Chapter 3. The Great Depression

Chapter 2, “Liquidity Risk: Concepts,” laid out the theoretical concept of liquidity and explained the effects of a liquidity shock on banks and financial markets. In this and the following two chapters, we turn to illustrating how these theoretical ideas manifest themselves in the actual world of financial markets and day-to-day economic activity. To do so, we focus on three historical economic crises induced by liquidity shocks—the U.S. Great Depression (1929-1933), Japan’s Lost Decade (the 1990s), and the U.S. Great Recession (2007-2009).

3.1 The Stages of a Liquidity Shock

We ended Chapter 2 with a discussion on how a liquidity shock in one asset class propagates to other classes via the banking system. This ...

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