Recent research has provided strong circumstantial evidence for the proposition that sustained deflation -- the result of a mismanaged international gold standard -- was a major cause of the Great Depression of the 1930s. Less clear is the mechanism by which deflation led to depression. In this paper we consider several channels, including effects operating through real wages and through interest rates. Our focus, however, is on the disruptive effect of deflation on the financial system, particularly the banking system. Theory suggests that falling prices, by reducing the net worth of banks and borrowers, can affect flows of credit and thus real activity. Using annual data for twenty-four countries, we confirm that countries which (for historical or institutional reasons) were more vulnerable to severe banking panics also suffered much worse depressions, as did countries which remained on the gold standard. We also find that there may have been a feedback loop through which banking panics, particularly those in the United States, intensified the worldwide deflation.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
3488.
Length: Date of creation: Oct 1990 Date of revision: Publication status: published relationship to a non-chapter. This should not happen. Please contact NBER. Handle: RePEc:nbr:nberwo:3488
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Anil K. Kashyap & Jeremy C. Stein, 1994.
"Monetary Policy and Bank Lending,"
NBER Chapters,
in: Monetary Policy, pages 221-261
National Bureau of Economic Research, Inc.
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