Gavyn Davies

A bank run is now happening within the eurozone. So far it has been relatively slow and prolonged, but it is a run nonetheless. And last week, it showed signs of accelerating sharply, in a way which demands an urgent response from policy-makers.

The fear of bank runs is deeply ingrained in all economists who know anything about the genesis of the Great Depression in the United States in the early 1930s. Then, the failure of the Bank of United States in December 1930 led to multiple bank runs across the country. Bank failures in the following two years wiped out personal savings and greatly exacerbated the collapse of demand in the economy.

The classic account of the crisis, by Milton Friedman and Anna Schwartz, concluded that the collapse was largely the fault of the Federal Reserve, which failed to provide enough liquidity to keep the banks functioning and thus end the panic. After the crash, the establishment of the Federal Deposit Insurance Corporation was intended to ensure that deposit holders never again had to live in fear that their savings would be in jeopardy. What are the lessons for the eurozone?

Central bank balance sheets in the major economies now range from 20 to 30 per cent of GDP, two-thirds of which is due to the emergency measures that have been taken to stimulate economies since the crisis began. As far as I am aware, the global scale of this action is completely unprecedented.

Critics see these bloated central bank balance sheets as the culmination of a decades-long process in which periods of excessively easy monetary policy have caused inflation, asset price bubbles and misallocation of investment flows in the economy. For example, this FT piece by former Republican presidential candidate Ron Paul concludes as follows:

“The world is awash in US dollars, and a currency crisis involving the world’s reserve currency would be an unprecedented catastrophe.”

Such an outcome is perhaps conceivable, but is far from inevitable.