Working Paper: NBER ID: w25452
Authors: Gary Gorton; Toomas Laarits; Tyler Muir
Abstract: Modern financial crises are difficult to explain because they do not always involve bank runs, or the bank runs occur late. For this reason, the first year of the Great Depression, 1930, has remained a puzzle. Industrial production dropped by 20.8 percent despite no nationwide bank run. Using cross-sectional variation in external finance dependence, we demonstrate that banks' decision to not use the discount window and instead cut back lending and invest in safe assets can account for the majority of this decline. In effect, the banks ran on themselves before the crisis became evident.
Keywords: Great Depression; banking crises; external finance dependence
JEL Codes: E02; E3; G01
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| bank behavior in 1930 (G21) | output decline compared to 1920-21 (N12) |
| banks' decision to significantly cut back on lending (G21) | industrial output decline (L16) |
| banks' shift towards safe assets (G21) | industrial output decline (L16) |
| external finance dependence (O19) | output decline in industries (L16) |
| reduction in loans (H81) | decrease in output measures (E23) |
| reduction in total assets (G32) | decrease in output measures (E23) |