Bank Failures and Output During the Great Depression

Abstract

In response to the Financial Crisis of 2008, macroeconomic policymakers employed a range of tools designed to prevent failures of large, complex financial institutions (“banks”). The Treasury and the Fed justified these actions by arguing that bank failures exacerbate output declines, rather than just reflecting output losses that have already occurred. This view is consistent with economic models based on credit market imperfections, but it is an empirical question as to whether the feedback from failures to output losses is substantial. This paper examines evidence on the relation between bank failures and output losses by reconsidering the findings in Bernanke (1983) on the relation between bank failures and output during the Great Depression. Our analysis provides little indication that bank failures exerted a substantial or sustained impact on output during this period.