Bank Asset Liquidation and the Propagation of the U.S. Great Depression
Posted: 12 Oct 2007
We hypothesize that financial disintermediation during and after the Great Depression arose from the slow liquidation of failed-bank deposits in the years following financial crises. We construct a data series containing the stock of failed national bank deposits for the period 1921-1940. Our data series indicates that the slow liquidation rate of bank assets correlates well with business cycle persistence. Vector autoregression models show that the stock of failed-bank deposits undergoing liquidation is as important as money stock in terms of explaining output changes over forecast horizons from one to ten years. Failed-bank deposit shocks lasted for about five years and then became transitory. Furthermore, failed-bank deposit shocks had permanent negative effects on money supply and transitory negative effects on prices. Consistent with recent theories concerning linkages between the financial system and economic growth, we infer that the dynamic effects of banking sector shocks were cumulative and pervasive during and after the Depression.
Keywords: Business cycles, persistence, bank failures, liquidation, bankruptcy costs
JEL Classification: E3, E6, G2, N0, N1, N2
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