Nonmonetary Effects of the Financial Crisis in the Great Depression
Posted: 22 Aug 2001
The credit hypothesis maintains that nonmonetary factors worsen declines in output during severe economic contractions, which has been a prominent rationale for stringent bank regulation. We apply recent advances in time series analysis to re-examine the role of U.S. bank failures in the Great Depression. In brief, month-by-month decompositions of output, prices, money supply, the liabilities of failed firms, and the deposits of failed banks indicate that bank failures did not initiate the fall in output and prices. However, chronic bank failure over at least a two year period of time in combination with a surge in failures in the latter part of this period of banking industry distress had large negative effects on all of the variables under study. We conclude that chronic bank failures coupled with subsequent threshold failure effects can have deep and pervasive influences on the economy, which justifies government intervention at such times.
Keywords: Bank failure, economic output, Great Depression
JEL Classification: E44, G21, N22
Suggested Citation: Suggested Citation