With a Bang, Not a Whimper: Pricking Germany's 'Stock Market Bubble' in 1927 and the Slide into Depression

Abstract

Asset price inflation presents central banks with a puzzle. I examine the case of Germany, 1925-7, when the Reichsbank intervened to bring down stock prices, rectify imbalances and curb speculation. Present value relations, comparisons with historical valuation measures and the time-series properties of the data suggest that there was no bubble in the German stock market. The German central bank under Hjalmar Schacht was therefore wrong to be concerned about stock prices, since no bubble can be discerned. I examine the effects of the misguided intervention by estimating a number of VARs. These suggest that a substantial part of the slowdown in the rate of capital formation after 1927 could have been avoided without the intervention.

Keywords: Stock market, foreign lending, fixed exchange rates, asset prices, bubbles, Germany, monetary policy

JEL Classification: E31, E43, E44, N14, N24