Miron and Rigol go after a classic

Jeff Miron and Natalia Rigol have a provocative working paper, "Bank Failures and Output During the Great Depression." They take on one of Ben Bernanke's most famous papers.

Bernanke concluded that the great depression was severe not because of a lack of money-- medium of exchange -- but because of the credit effects of so many bank failures.

You may say, "duh," but it's not so easy. If bank A fails, what stops you from going and getting a loan from bank B? Well, if your ability to get a loan is wrapped up in the knowledge that employees of bank A have about you. And if, as a result of some sort of friction, Bank B doesn't hire those people for their knowledge. And if, as a result of another friction, someone can't come buy the assets of Bank A, including people and knowledge, and continue to operate the bank. In the great depression, restrictions on branches and interstate banking did that. The process is, fortunately, much swifter now that the assets of a small local bank can be swiftly bought up by other banks even out of state.

Bernanke's paper was - and is -- enormously influential. It was part of a movement to put credit rather than money at the heart of monetary economics and understanding of Fed policy.

But, as Jeff and Natalia point out, what if the banks fell because output was going down, not the other way around? How strong was Bernanke's actual evidence?

Source: Jeff Miron and Natalia Rigol

The graph, from the paper, makes the basic point. We can argue about the "bank holiday" but you see that even the other failures came rather late in the game. It's not at all obvious that bank failures cause output declines and not the other way around.

And of course, "the economy will tank if banks go under" is the mantra that produced the bailouts. Jeff and Natalia's closing words:
To the extent U.S. experience during the Great Depression – and especially the view that bank  failures played a significant, independent role during that period – formed the intellectual foundation for  Treasury and Fed actions, however, our results suggest a hint of caution. If the Great Depression does not constitute evidence for Too-Big-to-Fail, then what historical episodes do provide that evidence? We leave  that question for another day
There are lots of important unsettled issues, justifying Jeff and Natlia's cautious tone in the paper.  How about regional evidence -- didn't  towns whose banks failed suffer more than others, and had lower loan volumes? (I vaguely remember seeing that.  I don't pretend to be an expert on empirical great depression work. If someone has the cross-sectional evidence, add a comment.)

Still, given how the "credit channel" view underlies most of Fed thinking, even though inequalities by definition don't always bind, and how deeply the "we can't let banks fail or there won't be any new lending" view underlies so much crisis policy, I salute a careful reexamination of even classic "facts."


On the cross-sectional point, Hanno Lustig found Hal Cole and Lee Ohanian's "Reexamining the contributions of money and banking shocks to the U.S. great depression" and suggests this graph as a summary. Not even in the cross section. Thanks Hanno!

Source Hal Cole and Lee Ohanian

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