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Aggregate Price Shocks and Financial Instability: A Historical Analysis

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  • Michael D. Bordo
  • Michael J. Dueker
  • David C. Wheelock

Abstract

This article presents evidence on the relationship between price and financial stability. We construct an annual index of financial conditions for the United States, 1790--1997, and estimate the effect of aggregate price shocks on the index using a dynamic ordered probit model. We find that price-level shocks contributed to financial instability during 1790--1933 and that inflation rate shocks contributed to financial instability during 1980--97. The size of the aggregate price shock needed to alter financial conditions depends on the institutional environment, but we conclude that a monetary policy focused on price stability would contribute to financial stability. Copyright 2002, Oxford University Press.

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Bibliographic Info

Article provided by Western Economic Association International in its journal Economic Inquiry.

Volume (Year): 40 (2002)
Issue (Month): 4 (October)
Pages: 521-538

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Handle: RePEc:oup:ecinqu:v:40:y:2002:i:4:p:521-538

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  1. Gerald P. Dwyer, Jr. & R. Alton Gilbert, 1989. "Bank runs and private remedies," Review, Federal Reserve Bank of St. Louis, issue May, pages 43-61.
  2. Weber, Ernst Juerg, 1986. "The causes of bank failures: deflationary spells," Economics Letters, Elsevier, vol. 20(4), pages 359-362.
  3. Carmen M. Reinhart & Graciela L. Kaminsky, 1999. "The Twin Crises: The Causes of Banking and Balance-of-Payments Problems," American Economic Review, American Economic Association, vol. 89(3), pages 473-500, June.
  4. Frederic S. Mishkin, 1991. "Asymmetric Information and Financial Crises: A Historical Perspective," NBER Chapters, in: Financial Markets and Financial Crises, pages 69-108 National Bureau of Economic Research, Inc.
  5. Dueker, Michael, 1999. "Conditional Heteroscedasticity in Qualitative Response Models of Time Series: A Gibbs-Sampling Approach to the Bank Prime Rate," Journal of Business & Economic Statistics, American Statistical Association, vol. 17(4), pages 466-72, October.
  6. Charles Calomiris & David Wheelock, 1998. "Was the Great Depression a Watershed for American Monetary Policy?," NBER Chapters, in: The Defining Moment: The Great Depression and the American Economy in the Twentieth Century, pages 23-66 National Bureau of Economic Research, Inc.
  7. Michael D. Bordo & Anna J. Schwartz, 1997. "Monetary Policy Regimes and Economic Performance: The Historical Record," NBER Working Papers 6201, National Bureau of Economic Research, Inc.
  8. Lucas, Robert E, Jr, 1973. "Some International Evidence on Output-Inflation Tradeoffs," American Economic Review, American Economic Association, vol. 63(3), pages 326-34, June.
  9. Chib, Siddhartha, 1996. "Calculating posterior distributions and modal estimates in Markov mixture models," Journal of Econometrics, Elsevier, vol. 75(1), pages 79-97, November.
  10. Michael D. Bordo & Michael J. Dueker & David C. Wheelock, 2001. "Aggregate price shocks and financial instability: a historical analysis," Working Papers 2000-005, Federal Reserve Bank of St. Louis.
  11. Milton Friedman & Anna Jacobson Schwartz, 1970. "Monetary Statistics of the United States: Estimates, Sources, Methods," NBER Books, National Bureau of Economic Research, Inc, number frie70-1.
  12. Eichengreen, Barry & Watson, Mark W & Grossman, Richard S, 1985. "Bank Rate Policy under the Interwar Gold Standard: A Dynamic Probit Model," Economic Journal, Royal Economic Society, vol. 95(379), pages 725-45, September.
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  14. Eichengreen, Barry & Grossman, Richard S., 1994. "Debt Deflation and Financial Instability: Two Historical Explorations," Department of Economics, Working Paper Series qt7kj202cz, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  15. Robert B. Barsky, 1986. "The Fisher Hypothesis and the Forecastability and Persistence of Inflation," NBER Working Papers 1927, National Bureau of Economic Research, Inc.
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