Do Bank Failures Affect Real Economic Activity? State-Level Evidence from the Pre-Depression Era

FDIC Center For Financial Research Working Paper No. 2005-06

25 Pages Posted: 13 Jun 2005

See all articles by Carlos D. Ramirez

Carlos D. Ramirez

George Mason University - Department of Economics

Philip A. Shively

Federal Deposit Insurance Corporation (FDIC)

Date Written: June 2005

Abstract

This paper provides empirical evidence documenting the existence of a credit channel during the pre-Depression era using a newly constructed, state-level quarterly time series from 1900Q1 through 1931Q2 for the 48 contiguous states. It also investigates the source and size of the credit channel, and it examines the dynamic effects of bank failures on business failures. Granger-causality tests find evidence that bank failures cause commercial failures at the aggregate U.S. level and over half of the 48 states. The cross-sectional variation allows us to test two explanations of the credit channel discussed in the literature: (i) a reduction in consumption spending from the slow liquidation of failed-bank deposits, and (ii) a decrease in investment spending from a disruption of credit to bank-dependent firms. Our results support both theories, but the evidence in favor of the first is stronger statistically. Branch banking restrictions, state-sponsored deposit insurance, and differences in the agricultural-manufacturing share of commerce do not affect the empirical importance of an independent credit channel. Using aggregate U.S. level data, our structural model indicates that bank failures account for about 25% of commercial failures, and that bank failures have only minor subsequent effects within the banking sector.

Keywords: Credit channel, bank runs, deposit insurance, Granger causality

JEL Classification: E32, E51, G21

Suggested Citation

Ramirez, Carlos D. and Shively, Philip A., Do Bank Failures Affect Real Economic Activity? State-Level Evidence from the Pre-Depression Era (June 2005). FDIC Center For Financial Research Working Paper No. 2005-06, Available at SSRN: https://ssrn.com/abstract=742418 or http://dx.doi.org/10.2139/ssrn.742418

Carlos D. Ramirez (Contact Author)

George Mason University - Department of Economics ( email )

4400 University Drive
Enterprise Hall MSN 3G4
Fairfax, VA 22030
United States
703-993-1130 (Phone)
703-993-1133 (Fax)

Philip A. Shively

Federal Deposit Insurance Corporation (FDIC) ( email )

Washington, DC 20429
United States

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