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Federal Reserve Bank of Minneapolis Research Department

Facts and Myths about the Financial Crisis of 2008∗
V.V. Chari, Lawrence Christiano, and Patrick J. Kehoe Working Paper 666 October 2008

ABSTRACT The United States is indisputably undergoing a financial crisis. Here we examine four claims about the way the financial crisis is affecting the economy as a whole and argue that all fourclaims are myths. Conventional analyses of the financial crisis focus on interest rate spreads. We argue that such analyses may lead to mistaken inferences about the real costs of borrowing and argue that, during financial crises, variations in the levels of nominal interest rates might lead to better inferences about variations in the real costs of borrowing.

∗

Chari, University of Minnesota andFederal Reserve Bank of Minneapolis; Christiano, Northwestern University and the Federal Reserve Bank of Minnneapolis; Kehoe, Federal Reserve Bank of Minneapolis, University of Minnesota, and NBER. All three authors thank the NSF for support. We thank Maxim Troshkin for excellent research assistance. The views expressed herein are those of the authors and not necessarily those of the FederalReserve Bank of Minneapolis or the Federal Reserve System.

Clearly, the United States and the world economy are undergoing a major financial crisis. Here we examine several pieces of evidence on the nature of the financial crisis and the mechanisms by which the financial crisis is thought to affect the nonfinancial sector of the economy. That the United States is undergoing a financial crisis cannot bedisputed. Evidence of the financial crisis consists of the following: First, several major financial institutions have failed. Second, various stock markets have fallen dramatically, especially in the week after the bailout plan was passed. Third, spreads on a variety of different types of loans over comparable U.S. Treasury securities have widened dramatically. Here we examine four claims about theway the financial crisis is affecting the economy as a whole and argue that all four claims are myths. Conventional analyses of the financial crisis focus on interest rate spreads. We argue that such analyses may lead to mistaken inferences about the real costs of borrowing and argue that, during financial crises, variations in the levels of nominal interest rates might lead to better inferences aboutvariations in the real costs of borrowing.

1. Four Myths about Quantities
The financial crisis has also been associated with four widely held claims about the nature of the crisis and the associated spillovers to the rest of the economy. The financial press and policymakers have made the following four claims about the nature of the crisis. 1. Bank lending to nonfinancial corporations andindividuals has declined sharply. 2. Interbank lending is essentially nonexistent. 3. Commercial paper issuance by nonfinancial corporations has declined sharply, and

rates have risen to unprecedented levels. 4. Banks play a large role in channeling funds from savers to borrowers.

Here we examine these claims using data from the Federal Reserve Board. Our argument that all four claims are false isbased on data up until October 8, 2008.1 Figure 1A displays weekly data on the total amount of bank credit for all U.S. commercial banks from 2001 onward. Figure 1B displays the same data from the beginning of 2008 onward. Bank credit consists of the aggregate amount of assets held by these banks excluding vault cash. As is clear from these figures, bank credit has not declined during the financialcrisis. Indeed, bank credit appears to have risen relative to trend in the month of September. Figures 2A and 2B display analogous data for loans and leases made by U.S. commercial banks. Again, we see no evidence of any decline during the financial crisis. Figures 3A and 3B display data for commercial and industrial loans. Again, we see no evidence that the financial crisis has affected lending to...