Working Paper: NBER ID: w16365
Authors: Michael D. Bordo; John Landon-Lane
Abstract: In this paper we revisit the debate over the role of the banking panics in 1930-33 in precipitating the Great Contraction. The issue hinges over whether the panics were illiquidity shocks and hence in support of Friedman and Schwartz (1963) greatly exacerbated the recession which had begun in 1929, or whether they largely reflected insolvency in response to the recession caused by other forces. Based on a VAR and new data on the sources of bank failures in the 1930s from Richardson (2007), we find that illiquidity shocks played a key role in explaining the bank failures during the Friedman and Schwartz banking panic windows. \n \nIn the recent crisis the Federal Reserve learned the Friedman and Schwartz lesson from the banking panics of the 1930s of conducting expansionary open market policy to meet demands for liquidity. Unlike the 1930s the deepest problem of the recent crisis was not illiquidity but insolvency and especially the fear of insolvency of counterparties.
Keywords: No keywords provided
JEL Codes: E52; N12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Public's fear (H12) | Increased withdrawals (E49) |
| Federal Reserve's failure to act as a lender of last resort (E58) | Collapse in money supply (E51) |
| Collapse in money supply (E51) | Economic downturn (F44) |
| Illiquidity shocks (E44) | Bank failures (G28) |
| Insolvency shocks (G33) | Bank failures (G28) |