Financial Frictions and Employment During the Great Depression

60 Pages Posted: 22 Mar 2017

Date Written: March 2017

Abstract

We provide new evidence that a disruption in credit supply played a quantitatively significant role in the unprecedented contraction of employment during the Great Depression. To analyze the role of financing frictions in firms' employment decisions, we use a novel, hand-collected dataset of large industrial firms. Our identification strategy exploits preexisting variation in the need to raise external funds at a time when public bond markets essentially froze. Local bank failures inhibited firms' ability to substitute public debt for private debt, which exacerbated financial constraints. We estimate a large and negative causal effect of financing frictions on firm employment. Interpreting the estimated elasticities through the lens of a simple structural model, we find that the lack of access to credit may have accounted for 10% to 33% of the aggregate decline in employment of large firms between 1928 and 1933.

Suggested Citation

Benmelech, Efraim and Frydman, Carola and Papanikolaou, Dimitris, Financial Frictions and Employment During the Great Depression (March 2017). NBER Working Paper No. w23216. Available at SSRN: https://ssrn.com/abstract=2938759

Efraim Benmelech (Contact Author)

Northwestern University - Kellogg School of Management ( email )

Evanston, IL 60208
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Carola Frydman

Northwestern University ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Dimitris Papanikolaou

Northwestern University - Kellogg School of Management - Department of Finance ( email )

Evanston, IL 60208
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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