Sunday, September 29, 2013

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


  1. Hi John:

    I think Cole and Ohanian look at the cross-sectional evidence on banking failures in the U.S. during the Great Depressions:

  2. The key graph in Cole and Ohanian is figure 1 on page 210: there is little correlation at the state level between bank closings and output (although it is negative).

  3. John,

    "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."

    FRED has records back to 1949. If anyone has prior records you could look at a comparison of credit growth with economic growth (nominal GDP) and determine that a contraction in the rate of credit growth starting before 1930 preceded the bank failures of 1932 / 1933.

    1. Indeed. But the issue is cause and effect. Did banks failing cause a reduction in credit supply -- everyone wants to borrow, but there is just a big crater where the bank is -- and that causes the reduction in output? Or do people stop demanding loans when they see the recession coming and stop investing?

      The same question is vital to 2008. Our credit channel friends say that everyone wanted to borrow just as much as usual in October 2008, but banks refused to lend because they were undercapitalized. (And all the usual channels to get around that blocked.) TARP gave them capital, which was supposed to bring lending right back. Or, by and large, did people and companies stop wanting to borrow to fund new investments?

    2. John,

      "Did banks failing cause a reduction in credit supply -- everyone wants to borrow, but there is just a big crater where the bank is -- and that causes the reduction in output?"

      Did banks failing cause a reduction in credit supply? No. Banks in the 1920's and 1930's had two restrictions - maintain dollar / gold exchange rate and maintain reserve ratio. A change in either the supply of gold or a change in the reserve ratio will affect credit supply.

      A change in credit demand would depend on what you are using the borrowed money to do - fund consumption or fund production. If you use it to fund production and prices are falling then your demand for credit would shrink.

  4. I think it's a dead end to look at the great depression and the coinciding banking crisis only in the US and ignoring the rest of the world. Before the great depression, the international financial system was relatively well integrated. The largest shock to the global credit channel came in my opinion in May 11, 1931 when Credit-Anstalt in Austria failed. Not arguing that this proves causality, but the timeline in that graph is very misleading, only showing the ripple effects that the global credit shock later caused in the US.

  5. One piece of evidence that still makes me think that the banking story is important is from a speech by Ben Broadbent of the UK's MPC. He show that measures of returns to capital have become more dispersed across sectors in the UK since the crisis began, possibly implying misallocation of capital.

    The "banks are important" story says that this is caused by the troubles in the banking sector. The "banks aren't important" story probably has a harder time with this fact. For example, you could argue that there are sectoral shocks which caused the crisis, but I find this less compelling.

    Anyway, this is certainly an interesting debate which needs a bit more attention, and I don't stand firmly on either side.



  6. On the cross-sectional evidence: Gabriel Chodorow-Reich had a nice paper which shows that firms whose banks were less healthy in the recent crisis were less able to borrow and cut employment by more.

  7. I don't have access to the NBER paper, but I wonder if they cite another Jeffrey Rogers Hummel. He compared Friedman's "monetary" story to Bernanke's "credit" one years ago.

    More recently, David Glasner criticized Milton Friedman for pinpointing the failure of the Bank of the United States as the instigation of the Great Depression, overlooking the contractionary effect the Bank of France had been exerting earlier.

  8. Some well-identified evidence for the role of the banking crisis.


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