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Financial History Extensive Notes
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Extensive notes of the 6 modules of Financial History Got 41 out of 50 in the exam (top 1%)
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Week 1: Introduction- The course is about Financial History and Intermediation. The first part is more historical, the
second part covers more recent times.
- These two parts are together in a course because Innovation in the mail driver of economic
development and growth
- History is important for the present as well & it is important to understand it. For example, the
2008 Financial Crisis was nothing new to a historian. The elements causing the bubble caused
other bubbles in the past, even if in different ways. Learning history will give us tools to
understand contemporary developments too.
- This course will focus on western world: Europe (especially UK, Germany, France and a bit of
Italy) & North America from 3000 BC to present days
- Needed: finance, macroeconomics (IS-LM model), functions of money & money multiplier, stats
and econometrics
🡺 How to read a regression table:
Take any regression table, there is a variable (ex. Debt-to-equity ratio) that is regressed on
many regressors, among which for example size of the company.
In the regression table for each variable we see two values. The first one is the coefficient
which tells us whether there is a positive or negative correlation between the dependent
and the independent variable & the size of this correlation. In this case the relation is
positive (larger companies have higher debt-to-equity ratios).
The second number in brackets gives the standard error of the estimate. The smaller the
standard error, the more precise the estimate. Usually, precision is indicated through the
idea of statistical significance, indicated by the stars near the estimates, which tells us how
likely it is that our coefficient is equal to zero (so that our estimate is not correct). Three stars
indicate that it is highly unlikely that the coefficient is equal to zero, so our estimate is very
precise. Two stars still very likely, one slightly less and so on.
Topic 1: Pre-industrial Era and the First Industrial Revolution
- The goals of this lecture are to understand what economic growth over the very long run is, to
talk about the origins of money and finance and look in detail at how institutions and
well-functioning capital markets cause economic growth. We will specifically look at two cases:
the Republic of Venice (which was very close to an industrial revolution but it didn’t make it) and
Britain between 1600-1850 which had a similar history as the one of Venice and the transition
actually worked, thanks to working capital markets and good institutions. And the industrial
revolution corresponded to the highest momentum in the history of finance.
- Until the 1750s, the world was a ‘boring’ place, in the sense that there wasn’t any growth. GDP
per capita remained constant for more than 2000 years. The growth of GDP per capita in Britain
between 1000 BC and 1750AD was approximately 0.1% per year. So if you were born in Syria in
1000 BC or in London in the 1700s you are more or less as rich.
There are some ups and downs (driven mostly by changes in climate, not humans), but the trend
is flat.
What changes is after 1750 and this is the Industrial Revolution. The idea of organizing
production in a different way brought to sustained economic growth that made us all richer.
, It is important to notice, though, that this upward trend has not happened for all the countries,
mostly for the western world, because some countries that were lagging behind (Asia, South
America) only started seeing this upward trend decades later.
- Thomas Malthus (🡪 Malthusian Era) tried to explain the fact that the trend was so flat for all
these years. He was a British pastor that analysed the trend with the relationship between GDP
growth and population size.
- He claimed that each society is characterized by certain birth rates and death rates. The trend he
saw was that the richer a certain society is, so the higher the GDP of a certain society is, the
higher the fertility rate. At the same time, as society becomes richer, people live for more years.
So the higher the GDP of a certain society, the lower the death rate.
GDP increases 🡪 birth rate increases, death rate decreases 🡪 population grows
- For Malthus this population increase was a problem because this high growth will outpace the
growth of GDP and resources.
- In the graph below we represent the relationship between GDP per capita (= income per person)
and population, which comes as a result from birth rate and death rate.
The relationship between birth rate and GDP per capita is an increasing relationship, as GDP
increases, fertility rate increases. People are richer so they have more kids. The relationship
between GDP per capita and death rate is downward sloping: as GDP per capita increases,
people are richer, so they die later.
Population growth is zero (population doesn’t grow) at the point in which birth rate crosses
death rate, so in a society in which the number of people that are born is the same number as
the people that die.
In the lower panel we take population (as a net of birth rate and death rate) and GDP per capita.
, Assuming that we start in a situation in which GDP per capita is y0. For y0, the birth rate is larger
than the death rate, so the population will increase. So we are going to move to the left, because
as the population increases, income per capita will decrease. This is because keeping income
constant, as population increases that some income will have to be divided among more people.
Therefore GDP per capita will decrease. If we had a 8-piece pie and we used to have 8 people,
each person would get 1 piece of pie. Now that the population has grown and there are 10
people, each person cannot eat a whole piece, but will only have 4/5 of one piece of pie.
Therefore, as income in a society increases, birth rate will increase and death rate will decrease,
causing a net population growth, which will in turn decrease income per capita to y*. This is
Malthus’s idea of population adjustment.
GDP increases 🡪 birth rate increases, death rate decreases 🡪 population grows 🡪 same GDPpc
- This explanation works very well to understand the world until the 1750s. It was very good to
understand society before the industrial revolution.
- If we include in our model technology and we consider a technological improvement, as a result
of it, the same number of people can produce more income.
, - As income increases, birth rate will increase and death rate will decrease, resulting in a higher
level of population. N therefore increases.
- In this case we will end up in the same level of income per capita as before, but just with more
people around
- Every time we have some technological progress that in the short-run is making us richer, in the
long-run, it will keep us as poor as before, only with more people around.
- So, any technological progress in the medium-long-run will translate into higher population but
not higher income per capita.
- However, positive population growth is not sustainable and the economy has to go back to a
situation where birth rate equals death rate.
- This process is called by Malthus ‘Positive Check’: plagues, wars and famine arise.
With technological progress:
GDP increases with technological progress 🡪 population grows 🡪
people produce more thanks to technology 🡪 same GDPpc as before, higher population
- Technological improvement increases returns from education, because new technologies are
more complex and therefore education is needed to make them work
- However, education is expensive (huge opportunity cost), so families need to have fewer kids
and educate them better 🡪 families can’t make the kids work in the field, these kids do not
produce and are very expensive, in terms of money and opportunity cost. So ‘producing less
kids’ & sending them to school is the only solution.
- So, with complex technology, a rise in income doesn’t produce a rise in population
- In this case, we escape the Malthusian trap. Because technology makes income higher, but the
use of technology is highly correlated with education, which is expensive. Therefore the birth
rate doesn’t increase as a consequence of higher income. And this higher income doesn’t need
to be shared among more people
- Thanks to complex technology, we escape the Malthusian trap, because technology increases
income, but higher income doesn’t increase population. Therefore there is a net rise in income
per capita.
With complex technology:
GDP increases with technological progress 🡪 people need education to use technology
population doesn’t increase 🡪 higher GDPpc
Technology represents the first explanation of the escape from the Malthusian trap.
- The second explanation of the escape from the Malthusian trap is through institutions.
- Institutions include legislation, courts, rule of law, quality of government, schooling.
- With better institutions, there is better legal protection in every dimension (from one individual
to another, from one individual to the government) and the credit market can flourish, as the
risk of getting expropriated decreases.
What is the role of finance in all of this?
- Finance has three main roles:
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