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Aggregate Price Shocks and Financial Instability: An Historical Analysis

  • Michael D. Bordo
  • Michael J. Dueker
  • David C. Wheelock

This paper presents empirical evidence on the hypothesis that aggregate price disturbances cause or worsen financial instability. We construct two annual indexes of financial conditions for the United States covering 1790-1997, and estimate the effect of aggregate price shocks on each index using a dynamic ordered probit model. We find that price level shocks contributed to financial instability during 1790-1933, and that inflation rate shocks contributed to financial instability during 1980-97. Our research indicates that the size of the aggregate price shocks needed to substantially alter financial conditions depends on the institutional environment, but that a monetary policy focused on price stability would be conducive to financial stability.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7652.

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Date of creation: Apr 2000
Date of revision:
Publication status: published as Bordo, Michael D., Michael J. Dueker and David C. Wheelock. "Aggregate Price Shocks And Financial Instability: A Historical Analysis," Economic Inquiry, 2002, v40(4,Oct), 521-538.
Handle: RePEc:nbr:nberwo:7652
Note: DAE
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  1. Charles Calomiris & David Wheelock, 1998. "Was the Great Depression a Watershed for American Monetary Policy?," NBER Chapters, in: The Defining Moment: The Great Depression and the American Economy in the Twentieth Century, pages 23-66 National Bureau of Economic Research, Inc.
  2. Michael D. Bordo & Anna J. Schwartz, 1997. "Monetary Policy Regimes and Economic Performance: The Historical Record," NBER Working Papers 6201, National Bureau of Economic Research, Inc.
  3. Eichengreen, Barry & Watson, Mark W & Grossman, Richard S, 1985. "Bank Rate Policy under the Interwar Gold Standard: A Dynamic Probit Model," Economic Journal, Royal Economic Society, vol. 95(379), pages 725-45, September.
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  9. Michael D. Bordo & Michael J. Dueker & David C. Wheelock, 2000. "Aggregate Price Shocks and Financial Instability: An Historical Analysis," NBER Working Papers 7652, National Bureau of Economic Research, Inc.
  10. Chib, Siddhartha, 1996. "Calculating posterior distributions and modal estimates in Markov mixture models," Journal of Econometrics, Elsevier, vol. 75(1), pages 79-97, November.
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  12. Weber, Ernst Juerg, 1986. "The causes of bank failures: deflationary spells," Economics Letters, Elsevier, vol. 20(4), pages 359-362.
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  15. Lucas, Robert E, Jr, 1973. "Some International Evidence on Output-Inflation Tradeoffs," American Economic Review, American Economic Association, vol. 63(3), pages 326-34, June.
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