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The Gold Standard, Deflation, and Financial Crisis in the Great Depression: An International Comparison

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  • Ben Bernanke
  • Harold James

Abstract

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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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3488.

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Date of creation: Oct 1990
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Publication status: published as Financial Markets and Financial Crisis, Hubbard, editor. Chicago: University of Chicago Press, 1991.
Handle: RePEc:nbr:nberwo:3488

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  1. Bernanke, Ben & Gertler, Mark, 1990. "Financial Fragility and Economic Performance," The Quarterly Journal of Economics, MIT Press, vol. 105(1), pages 87-114, February.
  2. Robert P. Flood & Peter M. Garber, 1981. "A Systematic Banking Collapse in a Perfect Foresight World," NBER Working Papers 0691, National Bureau of Economic Research, Inc.
  3. Michael D. Bordo & Finn E. Kydland, 1990. "The Gold Standard as a Rule," NBER Working Papers 3367, National Bureau of Economic Research, Inc.
  4. Eichengreen, Barry & Hatton, Tim, 1988. "Interwar Unemployment in International Perspective," Institute for Research on Labor and Employment, Working Paper Series qt7bw188gk, Institute of Industrial Relations, UC Berkeley.
  5. O'Brien, Anthony Patrick, 1989. "A Behavioral Explanation for Nominal Wage Rigidity during the Great Depression," The Quarterly Journal of Economics, MIT Press, vol. 104(4), pages 719-35, November.
  6. Ben S. Bernanke, 1983. "Non-Monetary Effects of the Financial Crisis in the Propagation of the Great Depression," NBER Working Papers 1054, National Bureau of Economic Research, Inc.
  7. Hamilton, James D., 1987. "Monetary factors in the great depression," Journal of Monetary Economics, Elsevier, vol. 19(2), pages 145-169, March.
  8. James D. Hamilton, 1988. "Role Of The International Gold Standard In Propagating The Great Depression," Contemporary Economic Policy, Western Economic Association International, vol. 6(2), pages 67-89, 04.
  9. Barry J. Eichengreen & Jeffrey Sachs, 1984. "Exchange Rates and Economic Recovery in the 1930s," NBER Working Papers 1498, National Bureau of Economic Research, Inc.
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