Fiscal Policy: Chad Stone Talks Sense
links for 2010-09-14

Economic History Seminar: Mrdjan Mladjan: Accelerating into the Abyss: Financial Dependence and the Great Depression

The credit channel, with U.S. weather as an instrument:

Economic History Seminar: Mrdjan Mladjan: Accelerating into the Abyss: Financial Dependence and the Great Depression  

Abstract: The role of bank failures in the propagation of the Great Depression remains disputed.  Cole and Ohanian (1999, 2000) concluded that bank failures could not have contributed much to the severity of the Depression, not least because deposits overall declined much less than output.  Even the research defending a role for bank failures emphasizes different mechanisms through which they could have had an effect on the real economy.  Friedman and Schwartz (1963) argued that the banking failures generated reductions in the money supply which in turn depressed economic activity.  Bernanke (1983) argued that bank failures raised the cost of credit intermediation. However, empirical support for both interpretations has been scant.  I examine how industries with different degrees of dependence on external finance performed after bank failures. I use both a new measure of financial dependence, which is appropriate for the times when capacities are under-utilized, and the external dependence indicator pioneered by Rajan and Zingales (1998). Because rural bank distress was frequently driven by weather conditions, I use weather shocks as instruments together with several previously used predictors of bank failures.  I find evidence of a statistically and economically significant financial accelerator, robust to a variety of specifications.  The results suggest a prominent role for the bank failures for predicting US manufacturing output during the whole inter-war period, including the Great Depression.

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