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Financial Intermediation and The Great Depression: A Multiple Equilibrium Interpretation

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  • Russell Cooper
  • Joao Ejarque

Abstract

This paper explores the behavior of the U.S. economy during the interwar period from the perspective of a model in which the existence of non-convexities in the intermediation process gives rise to a multiplicity of equilibria. The resulting indeterminancy is resolved through a sunspot process which leads to endogenous fluctuations in aggregate economic activity. From this perspective, the Depression period is represented as a regime shift associated with a financial crisis. Our model economy has properties which are broadly consistent with observations over the interwar period. Contrary to observation, the model predicts a negative correlation of consumption and investment as well as a highly volatile capital stock. Our model of financial crisis reproduces many aspects of the Great Depression though the model predicts a much sharper fall in investment than is observed in the data. Modifications to our model (adding durable goods and a capacity utilization choice) do not overcome these deficiencies.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5130.

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Date of creation: May 1995
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Publication status: published as Carnegie-Rochester Conference Series on Public Policy, Vol 43 (1995), pp. 285-323.
Handle: RePEc:nbr:nberwo:5130

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