Is Financial Friction Irrelevant to the Great Depression? - Simple modification of the Carlstrom-Fuerst model -
It is argued that existing theory implies that financial frictions appear as investment wedges. Since data show that the output declines in the Great Depression were mainly due to the productivity declines, it is also argued that financial frictions may not be the primary cause of the depression. By slightly modifying the model of Carlstrom and Fuerst (1997), I show that financial frictions may show up as declines in productivity. This result may restore the relevance of financial frictions to the Great Depression and other depression episodes, such as Japan's "lost decade."
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