Supports: Hubbard/O’Brien, Chapter 24, Money, Banks, and the Federal Reserve System; Macroeconomics Chapter 14; Essentials of Economics Chapter 16.
Apply the Concept: WHAT DO BANK RUNS TELL US ABOUT PANIC TOILET PAPER BUYING DURING THE CORONAVIRUS PANDEMIC?
Here’s the key point: Lack of confidence leads to panic buying, but a return of confidence leads to a return to normal buying.
In Chapter 24, Section 24.4 of the Hubbard and O’Brien Economics 8e text (Chapter 14, Section 14.4 of Macroeconomics 8e) we discuss the problem of bank runs that plagued the U.S. financial system during the years before the Federal Reserve began operations 1914. During the 2020 coronavirus epidemic in the United States consumers bought most of the toilet paper available in supermarkets leaving the shelves bare. Toilet paper runs turn out to be surprisingly similar to bank runs.
First, consider bank runs. The United States, like other countries, has a fractional reserve banking system, which means that banks keep less than 100 percent of their deposits as reserves. During most days, banks will experience roughly the same amount of funds being withdrawn as being deposited. But if, unexpectedly, a large number of depositors simultaneously attempt to withdraw their deposits from a bank, the bank experiences a run that it may not be able to meet with its cash on hand. If large numbers of banks experience runs, the result is a bank panic that can shut down the banking system.
Runs on commercial banks in the United States have effectively ended due to the combination of the Federal Reserve acting as a lender of last resort to banks experiencing runs and the Federal Deposit Insurance Corporation (FDIC) insuring bank deposits (currently up to $250,000 per person, per bank). But consider the situation prior to 1914. As a depositor in a bank during that period, if you had any reason to suspect that your bank was having problems, you had an incentive to be at the front of the line to withdraw your money. Even if you were convinced that your bank was well managed and its loans and investments were sound, if you believed the bank’s other depositors thought the bank had a problem, you still had an incentive to withdraw your money before the other depositors arrived and forced the bank to close. In other words, in the absence of a lender of last resort or deposit insurance, the stability of a bank depends on the confidence of its depositors. In such a situation, if bad news—or even false rumors—shakes that confidence, a bank will experience a run.
Moreover, without a system of government deposit insurance, bad news about one bank can snowball and affect other banks, in a process called contagion. Once one bank has experienced a run, depositors of other banks may become concerned that their banks might also have problems. These depositors have an incentive to withdraw their money from their banks to avoid losing it should their banks be forced to close.
Now think about toilet paper in supermarkets. From long experience, supermarkets, such as Kroger, Walmart, and Giant Eagle, know their usual daily sales and can place orders that will keep their shelves stocked. The same is true of online sites like Amazon. By the same token, manufacturers like Kimberly-Clark and Procter and Gamble, set their production schedules to meet their usual monthly sales. Consumers buy toilet paper as needed, confident that supermarkets will always have some available.
But then the coronavirus hit and in some states non-essential businesses, colleges, and schools were closed and people were advised to stay home as much as possible. Supermarkets remained open everywhere as did, of course, online sites such as Amazon. But as people began to consider what products they would need if they were to remain at home for several weeks, toilet paper came to mind.
At first only a few people decided to buy several weeks worth of toilet paper at one time, but that was enough to make the shelves holding toilet paper begin to look bare in some supermarkets. As they saw the bare shelves, some people who would otherwise have just bought their usual number of rolls decided that they, too, needed to buy several weeks worth, which made the shelves look even more bare, which inspired more to people to buy several weeks worth, and so on until most supermarkets had sold out of toilet paper, as did Amazon and other online sites.
Before 1914 if you were a bank depositor, you knew that if other depositors were withdrawing their money, you had to withdraw yours before the bank had given out all its cash and closed. In the coronavirus epidemic, you knew that if you failed to rush to the supermarket to buy toilet paper, the supermarket was likely to be sold out when you needed some. Just as banks relied on the confidence of depositors that their money would be available when they wanted to withdraw it, supermarkets rely on the confidence of shoppers that toilet paper and other products will be available to buy when they need them. A loss of that confidence can cause a run on toilet paper just as before 1914 a similar loss of confidence caused runs on banks.
In bank runs, depositors are, in effect, transferring a large part of the country’s inventory of currency out of banks, where it’s usually kept, and into the depositors’ homes. Similarly, during the epidemic, consumers were transferring a large part of the country’s inventory of toilet paper out of supermarkets and into the consumers’ homes. Just as currency is more efficiently stored in banks to be withdrawn only as depositors need it, toilet paper is more efficiently stored in supermarkets (or in Amazon’s warehouses) to be purchased only when consumers need it.
Notice that contagion is even more of a problem in a toilet paper run than in a bank run. People can ordinarily only withdraw funds from banks where they have a deposit, but consumers can buy toilet paper wherever they can find it. And during the epidemic there were news stories of people traveling from store to store—often starting early in the morning—buying up toilet paper.
Finally, should the government’s response to the toilet paper run of 2020 be similar to its response to the bank runs of the 1800s and early 1900s? To end bank runs, Congress established (1) the Fed—to lend banks currency during a run—and (2) the FDIC—to insure deposits, thereby removing a depositor’s fear that the depositor needed to be near the head of the line to withdraw money before the bank’s cash holdings were exhausted.
The situation is different with toilet paper. Supermarkets are eventually able to obtain as much toilet paper as they need from manufacturers. Once production increases enough to restock supermarket shelves, consumers—many of whom already have enough toilet paper to last them several weeks—stop panic buying and ample quantities of toilet paper will be available. Once consumers regain confidence that toilet paper will be available when they need it, they have less incentive to hoard it. Just as a lack of confidence leads to panic buying, a return of confidence leads to a return to normal buying.
Although socialist countries such as Venezuela, Cuba, and North Korea suffer from chronic shortages of many goods, market economies like the United States experience shortages only under unusual circumstances like an epidemic or natural disaster.
Note: For more on bank panics, see Hubbard and O’Brien, Money, Banking, and Financial Markets, 3rd edition, Chapter 12 on which some of this discussion is based.
Sources: Sharon Terlep, “Relax, America: The U.S. Has Plenty of Toilet Paper,” Wall Street Journal, March 16, 2020; Matthew Boyle, “You’ll Get Your Toilet Paper, But Tough Choices Have to Be Made: Grocery CEO,” bloomberg.com, March 18, 2020; and Michael Corkery and Sapna Maheshwari, “Is There Really a Toilet Paper Shortage?” New York Times, March 13, 2020.
Suppose that as a result of their experience during the coronavirus pandemic, the typical household begins to store two weeks worth of toilet paper instead of just a few days worth as they had previously been doing. Will the result be that toilet paper manufacturers permanently increase the quantity of toilet paper that they produce each week?
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