A crash course on crises: Macroeconomic concepts for run‐ups, collapses, and recoveries By Marcus KBrunnermeier and RicardoReis. Princeton University Press. 2023. pp. 136. £30.00 (hbk). ISBN: 978‐0691221106. £21.00 (ebk). ISBN: 978‐0691221113

In 1986 a paper by Anna Schwartz, ‘Real and Pseudo-Financial Crises’, was published in Financial Crises and the World Banking System (a collection edited for Macmillan by Forest Capie and Geoffrey Wood). The comments on it which Allan Meltzer made in the same collection have received less subsequent attention, but are also important. Both the paper and the comments bear on the book under review. But before considering their significance for Brunnermeir and Reis's excellent book, examining the book itself is well worthwhile. A good starting point is to note that the book's subtitle, Macroeconomic Concepts for Run-ups, Collapses, and Recoveries, is a much better description of what the book is about than is the book's title. The authors' aim is “…not to provide a survey for researchers, but rather to provide an entry point to the literature that teachers and students can use in classes to supplement their textbooks” (p. 3). The book is in three parts, the first dealing with the run-up to crises, the second the trigger which sets off the crisis, and the third the recovery. This description immediately exposes the book's lack of context. While all crises have a run-up, and at some time a recovery, it is not always possible to identify a trigger. Britain experienced a major crisis in 1825. But there was no clear trigger, and unless the Bank of England's raising interest rates to moderate a boom can be claimed as shock, neither was there a ‘trigger’ in 1866. Brunnermeir (Professor of Economics at Princeton University) and Reis (Professor of Economics at the London School of Economics) do show very clearly that uncertainty matters, and how prices can stay implausibly high despite almost universal agreement that they are implausibly high. Examples to complement the explanation are the Japanese financial and real estate booms of the 1980s, and the internet price boom of 1998–2000. The authors describe these booms as ‘bubbles’. I am more cautious than they are, and try to avoid using the word ‘bubble’. It seems to me that simply because prices have risen high and fast and have then collapsed it is not a demonstration that there was a bubble in the sense that the movement was the result of, for example, a Keynesian beauty contest, where everyone is trying to guess what everyone else will do. Perhaps the price movement exemplifies another of Keynes's observations: ‘When the facts change, I change my mind. What do you do, sir?’ But to that general caution about use of the word ‘bubble’, I add that the examples Brunnermeir and Reis give do seem to justify the word in each episode. Such events, the authors claim, are preceded by a ‘rush of capital’ into the country. (This was possibly correct in the time period they consider, but it is not true of Britain in 1825, 1866, or 1931.) The examples we get here are Portugal at the beginning of the twenty-first century and Chile in the 1970s. Much of this capital is misallocated, so the ultimate collapse is inevitable. What led to or allowed the misallocation is considered below. The final chapter of the first section “introduces the reader to modern financial institutions” (p. 4). (Are banks really ‘modern’ institutions? Managing liquidity and monitoring loans was important in the nineteenth century too.) Here the focus is on how such institutions are prone to runs, through their creating liquidity, but also on the incentives of managers to monitor loans and manage them ‘prudently’. This chapter cites as examples the housing boom and bust in the USA, and a sector of the banking system in Spain that is closely akin to Britain's building societies. We then move on to triggers for crashes, to the role of capital flows largely in the form of debt contracts, and to the concept of safe assets. (‘The only safe asset is one whose risks are yet to be discovered’, a frequent observation by Professor Peter Bauer in the 1980s and 1990s, seems recently to have been forgotten.) The final part of the book considers policy responses and how recessions may lead to capital controls and foreign exchange interventions being adopted. What this book lacks is context. If the aim was a short book, and that is a most laudable aim, another chapter containing both history and current affairs could still very reasonably have been allowed. In her 1986 paper Anna Schwartz distinguished between ‘real’ and ‘pseudo’ financial crises. The former are when bank runs lead to a wave of bank failures, a collapse in the stock of bank deposits (and thus of broad money), and a recession. That broadly characterises the Great Depression. ‘Pseudo’ crises, in contrast, may well reduce wealth. But the “manias, panics, and crises” which do that “are not per se financial crises unless the shift from tangible or financial assets to money leads to a run on the banks” (Schwartz, 1986, p. 24). What was needed to prevent a pseudo crisis turning into a real one was a lender of last resort to supply liquidity. Allan Meltzer (1986, p. 35) expanded this by proposing that there be less uncertainty in lender-of-last-resort policy. Uncertainty could be reduced by a clear statement from the lenders of last resort in each country. The statement should make clear the conditions under which central bank loans will be available and the assets which will be accepted as collateral. Some have argued that the world has changed since the times about which Schwartz and Meltzer wrote, that banks and other financial institutions have grown bigger, more international, and more complex. But the facts do not entirely support that. When Overend and Gurney failed in 1866 it was the biggest bank in Britain, and so far as can be seen the biggest ever in the financial history of the world. It was allowed to collapse and financial markets were stabilised after a very few days by lender-of-last-resort action. And what almost brought Barings down in 1890 were international entanglements in Argentina. What about increasing bank complexity? This is almost certainly a correct description of the evolution of banking. A recent statement from the Financial Economists Roundtable (8 April 2024) set out ‘Lessons Learned from the 2023 “Banking Crisis”’. It laid emphasis on reforms to regulation after the 2023 crisis in the USA. There should, it said, be “focus on structural flaws in supervision, regulation, and safety net policies…” (p. 1). These reforms should all increase incentives to prudent banking, and should reduce and restrict access to bank support. The emphasis was on making individuals and banks responsible for the consequences of their own actions. As they used to be. To turn to a problem which, Brunnermeir and Reis say, is part of the run-up to a possible crash and then crisis, what can be done about the capital misallocation produced by a rush of capital into a country? The first thing that should be done is to look closely at the facts of the situation. Ronald McKinnon did that for Southeast Asian countries: “....banks and other financial institutions were poorly regulated but their depositors were insured – implicitly or explicitly – against bankruptcy by their national governments. The resulting moral hazard … was responsible for the excessive build-up of short-term foreign-currency indebtedness” (‘The East Asian Dollar Standard, Life after Death?’, Economic Notes, 29(1), 2000, p. 32). The problem was a domestic one, and interfering with the foreign exchange market or with capital flows would be an example of incorrect policy assignment. To summarise, this is a clear, well-written, precisely focused book. But it lacks historical context, and sometimes pays insufficient heed to domestic policy errors. What goes on in the run-up to a crash is well explained, but the institutional background against which these developments take place is neglected. A one-chapter summary of these, with ample references, would turn a good book into a much better one, and make it much more generally useful.