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Financial Intermediation and The Great Depression: A Multiple Equilibrium Interpretation

  • Russell Cooper
  • Joao Ejarque

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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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
Date of revision:
Publication status: published as Carnegie-Rochester Conference Series on Public Policy, Vol 43 (1995), pp. 285-323.
Handle: RePEc:nbr:nberwo:5130
Note: EFG
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  1. Fulghieri, Paolo & Rovelli, Riccardo, 1998. "Capital markets, financial intermediaries, and liquidity supply," Journal of Banking & Finance, Elsevier, vol. 22(9), pages 1157-1180, September.
  2. Garcia, R. & Perron, P., 1990. "An Anlysis Of The Real Interest Rate Under Regime Shifts," Papers 353, Princeton, Department of Economics - Econometric Research Program.
  3. Azariadis, Costas & Smith, Bruce, 1998. "Financial Intermediation and Regime Switching in Business Cycles," American Economic Review, American Economic Association, vol. 88(3), pages 516-36, June.
  4. Benhabib Jess & Farmer Roger E. A., 1994. "Indeterminacy and Increasing Returns," Journal of Economic Theory, Elsevier, vol. 63(1), pages 19-41, June.
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  6. Christina D. Romer, 1988. "The Great Crash and the Onset of the Great Depression," NBER Working Papers 2639, National Bureau of Economic Research, Inc.
  7. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  8. Smith, Bruce D, 1991. "Bank Panics, Suspensions, and Geography: Some Notes on the "Contagion of Fear" in Banking," Economic Inquiry, Western Economic Association International, vol. 29(2), pages 230-48, April.
  9. 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.
  10. Robert E. Hall, 1986. "The Role of Consumption in Economic Fluctuations," NBER Working Papers 1391, National Bureau of Economic Research, Inc.
  11. Greenwood, Jeremy & Jovanovic, Boyan, 1988. "Financial Development, Growth, And The Distribution Of Income," Working Papers 88-12, C.V. Starr Center for Applied Economics, New York University.
  12. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  13. Fisher, Jonas D M, 1999. "Credit Market Imperfections and the Heterogeneous Response of Firms to Monetary Shocks," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(2), pages 187-211, May.
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  15. Jovanovic, Boyan, 1988. "Observable Implications Of Models With Multiple Equilibria," Working Papers 88-20, C.V. Starr Center for Applied Economics, New York University.
  16. Romer, Christina D., 1988. "World War I and the postwar depression A reinterpretation based on alternative estimates of GNP," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 91-115, July.
  17. Ben S. Bernanke, 1994. "The Macroeconomics of the Great Depression: A Comparative Approach," NBER Working Papers 4814, National Bureau of Economic Research, Inc.
  18. Gary Gorton, 1986. "Banking panics and business cycles," Working Papers 86-9, Federal Reserve Bank of Philadelphia.
  19. Satyajit Chatterjee & Russell W. Cooper & B. Ravikumar, 1993. "Strategic complementarity in business formation: aggregate fluctuations and sunspot equilibria," Working Papers 93-9, Federal Reserve Bank of Philadelphia.
  20. repec:cup:macdyn:v:4:y:2000:i:4:p:423-47 is not listed on IDEAS
  21. Barro, Robert J & King, Robert G, 1984. "Time-separable Preferences and Intertemporal-Substitution Models of Business Cycles," The Quarterly Journal of Economics, MIT Press, vol. 99(4), pages 817-39, November.
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  24. Mishkin, Frederic S., 1978. "The Household Balance Sheet and the Great Depression," The Journal of Economic History, Cambridge University Press, vol. 38(04), pages 918-937, December.
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  26. Gertler, Mark, 1988. "Financial Structure and Aggregate Economic Activity: An Overview," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 20(3), pages 559-88, August.
  27. Dagsvik, John & Jovanovic, Boyan, 1994. "Was the Great Depression a low-level equilibrium?," European Economic Review, Elsevier, vol. 38(9), pages 1711-1729, December.
  28. Russell Cooper & Joao Ejarque, 1994. "Financial Intermediation and Aggregate Fluctuations: A Quantative Analysis," NBER Working Papers 4819, National Bureau of Economic Research, Inc.
  29. Cooper, Russell & John, Andrew, 1988. "Coordinating Coordination Failures in Keynesian Models," The Quarterly Journal of Economics, MIT Press, vol. 103(3), pages 441-63, August.
  30. Jeremy Greenwood & Zvi Hercowitz & Per Krusell, 1992. "Macroeconomic implications of investment-specific technological change," Discussion Paper / Institute for Empirical Macroeconomics 76, Federal Reserve Bank of Minneapolis.
  31. Nathan Balke & Robert J. Gordon, 1986. "Appendix B: Historical Data," NBER Chapters, in: The American Business Cycle: Continuity and Change, pages 781-850 National Bureau of Economic Research, Inc.
  32. Javier Diaz-Gimenez & Edward C. Prescott & Terry Fitzgerald & Fernando Alvarez, 1992. "Banking in computable general equilibrium economies," Staff Report 153, Federal Reserve Bank of Minneapolis.
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