the top 10% wealth share in the 15th century is around 50 60%, comparable actually two levels today, okay? It’s not dramatically different, which means that 50 60% of your fixed income assets around there are subject to the dynamics in that particular social and economic group, okay. And this is what we should focus on. Okay. If there’s any big institutional factor that only affects these people in it, but in a big way, then this might be much, much more important for capital markets. Then one big event that affects everybody. In other words, something like the French Revolution. Okay. And that’s actually the case, I think. So what happened in the late 15th century was for instance, that the feud, the feud was outlawed. Oh, wow.

William Jarvis 30:18
Right, right. Yeah, there’s big movie. Ridley Scott just talked about this reset like, right, you know, like, yeah.

Paul Schmelzing 30:27
Exactly. So so for them. In 1495, the feud is outlawed in Germany. Okay. What does this mean, in the, in an economic sense, we can see the effect in a dramatic reduction of personal violence. Okay. For two centuries, it’s perfectly legal and actually expected that if your neighbor insults you in any way, shape, or form, or he doesn’t repay some sort of personal loan that you give him or, you know, he, I don’t know, he insults your daughter or whatever have you. It’s perfectly normal and expected that you gather a few friends of yours, you, you you, you assemble some horses, and you rate his his properties, you put his you put his castle on fire. Excuse me, and, and you destroy his property as as comprehensively as possible. And you kill him as well. In the end, when the feud is outlawed, we see a sharp drop in top 10%, top 5% violent deaths. Okay, oh, wow. So even though society wide life expectancy doesn’t change, and population growth doesn’t change, for this particular group was active on financial markets all the time, life becomes so much more stable. Stable. Exactly. And so what does it mean? It means that if you don’t have to fear being stabbed or or killed on the street, every every other day by your neighbor, or by someone else, your investment style changes in very different ways. In very fundamental ways, you are much, much more likely to take out a a 30 year mortgage or a or lend money to your king or to your Duke for 30 years. Because you’re you’re much more confident that you live when the contract ends, and you can you can receive the principle back. Okay? This is what what economists have called the time preference before time preference, how patient are you in the end, okay. So what it what it means is that suddenly, people are becoming much, much more patient in financial markets now. So these inflection points in patience, line up very well with what we’re seeing on the real interest rate series. And it would, I think, be a very plausible, plausible explanation, at least part of the story, a very plausible part of the story, which we don’t get from a lot of these other factors love these other channels are thrown around for years now in the secular stagnation debate. Patience is increasing. And it starts in the 16th century that people are becoming more patient in financial markets. The I can go on for hours, basically, until you interrupt me will.

William Jarvis 33:47
The this is great, this is great. I mean, that’s such an interesting thing to think about is like, you know, humanity, especially it sounds like the elite section of society has gotten more patient over time, because their lives have become somewhat more stable. It’s pretty steadily

Paul Schmelzing 34:04
right, the the one big inflection point in recent times, in terms of patience and in top 10% is world war one actually. Why? Because a lot of historians including David Canadain, for instance, for for Britain, who wrote a seminal book on the decline and fall of the British aristocracy, they always point to World War One as the last stand of the, of the old elite basically, in in, in the world, okay, so in no other conflict since, since the Italian wars in the 16th century, basically, did such a great number of top 5% or 10% Invest Stress dies suddenly on the battlefield, then World War One. And we see it in the violent death series that I mentioned for for for financial market participants basically, one more time, one last time, it surges during 1914 to 1918. In in ways that that nobody would have expected. Because a lot of this you know, top 10% people, for one reason or another for cultural reasons, for reasons of pride and honor, call it what you will they go to France, they go to the to the front, and they die in the trenches, actually, it’s a huge, huge number. It’s not just the common soldier, if you actually look at the figures. It’s the biggest Violent Death Event for for the European elite in centuries World War One. Wow. So that’s, that’s another inflection point, actually, that aligns very, very nicely with the real interest rate series, the big statistical break in the interest rates series over time, over centuries since the Renaissance, or the year 1510. And the 1912. And these are also it happens, the two big, Violent Death Events in advanced economies for centralism. So I think this channel is one of the most promising that I’m looking at.

William Jarvis 36:32
Gotcha, gotcha. Did you have one more other than the patient’s people getting more patient over time?

Paul Schmelzing 36:38
Yep. The other one is what I call the capital longevity story. In other words, the capital the interest rate is a function of capital demand and supply, obviously. And if your capital stock grows faster than the demand for or the site, if the existing supply rises faster than then the demand to take out new investment projects, new loans, for whatever reason, then obviously, we should expect the interest rate to fall. Now, why would this happen in a structural sense, in a long run sense? It happens because of the fact that our capital stock is becoming more advanced, more durable. So goods so Simon Kuznets, the famous US economist, once wrote a fascinating article about the early modern economy. And he quipped basically, and said, There’s no such thing as permanent, durable capital in the early modern economy, except for cathedrals, everything else. So basically, a bridge in the early modern economy and infrastructure, fixed acid collapses within two years, basically, given its its its technological features, etc. Your average house you ever had, as I mentioned, is burned down by some sort of Raider or mercenary, typically, within a short period of time, or just collapses in the same fashion because it’s made out of mud, or, or primitive stones or whatever. There’s a slow but steady process, where the capital stock is becoming more and more and more durable, and long, long living. Now contrast that that bridge or that hat with things you see today. I mean, for for every European, who flies into JFK, which is a big fixed infrastructure acid, JFK Airport in New York, it often feels like time travel for a European, you know, I’m going back to it’s like going back to the 1960s or 70s, the way it looks like but what I’m trying to say is that it’s a it’s a big fixed capital item, which can last and live for 6070 years without any issues at all without any anybody wondering about this. So capital is becoming more and more durable. which means which means we do not mean it depreciates Of course, capital depreciates you have to reinvest, you have to keep your runway in shape and the in the case of JFK, but it’s a different story to having to reinvest and rebuild the entire capital stock time and time again. Okay. And of course, the other big factor is simply wars that destroy big portions of the capital stock all the time in the early modern economy. Okay, so say during the 30 years war, the 30 Years War is perhaps the greatest capital destruction event that we’ve ever seen. And in in one of my chapters of a dissertation, I tried to, to estimate the capitalist eruption from some of these big wars in the early modern period. And and compare it to say World War One World War Two. Because I was interested, if it is a plausible explanation for what’s happening on the on the asset pricing side, right on in capital markets. So during the 30 years more, around a quarter of the capital stock in Germany is completely wiped out. And the 30 Years War, of course, is only one more event of a very, very frequent, very, very violent, Early Modern period. Now. What we are seeing since 1945, the fact that we did not have a war between advanced economies invading each other for a period of eight years now almost, in advanced economies, it’s unprecedented in, in long run Economic History In,

in financial markets, okay, so, I the other day, I tried to, to actually, I tried hard to find a previous period, where we had such a long, long time, where two countries advanced economies of the day, did not fight each other and destroy each other’s and the the most recent period that I could find was the aftermath of the war of St. subbass. In the year 1215. Six, which was a war involving Jeonhwa. And, and other Italian city states. After that war, we had another 75 year period, where the leading economists did not fight each other. In other words, these past eight years were remarkable for the fact that we could build up a capital stock that was not subject exactly to to destruction to bombings to all sorts of capitalist structure dynamics, which were perfectly normal and going on all the time. Historically, okay. That’s the other that’s what I mean with with capital longevity, which is the other. But not to confuse people, these these wars that I’m talking about, I talked about the violent death channel, the 30 Years War, all these other wars, they are fought not by the top 10%, not by the top 5% by but mainly by people who do not buy and sell assets themselves, because they don’t have savings in a 17th century, just like they are more unlikely to have savings nowadays in big in big numbers. So these are two under saying these are two separate channels. Okay, one, the capital destruction channel, and one the the patient’s channel, which is more a function of the actual group of people who invest in markets all the time.

William Jarvis 43:52
That makes sense, that makes sense. No, I really love that. And it, it almost echoes, you know, Steven Pinker’s better angels of our nature, you know, like, if the world is getting less violent over time, you know, maybe we see that reflected in real interest rates over time, which is quite interesting.

Paul Schmelzing 44:08
And Vita Scheidel has written something about about capital destruction events, as well, of course, but none of them have have tried to make the link to asset markets and read to, to what we’re seeing since the 1980s, of course, and thought about in more comprehensive ways, what it means for asset pricing, per se, you know, in a fundamental way. Yeah.

William Jarvis 44:32
Gotcha. Gotcha. Very, very, very interesting. I want to shift a little bit for our last couple of minutes and talk about, you know, banking crisis, these crises. So you said, you know, you were working with the ECB 2008 So you got to see these things kind of firsthand and how everything unfolded. What’s your sense? Have policymakers gotten better at dealing with banking crisis over time? You know, I like to read Scott Sumner Scott’s got this idea that you know, we could have prevented The 2008 financial crisis, but we didn’t do the Federal Reserve debt. And for whatever reason, you could have been bureaucratic reasons not clear exactly why. Yeah. What’s your thought on that? Have we gotten better over time at dealing with these?

Paul Schmelzing 45:15
Well, that’s a great question, which allows me to advertise my latest project here at the ale with Andrew metric. What we did over the last two years was built a new database, which covers banking crisis interventions, since the year 1215 757. Up until 2019, the idea being we wanted to catalog and analyze every single intervention that public authorities or other private market participants made in the banking sector to relieve some sort of stress event to address some sort of male function in the in the banking sector over time, based on 20 different intervention categories. And then study, the longer run trends in responses to bank stress banking crisis, okay, with the exact intention, you know, can we learn something about how the secular response to these stress events changes? Are we getting any better? Or are we getting worse? Or do we have to do more and more and more intervening in the financial sector? Because it’s it? It’s malfunctioning in ever greater ways? Yeah. And so that that database is publicly accessible, and everybody can study it, but our take away for one is that interventions are in fact, becoming more and more and more frequent. Okay. And they have to become larger and larger in size as a share of GDP. Certainly, so we have to spend more and more money to address problems in the banking sector to try and alleviate stress and, and prevent systemic events from happening basically. Now, that simple fact suggests that I mean, the counterfactual is, would it would it? Would it be even worse, had we done nothing in, you know, the last decades or so but one way or another, at least, it’s not falling? That it’s, it’s, it’s a disturbing finding, I would say, it does not suggest that the problem is, is fading that we are getting better at No, we might be getting better in a relative sense compared to doing nothing, but we still have to spend more and more and more money, trying to fix the banking sector. And that’s not a good thing, certainly for society. That means that the problems are are continue to accumulate in the banking sector in the financial sector, and that we have to spend more and more resources trying to fix whatever is going wrong there. So in that sense, no, we have not gotten better in that sense. So we showed the exact numbers here. So we are saying basically, that the average intervention size in the economy goes from something like 2% of GDP in a typical intervention. Gotcha. So in the, in the mid in the mid 20th century, the typical intervention size is something like 2% of GDP, if you include emergency liquidity, capital, injections, debt guarantees, okay, if you if you focus on on these, these three categories alone, which are the most important interventions, the average intervention is 2% of GDP. Nowadays, post oh eight, your average intervention is 4x, that number Jesus, IE as much better than 8% of GDP. So our average, our average badgered style, emergency response nowadays is 8% of GDP, to try and fix something in the banking sector. And that’s a disturbing finding that number increases so sharply and so dramatically. It’s not just advanced economies, it includes emerging markets, we find the same trend there. It’s across the world. Whether you’re high income or low income, whether you are highly regulated or low regulated, it’s true for almost every country in the world. And it does suggest that something

is still fundamentally wrong and continues to, to deteriorate in a bigger way. And this certainly started before Oh, eight, okay. It’s a longer run trend that we’re seeing. And maybe ultimately, it is a phenomenon that might be connected to the fallen interest rates. Because it’s a phenomenon of bubbles. Okay. And we know that when interest rates are low, the probability of financial bubbles increases. Okay. So I mean, that’s, that’s fascinating question for a future paper, of course, but I would venture that there might be an interesting link, actually, between these two, two questions that you brought up.

William Jarvis 51:03
Gotta say something about baby interest rate rates, you know, as they trend lower people try to, you know, invest in riskier assets to get returned. And then.

Paul Schmelzing 51:13
So why do we have the rise of Bitcoin, for instance? Partly, that might be a perfectly rational response to the fact that you earn zero on a 10 year German bond or, or a Japanese government bond. So you want to search for alternative investments for for new acids that fill that function that government bonds played in the past? Okay. And I’m not saying that that Bitcoin is necessarily a bubble, or that it’s not quite quite rational. I’m just saying, from financial markets from the banking sector, our intervention metric over time, is also a bubble metric over time, okay, it’s a proxy for for bubble dynamics in the financial sector. And it overlaps pretty nicely with the trends in asset pricing that that I talked about for the first half of this podcast. Okay. So, gotcha. Lower rates, higher bubble frequency.

William Jarvis 52:24
Makes sense? Makes sense. Very, very interesting. Well, Paul, thank you so much for coming on the show. I’ve learned a ton with you today. I really appreciate it. Where can we send people? Where can people find your work?

Paul Schmelzing 52:39
You can find me, I’m not super active on Twitter and these social media channels, but But I might, maybe I become more active in the future. But you can you can find links to my webpage there. Or if you search for my name, I posted my some of my latest research you find on my website, which is which is publicly accessible if you just search for my name. Or if you go on Twitter and follow me there, you can see the link. And otherwise, people will have to wait for the book release with the elite university press, which will hopefully happen sometime next year, late next year. Depending on on the supply shortages in paper, I guess.

Unknown Speaker 53:30
I love that. I love that.

Paul Schmelzing 53:33
But yeah, that’s that’s the easiest way to to look for details and read more.

William Jarvis 53:39
Excellent. Well, Paul, thank you so much for coming on the show. We’ll get those links in the show notes.

Paul Schmelzing 53:44
No, we’ll thanks so much for the invitation. And this was a pleasure to talk to you.

William Jarvis 53:49
Absolutely. Thanks.

Thanks for listening. We’ll be back next week with a new episode of narratives.

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