2012-06: Measuring the macroeconomic costs of banking crises (Working paper)

Abstract

Fractional Reserve Banking - the system of banking where depositors place their money at a bank for, ostensibly, a short time, but the bank lends it out for periods of perhaps up to 30 years - has been with us since, at least, London goldsmiths developed the practice in the 17th century. Despite its modern guise, and layer upon layer of regulatory oversight, Fractional Reserve Banking can still cause great economic harm, not least because of the fundamental weakness in its premise: the false expectation that all depositors are able to withdraw all their money at the same time, if they so desire. This paper begins by outlining the development of the young science of measuring the economic impact of financial crises. It then turns to measuring the extent to which banking crises have impacted, and continue to impact, on global outputs. Using the Laeven and Valencia (2010) database of more than 140 banking crises since the end of the Bretton Woods era, I determine that the lingering impact of banking crises has been to collectively lower global GDP by 6.5% pa, which is more than the size of the Japanese economy (measured in PPP).